BUSINESS ECONOMY

Memotec’s tangled roots

TOM FENNELL March 23 1987
BUSINESS ECONOMY

Memotec’s tangled roots

TOM FENNELL March 23 1987

Memotec’s tangled roots

BUSINESS ECONOMY

The value of the prize was in dispute. Officials with the Montreal-based telecommunications firm Memotec Data Inc., which purchased Teleglobe Canada for $488.3 million on Feb. 11, were still weighing the deal last week. As part of the buy, due to close by March 31, Memotec is supposed to pay the Crownowned Canada Development Investment Corp. (CDIC) $18 million in excess profits that Teleglobe is expected to earn in 1987. But according to Memotec’s own estimates, the real 1987 excess-profit figure will be closer to $16 million, and the firm’s president, William McKenzie, says that lawyers representing the two groups were at loggerheads over the issue. But on March 12 they finally settled at $16.7 million.

Said McKenzie: “I did not want to pay $18 million.”

In its deal to purchase Teleglobe, Memotec outmanoeuvred five corporate giants. But last week Memotec managers said that they were not only worried about the profit figures but also about Teleglobe’s asset values. The Canadian Radiotelevision and Telecommunications Commission (CRTC) sets major telephone toll charges in Canada, including Teleglobe’s now that it has been sold to the private sector. The CRTC bases charges on a ratio of company assets, debt and profits. McKenzie said that he is concerned that if the CRTC reduces the value of Teleglobe’s assets at future rate hearings, it could force Teleglobe into a corresponding rate cut. Said McKenzie: “I hope that someone at the CRTC does not disqualify certain assets in calculating the rate base.”

Meanwhile, as Memotec management works its calculations, a top communications official in Ottawa said that the Teleglobe deal could run into trouble. Memotec, he said, is simply too small to manage Teleglobe properly. And the federal government and the Quebec and Ontario Securities Commissions are continuing an inves-

tigation into the possibility that someone illegally benefited from the deal. As well, there is a complicated web of associate companies and officials stretching from Memotec back to the CDIC and the Canada Development Corporation (CDC).

The sale of Teleglobe, Canada’s ma-

jor carrier of international telephone, Telex, telegram and other telecommunications traffic, is part of the Mulroney government’s campaign to privatize Crown corporations. Since July, 1985, 11 firms have been sold, including de Havilland Aircraft of Canada Ltd., Canadair Ltd., the CDC and Canadian Arsenals Ltd. But Teleglobe, a well-managed communications giant with steadily rising revenues, and at least a five-year monopoly to deliver almost all long-distance telephone sig-

nals in Canada until 1991, was considered the jewel of the bunch.

Memotec was formed in 1977 in Montreal, but until its successful bid for Teleglobe it remained all but unknown. Its corporate roots stretch back through three companies to the CDIC and the CDC, which was 48-per-cent

owned by the CDIC. Memotec’s chairman, Eric Baker, a former Union Carbide manager, joined Montreal-based Innocan Investments Inc. in 1973. Innocan, a venture-capital company, had just been launched with $4 million from the CDC and $5 million from private sources. The CDC kept 25 per cent of the company until 1985, when it downgraded its stake to 10 per cent. It still retains a directorship on the Innocan board. In 1976 Innocan purchased 60 per cent of International Syscoms

Ltd., and Baker was put in charge of the company, and in 1979 Syscoms purchased Memotec. In 1983 Baker recruited McKenzie, Memotec’s current president and chief executive officer, from Montreal-based AES Data Ltd.—a wholly owned subsidiary of the CDC. Baker retained responsibility for Memotec until he left Innocan in mid-1984.

Baker then formed Altamira Capital Corp., a venture-capital company backed by more than 30 investors, including pension funds, life insurance companies and several wealthy individuals. He recruited Christopher Winn, an Innocan executive, as his vice-president of finance. But in May, 1985, Baker joined forces with Novacap Investments Inc., another Montreal venture-capital company, to return to Memotec. With a number of investors behind him, he rapidly acquired 77 per cent of Memotec’s shares from Innocan. Two Novacap executives,

Marc Beauchamp and Abraham Rolnick, also held top management positions in Innocan and AES respectively.

Memotec expanded quickly.

The firm manufactured and marketed four different products that allow communications between different computers.

Sales jumped to nearly $18 million in 1985 and $57 million last year from $8 million in 1984.

The company’s assets rocketed to nearly $84 million last September from $5 million in 1984, following the purchase of two high-tech companies in the previous 12 months.

Memotec then turned to Teleglobe. To acquire it from the CDIC, it had to outbid five powerful competitors: the Quebec conglomerate Caisse de dépôt et placement du Québec, Spar Aerospace Ltd. and Canadian Telecom Carriers International Inc.; First City Financial Corp.;

Gordon Investment Corp.; Inter-City Gas Corp.; and Power Corp. of Canada. But Memotec won with the highest offer, which included paying off Teleglobe’s $143-million debt to the government.

McKenzie told Maclean's that Memotec’s decision to go after Teleglobe was made last December after he and Baker read in a newspaper that Ottawa was calling for new bids on Teleglobe. Said McKenzie: “Memotec has always had an acquisition strategy, and we were looking for companies that would add to a complete communications network.” McKenzie went to Ottawa to discuss the Teleglobe deal with various officials. Baker and

McKenzie also met with their pensionfund backers, who quickly endorsed the project. Within a little more than a month of reading the article, the pair had pulled together $225 million in short-term loans to table the winning bid.

