TELUS Corporation Capital structure
TELUS Corporation uses the highest percentage of gearing as compared to similar firms in the industry, both in Canada and in the US. The high levels of equity have not provided an attractive average return on equity (ROE) as calculated in the past three years. Low returns have impacted negatively on investor confidence, resulting in the low price-to-earnings ratio. BCE Inc which could be considered as the market leader in Canada has significant stakes in other telecommunication firms in the country. As a result, the firm is able to claim more revenues from its diversified asset base. TELUS Corporation is the second-largest telecommunication firm in Canada, based on revenues, assets, geographic coverage, and the number of customers in Canada.
The high levels of leverage expose the firm to financial risks, increasing the probabilities of insolvency (Baker & Powell 2005). Long-term debt as a percentage of earnings has been increasing at a sharp rate between 1998 and 2002 (Exhibit 5). The industry has faced decreasing revenues in the same period though companies in the industry are optimistic about the future prospects in the industry. Firms have maintained their capital expenditures mostly financed with debt despite banks being forced to review their financing options after BCE Inc failed to provide financial long-term backing for one of its subsidiaries, resulting in the subsidiary declaring bankruptcy.
Assessment of TELUS Corporation Financial condition
TELUS Corporation has high debt levels, as most of its acquisition strategies have been financed by the use of leverage. The company has been involved in several bridge loans, such as in the Cdn $6.6 billion acquisition of Clearnet Communications Inc and the remaining 30 percent stake in QuebecTel for Cdn $285 million. The use of bridge debt, amounting to Cdn $6.25 billion in the case of the acquisition of Clearnet Communications Inc, may require TELUS Corporation to incur higher than market level interest rates as the company increases the use of leverage. Another case where TELUS Corporation encouraged the use of leverage is by the use of the revolving credit facility from the banking sector.
In the fiscal year 2001, the proportion of debt exceeds equity in the total capitalization of the company. 55.2 percent of the total capitalization of TELUS Corporation is financed by long-term debt which comes as a result of the company’s aggressive growth strategy financed mostly by debt. Earnings of the company have been increasing at a modest rate, while the proportion of long-term debt to EBITDA (earnings before interest, taxes, depreciation, and amortization) remains high at 3.4.
The LT debt to EBITDA ratio measures a company’s capacity to service its incurred debt (Gallagher & Andrew 2008), information of which can be used by investors and credit rating agencies to estimate the period that a company would need to clear its debt, or the probability of the company defaulting (Van Horne & Wachowicz 2008). TELUS Corporation’s 3.4 LT Debt to EBITDA is the highest among its competitors, meaning that the company despite its size could find it difficult to access funds in the market as banks would opt to provide loans to companies in the industry that have a lower LT Debt to EBITDA ratio. Subsequently, TELUS Corporation has a low EBITDA to Interest ratio. Although at an EBITDA to interest ratio of 3.6 the company can pay off its interest on debt, the company would strain more than its competitors when using profits from operations.
Moody’s Downgrade
TELUS Corporation had a high probability of getting downgrades from major credit rating agencies, but the company was mostly hoping for its credit rating to be taken a notch lower. While the market growth in Canada for most of TELUS Corporation’s service offerings appeared positive, increasing competition in the market meant that incumbents such as BCE Inc and TELUS Corporation would be affected in terms of revenues and they may therefore not realize the full benefits of the positive market outlook.
The CRTC (Canadian Radio-television and Telecommunications Commission) was the agency responsible for regulations in Canada’s telecommunication industry and as such sought to increase competition by deregulations in the industry. The regulative environment gets more negative with the introduction of a price cap regulative regime which prevented incumbent carriers such as TELUS Corporation from raising prices they charged to consumers and competitors who purchased services from them for resale. Most credit rating agencies expect the regulatory decision will reduce TELUS Corporation’s EBITDA by about Cdn $300 million on an annualized basis.
The technological environment was advancing quite rapidly, meaning TELUS had to engage in acquisition programs for it to remain competitive in the industry. TELUS Corporation’s business model aims to improve revenues, cut costs and improve productivity. Execution risk for the company remains relatively high in relation to its cost-cutting plans, as reflected by the high costs of restructuring the company. TELUS Corporation tends to use long-term public debt to clear short-term borrowed finances. While this results in debt restructuring, debt levels for TELUS Corporation have not yet been reduced (TELUS Corporation).
With the bankruptcy of firms such as Enron and WorldCom, Moody’s credit rating agency could not afford to take anything for granted especially in the troubled telecom industry. The financial statements of TELUS Corporation indicate that the firm is still profitable, though the debt levels could reach unsustainable levels. The restructuring of the company may indicate that the firm could lower its debt levels but there is a lack of evidence to point out that the execution risk of the phased Operational Efficiency Program is low. In his regard, the downgrade of credit rating was inevitable but Moody’s downgrade was a bit harsh on TELUS Corporation.
Actions to assure Investors
Robert McFarlane, CFO of TELUS Corporation, could first propose measures that aim at lowering the LT debt to EBITDA ratio in the balance sheet, before initiating procedures that aim at lowering the proportion of long-term debt in the total capitalization of the company. TELUS has already reduced dividend payments, though further deductions may be used to trim the debt levels. The enhanced dividend reinvestment plan (DRIP) may fail to make the desired impact since major shareholders have reduced their participation in the program. Issuance of equity may not be feasible in the short run due to low stock prices in the market.
An appropriate solution in the short term would be to cut costs, in accordance with the Operational Efficiency Program, through job cuts. The company could also dispose of its non-strategic assets so as to improve cash flows (Brigham & Ehrahdt 2008). The option to swap debt for equity with the US-based hedge fund is available to McFarlane, but the hedge fund appears to have shorted the company’s shares meaning that a further decline in prices may be possible. Debt repayments and repurchases, and reducing capital expenditures may reduce the debt to EBITDA ratio if TELUS maintains its revenue levels. Operational efficiencies may improve the company’s cash flows and profitability, and therefore assure both investors and credit rating agencies.
References
Baker, H. K. & Powell, G. E. (2005). Understanding financial management: a practical guide. Oxford, UK: Wiley-Blackwell
Brigham, E.F. & Ehrahdt, M.C. (2008). Financial management: theory and practice, 12th edn. New York: Cengage Learning.
Gallagher D. & Andrew, M. (2008). Financial Management; Principles and Practice. New York: Freeload Press Inc. TELUS Corporation: Capital Structure Management (Case number Ivey 9B06N020)
Van Horne, J. C. & Wachowicz J. M. (2008). Fundamentals of financial management, 13th edn. New York: Financial Times/Prentice Hall.