Dec. 11 (Bloomberg) -- BCE Inc., the Canadian phone company that had been planning to go private for the past 18 months, may have to buy back shares or restore its dividend to placate investors now that its leveraged buyout has fallen apart.

The C$52 billion ($41.5 billion) takeover was jeopardized last month when auditor KPMG said the transaction might leave the parent of Bell Canada insolvent. Today, the deadline for the deal, the group planning the transaction terminated the takeover because of the KPMG report. That leaves investors with a deficit of C$16 billion from where the bid valued BCE.

“They might even pay a special dividend to make the shareholders whole who have lost out on the last two quarters of dividends,” said Gavin Graham, director of investments at BMO Asset Management, which manages the equivalent of about $42.7 billion in assets and owns BCE shares. “If not, they can use that cash on the balance sheet to buy back 10 percent of the shares.”

Chief Executive Officer George Cope could also opt to spend more on upgrading BCE’s phone networks and wireless business to keep rival Rogers Communications Inc. at bay. BCE lost 72,000 home-phone lines last quarter as customers switched to wireless lines or to cable companies such as Rogers. BCE’s wireless unit, which makes up one-fourth of sales, grew at less than half the rate of Rogers’s mobile unit.

“They have to get their strategy out to investors, because right now there are just so many questions,” said Troy Crandall, an analyst in Montreal with MacDougall, MacDougall & MacTier Inc., Canada’s oldest brokerage. “You have to balance growth versus shareholders’ immediate desire for the return of cash.”

Ontario Teachers’

Ontario Teachers’ Pension Plan and buyout firms, including Providence Equity Partners Inc. and Madison Dearborn Partners LLC, made the bid in June 2007, funded with about C$34 billion in debt. The deal hit a roadblock last month, when KPMG said the transaction would load BCE with too much debt. BCE’s market value is currently about C$18.6 billion, or almost C$16 billion less than the cash portion of the offer.

BCE, based in Montreal, brought in a second accounting firm, PricewaterhouseCoopers LLP, this week to convince KPMG to change its stance. PwC’s work shows the company would remain solvent after a buyout, BCE said Dec. 8.

BCE spokesman Mark Langton said yesterday that the company was considering legal action to recover a termination fee of C$1.2 billion if the deal fell through. Deborah Allan, a spokeswoman for Toronto-based Ontario Teachers’, declined to comment. The buyout firms said in a statement today that no termination fee is owed.

Gassed-Up Truck

“I’d say the truck has gas in it, but hasn’t started up yet,” Langton said, in an analogy to papers having been prepared but not having been filed.

Without a buyout, BCE could use as much as 70 percent of its cash balance in a share buyback, with the rest funding investments in its networks, Crandall said. BCE had about C$2.66 billion in cash at the end of last quarter. The company may also reinstate and raise its dividend, which amounted to C$1.46 annually before the company discontinued it in June.

With the global economic crisis keeping credit markets tight, Cope, who became CEO in July, should use cash to reduce debt, said Kathleen Gaffney, co-manager of the Loomis Sayles Bond Fund, which holds BCE bonds.

“Keeping up your revenue and keeping your costs down is best,” Gaffney said in an interview from Boston. “They need to just continue to generate good cash flow and actually work to pay down debt as opposed to taking on debt. We’re in an environment where cash is king.”

Still Profitable

The company will continue to be “extremely profitable” even with customer losses, said Graham of BMO.

“It’s going to be run by a really good telephone guy, George Cope,” he said. “It’s being run by somebody who has an idea how a phone company should work, as opposed to finance guys. He’s probably going to do a better job at resisting that erosion of its market share.”

Cope risks a higher rate of customer losses to cable companies such as Rogers and wireless service providers such as Telus Corp. if he doesn’t improve BCE’s customer service and beef up Internet speeds, said Brownlee Thomas, an analyst with Forrester Research Inc. in Montreal.

“The cable companies have been very, very aggressive in terms of one-year contracts and all these discounts,” said Thomas, who said she doesn’t own BCE shares. “They need to respond in kind. That means potentially they’re going to have to get some loyalty incentives out there to the marketplace.”

BCE must also decide whether to invest in fiber-optic lines for its home customers and whether it should provide Internet- based TV service, Crandall said.

Stock Performance

BCE, which owns Bell Canada, rose 52 cents, or 2.3 percent, to C$23.02 yesterday in Toronto. That compares with the C$42.75- a-share offer from the takeover group, which also includes the buyout unit of Merrill Lynch & Co.

The buyout was in doubt for months because debt markets have seized up, making it hard for lenders to sell the bonds and loans needed by the buyers to pay for BCE.

Last week, some of the buyers floated an alternative to the LBO, offering to buy C$8 billion to C$10 billion in preferred securities for about a 20 percent stake, people familiar with the plan said last week. The banks balked at arranging the debt needed, and BCE said it never received a new offer.

The purchase would have been the second-biggest LBO, ranking behind the 2007 purchase of energy producer TXU Corp. by KKR & Co. and TPG Inc. for $43.2 billion, including debt.

To contact the reporter on this story: Crayton Harrison in Dallas at tharrison5@bloomberg.net

Last Updated: December 11, 2008 00:12 EST