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BCE: A Quality Canadian Telecom Paying Dividends Since 1949

Bell Canada Enterprises was founded in 1880 and changed its name to BCE (BCE) in 1983. The firm is one of Canada's big three telecom companies and provides wireless, wireline, internet, and television services to residential, business, and wholesale customers across the country. 

BCE organizes its business into three segments: 

  • Bell Wireless (37% of sales, 52% of operating profit): provides wireless voice and data services and equipment. BCE's 4G LTE network covers 99% of the Canadian population coast to coast. This is the fastest-growing and highest-margin part of the company.

  • Bell Wireline (51% of sales, 37% of operating profit): broadband internet, satellite TV, and IPTV services account for 36% of company-wide sales, with home phone services accounting for the remaining 15% of revenue housed in this segment. Despite the secular decline in landline phones, this segment has continued generating low-single digit growth thanks mostly to growth in high-speed internet services.

  • Bell Media (12% of sales, 11% of operating profit): owns and operates many TV stations and channels, streaming services, websites, and radio stations which make money from advertising and subscriber fees. BCE also provides various advertising services.

BCE and its predecessors have paid dividends since 1949. In 2008 the company suspended its dividend for two quarters to preserve cash while finalizing a buyout deal. However, the deal fell apart by the end of the year, and BCE resumed its dividend, which it has grown by at least 5% every year since then.

Business Analysis
BCE is the largest telecom company in Canada, and its appeal as a long-term dividend growth investment stems from several attributes, starting with the oligopolistic nature of the industries in which it competes.

In Canada, BCE is the largest internet service provider, the largest TV provider, and one of the largest wireless operators. Wireless is arguably the company's most important business since it generates approximately 50% of BCE's cash flow. 

BCE and its two national rivals Rogers Communications (RCI) and Telus (TU) command over 90% of the Canadian wireless market's revenue, according to the company's annual report. 

Thanks to relative network parity between the three national giants, the Canadian wireless market has largely avoided the price wars that have rippled through the U.S. market in recent years. Churn levels are also comparable to the low rates enjoyed by AT&T and Verizon, resulting in substantial cash flow that can be used to reward shareholders with dividends and further improve the network.

BCE routinely invests hundreds of millions of dollars in its wireless network each year to improve its performance and coverage. For example, the firm's LTE wireless service is available to 99% of Canada's population, and the firm's network achieves industry-leading speeds.

Continued population growth, the trend toward owning multiple connected devices, greater data usage, and increased mobile adoption (Canada's wireless penetration was 89% in 2018 compared to over 100% in the U.S. and Europe) are all expected to drive growth in the nation's wireless market going forward.

However, the wireless market's pace of growth is still relatively slow compared to many other industries, making it hard for new entrants to disrupt the incumbents. Specifically, the high cost of building out a nationwide network (including hard-to-acquire spectrum) demands a very large subscriber base to support ongoing costs.

The industry's three giants have the greatest economies of scale and lowest costs per subscriber, making it extremely difficult for smaller players to try and gain market share. Simply put, it's a lot easier to maintain an existing subscriber base than acquire a new one, especially in mature, capital-intensive markets.

Similar advantages exist in the capital-intensive internet and TV markets, where BCE is the largest player in Canada. In the internet market, the four largest cable companies controlled 54% of the total market at the end of 2018. BCE has invested heavily to deploy its broadband fiber network in more areas to strengthen its speed advantages, helping the company gain market share in recent years. 

The pay-TV market is similarly concentrated. At the end of 2018 Canada's four largest cable companies had 53% market share, though the rise of digital streaming services is slowly loosening their grip. While BCE has a large satellite TV business that is losing customers to streaming, it also offers internet protocol TV (IPTV), which streams television through an internet connection and has more subscribers than the firm's satellite TV division. 

IPTV growth, plus the content owned in BCE's Media segment, has helped stabilize the total number of subscribers across the firm's overall TV business, and expansion of BCE's broadband internet service has thus far helped the company's Wireline segment continue its profitable growth despite the challenging satellite TV and landline phone markets.

Management's top priorities going forward are to continue expanding BCE's fiber network to drive strong growth in broadband internet and IPTV. The firm is also focused on the upcoming 5G transition that holds promise for not just expanding its existing wireless business, but potentially also pushing it deeper into other industries such as the Internet of Things. 

Overall, BCE represents a solid Canadian telecom. The company's economies of scale, vertical integration, recession-resistant services, and investment-grade balance sheet make it a decent source of growing income. However, there are several risks that investors should consider before investing.

