Time Warner Cable Shouldn’t Give in to John Malone
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A few days ago, Bloomberg reported that billionaire John Malone’s Liberty Media is exploring options to acquire Time Warner Cable (NYSE: TWC). Ever since Malone made a comeback in the U.S. cable market by acquiring a 27% stake in Charter Communications (NASDAQ: CHTR), consolidation in the cable industry has seemed to be in the cards.
The U.S. pay-TV market has become saturated and fiercely competitive. Cable companies continue to lose their subscriber base, and Time Warner is no exception. Time Warner was late in adopting the digital platform that had drawn customers to satellite firms like Dish Network and DirecTV, and telecom operators like Verizon and AT&T. As a result, Time Warner’s customer base declined from 13.3 million in 2007 to about 12 million in 2012.
Well, now Malone wants to buy Time Warner Cable through Charter Communications. I believe Time Warner shouldn't consider a merger with Charter Communications, not even in its wildest imagination.
Malone would crush Time Warner under debt
Charter is much smaller than Time Warner Cable. It has only about four million subscribers compared to 12 million of Time Warner. Charter has a market capitalization of $12.5 billion, and a debt burden of $12.8 billion. In contrast, Time Warner Cable’s market value stands at about $33 billion. Including about $19 billion in debt. Time Warner Cable’s enterprise value will shoot up to $54 billion. If Charter makes an acquisition attempt, it has to pay a premium which, let’s assume, will take the deal to at least $60 billion.
The big question is how will Charter finance the deal? It is already crushed under debt. Even if you include the market value of its parent company Liberty Media ($15.3 billion), their combined value is still much lower than Time Warner Cable’s. Sources told Bloomberg that Charter may borrow against Time Warner Cable’s assets to raise funds needed for the offer. In an industry that is going through a rough patch with companies continuing to lose subscriber base amid fierce competition, a debt-laden firm raising more debt makes no sense. The heavy debt burden on the combined company is what makes me skeptical about the deal.
Moreover, Time Warner is currently adopting new strategies to bolster its growth. It may not like Charter disrupting the move. The company is launching a cloud-based interface that will help users navigate programs through an online menu. It is cutting costs on promotions and charging more on enhanced services like multi-room digital video recorders and faster broadband. Recently, Time Warner partnered with Microsoft to provide more than 300 live TV channels to the Xbox 360.
So, what makes sense for Time Warner Cable?
Time Warner Cable should bolster its growth through acquisitions rather than being swallowed. It has been eyeing Cablevision Systems (NYSE: CVC) for quite some time.
Cablevision, of which the Dolan family owns a 72.9% stake, has more than 3.2 million subscribers in the New York region. That would be the right fit for Time Warner’s New York systems. The Dolan family-controlled company enjoys a high-income subscriber base.
Todd Mitchell, an analyst at Brean Murray, says that Time Warner and Cablevision have neighboring cable systems. And more importantly, their markets don’t overlap, so there are unlikely to be any regulatory issues in the deal.
Yes, I know the Dolan family hasn't shown any interest in selling its stake. But now their company is facing fierce competition from Verizon in its strongest markets including New Jersey, Long Island and Connecticut. Cablevision is losing video customers, and its cash flow continues to decline. Sources told Reuters that after witnessing this scenario, Cablevision’s 86-year old founder Chuck Dolan may be more in the selling mood now. Cablevision is still a valuable asset that interests Time Warner.
Time Warner shareholders have been frustrated with its sluggish growth. But accepting John Malone’s offer isn't going to enhance shareholder value because it will put a large amount of debt on the merged company’s balance sheet. And the company management realizes this fact. It would be better off leading the consolidation wave by acquiring companies that offer great synergies.
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Vikas Shukla has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!