Officials with the CDIC said that Memotec’s lineage through Innocan to both the CDC and CDIC had not influenced its decision to sell Teleglobe to Memotec. Said CDIC executive vicepresident Michael Carter: “Obviously people know people. As far as I know, I do not think anybody on the CDIC knew Bill McKenzie. One or two may have met Eric Baker, but they cannot claim to have influence.” Carter also downplayed the chain of ownership from

the CDIC to the CDC and Innocan: “You are getting pretty tenuous when you talk about an ex-holding of 10 per cent of a 14-per-cent-owned company. They did not get any help from us.” In fact, the CDIC hired independent accountants and the investment houses Dominion Securities Inc. and Levesque Beaubien Inc. to examine the bids and discuss how Teleglobe would be integrated into the firms.

The government, said a Toronto communications consultant who worked for a firm trying to win the

Teleglobe bid, did not sell to Memotec because of the CDIC-CDC-Innocan-Memotec connection. Instead, he said, Ottawa simply chose to make the most of potential political gains by selling Teleglobe to a small, aggressive firm. By doing so, the government avoided the appearance of peddling Teleglobe to a major Canadian corporation with links to the federal Progressive Conservative party. Memotec with Teleglobe, argued Barbara McDougall, the minister responsible for privatization, would ultimately increase competition in the communications industry. Added John Bennett, a Montreal-based vice-president of finance at McLeod Young Weir Ltd., the investment firm that has handled two Memotec share issues in the past: “These guys are dynamite. They are blue-chip.”

Some of the losing firms, however, are still disgruntled. One senior executive who worked on the Teleglobe deal for a year said that, although the bidding process was fair, he found it strange that Memotec could come in so late and then easily outbid its competitors. And one analyst involved in the sale said that, in the long run, the government may not have gotten the best price it could have for Teleglobe. Gordon Capital of Toronto, for one, offered $430.8 million for Teleglobe. Although that figure was lower than Memotec’s, the firm reportedly offered to give the federal government a slice of future revenues from a publicshare issue in Teleglobe. Other offers were also lower in upfront cash but included more in future royalties for the federal government over a long period of time.

As well, a very senior official in the communications department says that he is still concerned about the Teleglobe deal, claiming that his department’s advice was overshadowed by the government’s political objectives. He said that such a critical telecommunications vehicle as Teleglobe should not have been sold to a small firm like Memotec. Memotec, he said, is simply too small and is saddled with debt that may jeopardize Teleglobe’s operation. Said the official: “On straight dollars, Memotec made the best offer. But the government did not make the best deal for Teleglobe, and that is dangerous for such a strategic industry.”

The official argues that if the CRTC does cut Teleglobe’s long-distance telephone rates, or if the firm is forced to

bring its rates into line with those offered by Teleglobe’s U.S. competitors, both Memotec and Teleglobe could be hurt. Indeed, as part of the deal, the Tories ordered a 13.5-per-cent reduction in telephone rates and a 10-percent cut in Telex rates effective in January, 1988.

Memotec’s bid is aggressive when compared with its competition. The equity value of Power Corp. of Canada’s offer for Teleglobe was $310 million, which represented 132 per cent of Teleglobe’s book value. According to CDIC documents, Power’s return on its investment would have been 11.5 per cent annually. Memotec’s offer, meanwhile, was 147 per cent of Teleglobe’s worth, but a Power official said that the prospect of taking on added debt to go above 132 per cent deterred the giant Montreal-based holding company.

But Baker said that Memotec does not believe taking on such a large debt is a problem. He said that the firm plans to issue shares to cover the $225 million in short-term debt, and a sizable chunk of the remaining $263 million will be financed through further share issues and Memotec’s pension-fund backers. Richardson Greenshields of Canada Ltd. analyst Daniel Côté said that Memotec should not have any problem raising money publicly because Teleglobe is a monopoly with revenues guaranteed for

the next five years—and an extension will likely be offered beyond that point. Memotec itself has a long-term debt of $33.4 million and shareholder equity of $44.1 million.

Memotec and Teleglobe will face stiff competition in the future. Such major telecommunications firms as Telecom Canada could, if Teleglobe’s

monopoly is broken, divert telephone calls moving in its system through associated telecommunication grids in the United States. There is considerable linkage into America already. Canadian companies with telephone connections to their U.S. parent firms are increasingly rerouting signals overseas through their own U.S. facilities.

Meanwhile, the federal department of consumer and corporate affairs and the two provincial securities commissions continue their investigations into the trading of Memotec shares in the weeks leading up to the Feb. 11 announcement. On Feb. 5 the CDIC recommended that the government sell Teleglobe to Memotec. Although the decision had not been publicly announced, Memotec shares began trading that morning at $10.75. And by the time the Montreal and Toronto stock exchanges halted trading at 2:20 p.m. the price had jumped to $13. A total of 23,175 shares were traded. Investigators are particularly interested in activities in Montreal, where more than 80 per cent of the shares that moved on that day were purchased. But Memotec’s management now says that it is undeterred and is confident that Memotec’s upcoming share issue will silence critics.

TOM FENNELL with D’ARCY JENISH,

ANN WALMSLEY and THERESA TEDESCO in Toronto and BRUCE WALLACE in Montreal