Key Risks
First, note that as a Canadian company, BCE pays its dividend in Canadian dollars. This creates some currency risk in that a stronger U.S. dollar might decrease the effective dividend amount for American shareholders, at least in the short term (each quarterly dividend is converted from Canadian dollars to U.S. dollars when it is paid, based on prevailing exchange rates).

In addition, like all Canadian stocks, U.S. BCE investors face a 15% foreign dividend tax withholding. Tax treaties between the U.S. and Canada allow U.S. investors to potentially recoup this withholding, but it can be a complicated and lengthy amount of paperwork at tax time.

There are several company-specific risks to consider as well.

First, cord cutting remains a headwind for the company, with a steady decline in legacy landlines and satellite TV subscribers expected to weigh on the wireline business going forward. Fortunately, growth in other businesses, including IPTV and broadband internet, are expected to more than offset these declines. 

Turning to the Canadian wireless market, BCE faces regulatory risks that could slow its pace of growth. As previously discussed, BCE, Telus, and Rogers dominate the wireless market in Canada. However, in recent years the Canadian Radio-television and Telecommunications Commission, which regulates the industry, has become concerned about a lack of competition.

This has resulted in some unfavorable developments for BCE. For example, a 2015 rule change capped wireless contracts at two years (previously they had been as long as three years).

A major new entrant could also disrupt the Canadian telecom industry’s favorable structure. In 2012, for example, the industry grew fearful that Verizon was planning to buy wireless company Wind Mobile in an effort to enter Canada and challenge the three major incumbents. Valuation multiples quickly droppedbetween 7% and 27% for Telus, Bell Communications, and Rogers.

While the potential threat from Verizon never materialized, cable operator Shaw Communications (SJR) ended up acquiring spectrum-rich Wind Mobile for $1.6 billion in March 2016, marking its entry into the wireless market in an effort to better compete with Telus’ bundled services. Shaw can now offer television, wireless, and internet in major urban areas such as Ontario, Alberta, and British Columbia.

Here’s what Shaw CEO Brad Shaw said in an interview, according to TheTelecomBlog.com:

“Wireless was a missing piece. Now we’re on the same page, we’re at the same level…and we’ve improved our competitive position in Western Canada just by doing this deal, let alone the opportunity in the East.”

Shaw rebranded the wireless business Freedom Mobile and positioned it as a lower-priced option compared to the major three operators (driven by its inferior service quality). Regardless, Shaw is looking to play the role of disruptor and is now the fourth telecom company to cover the entire length of Canada.

Should Freedom Mobile improve its network coverage and quality enough to experience strong growth (Freedom Mobile had 1.6 million wireless subscribersas of June 2019, compared to more than 9 million for BCE), the big three incumbents could face subscriber growth pressure and margin compression over the coming years.

The good news is that the Canadian wireless market is still growing, providing some elbow room, and BCE continues reporting solid network performance and customer service results, as demonstrated by its subscriber growth and healthy churn rates.

Only time will tell if BCE’s strong network quality will allow it to continue enjoying solid profitable growth, or if it will ultimately face pressure to lower prices in an effort to close the gap with lower-priced competition.

Finally, telecom investors should remember that the industry (especially wireline) is extremely capital intensive. In fact, BCE routinely spends over 15% of its total revenue on capital expenditures, mostly to grow its fiber network to provide faster internet service and to support its wireless network as 5G ramps up.

These investments are necessary to handle the exponential growth of data flowing through BCE's network and keep the firm's services competitive. However, the steep costs of network equipment and spectrum can weigh on a telecom company's free cash flow and balance sheet.

BCE has a policy of paying out 65% to 75% of free cash flow as dividends, so higher than expected capital expenditures could slow the firm's dividend growth rate although the payout would likely remain safe given BCE's overall financial health. 

Closing Thoughts on BCE
BCE represents a solid Canadian telecom that has many positive attributes, including strong market share positions in most of its core business lines, substantial economies of scale, and access to low cost capital to help it meet its future growth plans.

When combined with the non-discretionary nature of most telecom services, BCE is able to generate stable cash flow that supports a generous and slowly but steadily growing dividend. 

The biggest knock on the company compared to its peers is its larger exposure to residential landlines and satellite TV services, which are under pressure from cord cutting. However, BCE's wireless, internet, and IPTV businesses are all attractive and more than offsetting subscriber losses elsewhere. 

Investors considering the stock just have to realize that BCE is unlikely to deliver more than 3% to 5% annual dividend growth over the long term, making it all the more important to buy the stock at an attractive yield.

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