Veritas: Buy, Intrinsic Value: $26.00
Bell Aliant’s FY09 results were uninspiring. NAS declined at an accelerating pace with the Company losing 155,500 lines in F09 compared to 109,300 in F08, resulting in local access revenue decline of 3.5% in the year to $1,356.9 million. Long Distance revenues declined 6.3% YoY to $423.9 million. Meager data revenue growth of 3.7% in the year failed to stem the decline in total annual consolidated revenues of 2.2%. Aliant forecasts a revenue decline of approximately $74 million – 2.4% YoY- at the mid-point of its guidance, while the company expects its distributable cash to stay flat at $ 770 million (the midpoint of its guidance excluding pension funding). The Company believes that it can mitigate the effect of declining revenues by additional cost rationalization. Cost reduction in 2009 boosted reported EBITDA margin to 46.2% from 44.7%. Bell Aliant guided to pension deficit funding of $80-$110 million for F10, which is higher than the $74 million of 2009 but is in line with Veritas estimates. The Company’s guidance does not take into account the potential impact of the changes to the funding rules announced by the federal government in October of 2009. Management believes that the changes announced by government may allow them to lower the cash portion of funding by approximately $30M in F10. Taxable retail investors constitute 40% of the unit holder base at Aliant. To the investor in the highest tax bracket, a $2.90 distribution is equivalent to a $1.55 in eligible dividends. That implies a 95% payout of Aliant’s fully taxed net income of approximately $1.63 per unit for F11. That stacks up against the Company’s need to manage not only a decline of its legacy business, but also invest on an accelerated basis in its FTTH project. On top of that $755 million in debt is coming due for refinancing in 2011. Assuming that the Company sets a dividend of $1.55 per share for F11, on a prospective basis Aliant is yielding 5.9%, which in line with the yield of Telus Corp (6%) and BCE Inc. (6.3%). Therefore, it appears that the market has priced in a high payout of Aliant’s after tax earnings in F11. Moreover, in the past the Company has highlighted availability of tax shelters at its disposal to moderate the impact of taxation. However, all valuation metrics – other than the current yield – suggest Aliant is an overvalued security. But as someone wise once said, “More money has been lost reaching for yield than at the point of a gun”. Veritas’ buy rating is based upon the safety of the $2.90 distribution for F10 and an expectation of higher dividend than currently anticipated for F11 and beyond. While for F10 the $2.90 is certain, the uncertainty surrounding the dividend in F11 has risen considerably. We maintain our buy rating with the caveat that if the announced dividend is less than $1.55 per share, the stock could decline to $23.00.

(1) no wireless exposure (and risk of new entrants);
(2) BA’s territory is semi-rural which is less at risk of wireless substitution, in our view; and
(3) a relatively stable competitive environment, and our expectation for moderating line losses. BA
units currently have a 10.4% dividend yield now (8% yield fully-taxed post 2011) with 2 further years of tax shelters.
Finally, Once BA converts to a corporation in 2011, RBC CM believes BCE will be interested in finally acquiring and integrating the assets, especially if done with a TELUS merger.

On Tuesday, Bell Aliant announced a $60 million investment to bring fiberto-
the-home (FTTH) technology to 70,000 homes and businesses in the
cities of Fredericton and Saint John in New Brunswick. In support of Aliant,
the government of New Brunswick is contributing $1 million to the project.

While FTTH has been widely deployed in the U.S., mainly by Verizon, it is
still a relatively nascent technology in Canada. Bell Aliant’s FibreOp network
will be Canada’s first 100% FTTH network to cover an entire city. The
network should be operational by mid-2010.

The 2009 portion of Bell Aliant’s investment in FibreOp is already included
within the company’s 2009 capital intensity guidance of 13.5% to 14.5% of
revenues. The remainder of the spending is expected to be part of Bell
Aliant’s normal capital program in 2010.

Bell Aliant’s investment should not come as a surprise, and supports a
longer-term view that telcos need to increase investments in fiber
(FTTN/FTTH) to narrow the cablecos’ current bandwidth advantage
(especially with the rollout of DOCSIS 3.0) to stay relevant.