It might not be cash in the bank just yet, but things are coming down to the wire on the leveraged buyout deal for Canadian telecom giant BCE Inc. (NYSE:BCE). Analysts still place high odds on the deal going through at the originally agreed price of $42.75 per share.

With the stock now trading under $36, there's about a 20% risk arbitrage premium on the table for those investors prepared to bet that the analysts are calling this one correctly. But betting involves gambling on the outcome of a series of potential deal show stoppers. (For more on takeover and merger arbitrage, see Trading The Odds With Arbitrage.)

Not Out Of The Woods Yet
When the $51.7 billion deal to privatize BCE was announced last June, it looked like the consortium comprising the Ontario Teachers' Pension Plan and affiliates of Providence Equity Partners Inc. and Madison Dearborn Partners LLC., would have an easy route to securing Canada's largest telecom operator, and the shares quickly shot up to just shy of the offering price.

However, since November, the shares have lost ground as a number of uncertainties have raised fears that the deal could either fall through, be delayed indefinitely or be consummated at a lower price.

Here are the three main problems that could delay or completely destroy the deal:

  • Bondholders Revolt - Topping the list of potential deal killers is a lawsuit by disgruntled bondholders in a BCE subsidiary Bell Canada. BCE's relevant bond indentures do not allow for a restructuring without bondholder consent and the court's decision hinges on whether the deal is seen as a restructuring or not. If they win their court case, the bondholders could be eligible for a payment of $1-1.5 billion, which could implode the deal according to the Teachers' Pension Plan. A ruling is expected as early as the week of February 18.
  • Regulatory Challenge - Another stumbling block is the upcoming hearings on the deal before Canada's telecom regulatory watchdog, the Canadian Radio-television and Telecommunications Commission (CRTC). While Teachers' holds the largest equity stake, 51.6% in the deal, the CRTC needs to be satisfied that the acquiring consortium is "Canadian" within the meaning of the foreign-ownership direction issued to the CRTC by the Canadian government. Hearings begin on February 25.
  • Funding Uncertainty - A final uncertainty relates to the funding of the deal. Rumors have been swirling that ongoing credit market turmoil could force one or several members of the banking syndicate to opt out. The syndicate includes Citigroup (NYSE:C), Toronto-Dominion Bank (NYSE:TD), Deutsche Bank (NYSE:DB) and Royal Bank of Scotland Group (NYSE:RBS). Another potential weak link could be Merrill Lynch (NYSE:MER) which is contributing $475 million to the equity portion of the financing.

Downside Limited
However, should any of these cause the deal to fall through, there is still a floor under the share price. First off, there is a more than $1 billion ($1.24 per share) break fee that the buyers would be obliged to pay if they walked away from the deal. BCE's dividend should also provide a floor. Currently paying an annual dividend of $1.44 per share, if the shares were priced to match the 4.4% yield offered by competitor Telus (NYSE:TU), they'd be priced at $32.75. Incidentally, Telus had earlier shown interest in acquiring BCE, but bowed out when it was outbid by the Teachers' led consortium.

The Bottom Line
In the very short-term, the pessimists are likely to push the share price lower. That should set up some buying opportunities for patient investors who are prepared to wait out what could be a protracted set of regulatory hearings and a possible appeal by the bondholders if they lose the initial court decision. If the deal does fall through, a 4% dividend yield offers some consolation as does the possibility of another, more modest, bid by Telus.

To learn about the risks and rewards of the arbitrage game, see Trade Takeover Stocks With Merger Arbitrage.

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