Description

Shaw Communications Risk Arb

On March 15, 2021, Rogers Communications Inc. announced a friendly transaction for Shaw Communications Inc. at an all-cash price of $40.50 per share, representing a coming together for two Canadian family-controlled cable companies.

Shaw shares currently trade around $36, representing a 12.5% spread for a transaction that is anticipated to close in Q1 2022. The 8x monthly Shaw dividends you would receive between now and closing, that adds another $0.79 to the spread. This equates to a 14.3% net spread, assuming a March 15, 2022 close date (as guided by the company), this would equate to an annualized return of 19.5%. The Class A shares offer a slightly higher spread, but those shares are much less liquid and difficult to implement. 

In a zero rate world, a 19.5% annualized return is nothing to scoff at, particularly when the intricacies of the transaction are understood. 

Why is the Spread So Wide?

This transaction is headline heavy, with everyone and their grandmother having a view on it. Just take a look at some headlines. 

The Rogers-Shaw transaction has caused normal journalists to ask existential questions about the purpose of the telecommunications industry, and even the purpose of the economy… very deep stuff.

What is the Root Source of the Risk?

Nearly all of the public outrage and investor skepticism on the transaction can be sourced back to the wireless business. Shaw owns Freedom Mobile, which is the fourth wireless operator in the Canadian provinces of Ontario, BC, and Alberta. Freedom Mobile (previously WIND Mobile Canada), has been the beneficiary of a significant amount government support in the form of wireless spectrum set-asides. When Freedom/WIND purchased those spectrum licenses, it was understood that the licenses could not be freely transferred to the Big 3 telecom operators (Rogers/Bell/Telus), and would be subject to a spectrum license transfer framework, basically giving the Federal government a significant amount of leeway on approval/denial on spectrum transfers: https://www.ic.gc.ca/eic/site/smt-gst.nsf/eng/sf10653.html#p2.3

While this is a legitimate concern, focusing too much on the wireless business is missing the forest for the trees.

Rogers’ Acquisition of Shaw was Underwritten by the Cable Business

Rogers’ management has been very clear that the value of the transaction from Rogers’ perspective is predicated on the benefits from acquiring Shaw’s cable assets. The reason for this is as follows:

1. By not owning cable assets in Western Canada, Rogers is forced to compete against Bell and Telus with a single product line (wireless), and is unable to realize any benefits from bundling. Bundling provides powerful levers for churn management and ARPU/ARPA optimization, without which you are typically competing on price or device subsidies. While easy to think of Canada as a single ubiquitous country, competition, wireless price plans, and relative market shares differ greatly between the west, center, east (and particularly in Quebec). Adding Shaw’s cable footprint would greatly improve Rogers’ position in Western Canada.
   
   

2. Rogers assumed $1 billion of annual synergies in their original slide presentation. In conversation with investors, management added that this amount is coming from revenue bundling with cable assets, capex synergies and duplicative wireless backhaul, and opex synergies (will become biggest content distributor with more leverage than Bell post-transaction close).
   
   Notably, none of the synergies come from wireless.

3. Rogers’ and Shaw’s cable businesses do not overlap, resulting in very little standing in terms of a anti-trust hurdle for that aspect of the transaction. This dates back to the early days of the cable landscape in Canada when Ted Rogers and JR Shaw had a gentleman’s agreement to not compete with each other. For a history of cable in Canada, see here https://en.wikipedia.org/wiki/Multichannel_television_in_Canada.
   
   
   

Analysis of the Arrangement Agreement Indicates That Rogers is Prepared to Dispose of Freedom to Close the Transaction

The transaction has been structured as a Plan of Arrangement and the Arrangement Agreement has been filed. An analysis of that Arrangement Agreement, in particular Section 4.5 – Regulatory Approvals, reveals that Rogers (i.e. “Purchaser”) has agreed to sell, divest, license, hold separate, or dispose all or any part of its own business, or Shaw’s business, in fulfilling its obligations to seek regulatory approval for this transaction.

The level of undertaking that Rogers has committed to here is about as strong as one could ask for. This makes complete sense, as the Shaw family would have only agreed to a transaction where the entirety of the regulatory risk falls upon the acquiror’s shoulders. 

It is difficult to overstate the magnitude of the commitment here. Given the nature of the cable business and the lack of geographic overlap, it means that Rogers has effectively agreed that a sale of Freedom is not only acceptable and that any valuation risk of the disposition of the asset would be for the account of Rogers, but that such a scenario is the base case. This is particularly obvious when taking into account how Rogers has framed the investment thesis and synergies when communicating with institutional investors (i.e. entirely dependent on the cable business).

Where would the Freedom asset go? There is already a bidder in the wings – Quebecor Inc, which owns and operates a very successful wireless business in the province of Quebec. Their CEO, Pierre Karl Peladeau, is already positioning his company with media statements and political lobbyists working away:

Other Evidence of Rogers’ Motivations

1. Rogers forced Shaw to call its preferred shares
   The Arrangement Agreement has an interesting section, 4.8 – Company Preferred Shares, which gives Rogers the sole discretion to require Shaw to redeem its preferred shares on June 30, 2021. If Rogers does so, they will wire $120 million dollars to Shaw immediately, of which this amount is not credited towards the Reverse Termination Amount.
   
   When the notification date for this clause passed (notably one day after Shaw’s shareholder vote), Rogers did indeed force Shaw to redeem its preferred shares. Based on precedent, it appears that leaving the preferred shares outstanding would have resulted in Shaw continuing to be a reporting issuer even if the transaction closed, and the preferred shares are only redeemable once every five years.
   
   Although not definitive, the fact that Rogers asked for this right in the Arrangement Agreement and then indeed exercised it indicates that they are deeply committed to the transaction and remain so as recently as a couple weeks ago.
   
   
   

2. Shaw is Skipping the 3.5 GHz Spectrum Auction
   On April 7th, ISED published its list of applications for the 3.5 GHz Canadian spectrum auction. It was noteworthy that Shaw was not registered as an applicant. BMO’s analyst views this as evidence that Shaw is “all-in” on the proposed transaction with Rogers.

3. Reverse Termination Amount is $1.2 Billion Dollars
   This represents 6% of the equity value of Shaw, and is a large sum of money, even in the context of billion dollar cable companies. It would represent approx. half of Rogers+Shaw’s anticipated capex investment for 5G in the West. 

Conclusion

Rogers Communications, the Rogers family, and their advisors are not delusional – they recognize that it will be very difficult to acquire Freedom. As such, they have underwritten their investment thesis on acquiring Shaw’s cable business and all of their investor communications are centered around the benefits from that. The Arrangement Agreement provides that Rogers has agreed to the disposition of Freedom (or any or all other parts of its own business or Shaw’s business) in order to fulfill its obligations to seek regulatory approval for the transaction.

As a result, investors can buy SJR/B shares for a 19.5% annualized return to close. 

Catalyst

Closing of transaction