This Cable Business Seems to Be a Good Buy
Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently, Time Warner Cable (NYSE: TWC) experienced a huge gain of nearly 8% in a single day after an acquisition rumor. According to CNBC, CEO Greg Maffei of Liberty Media (NASDAQ: LMCA) has approached CEO Glen Britt of Time Warner Cable to discuss about the potential merger with Charter Communications (NASDAQ: CHTR). Following the buyout rumor, Charter Communications also rose nearly 5% to $116.60 per share.
Consistent growth but weak balance sheet
Time Warner Cable has been generating its revenue from providing video, high-speed data, and video services to both residential and business customers. The majority of its revenue, $18.18 billion, was generated from residential services, while business services and advertising contributed only $1.9 billion and $1 billion, respectively, in revenue. Within residential services, video accounted for the majority of revenue with more than $10.9 billion in sales while high-speed data ranked second, with more than $5 billion in sales in 2012.
Time Warner Cable has managed to consistently increase its residential customer relationship average revenue per user (ARPU) for every month in the first quarter, along with the 6.6% growth in revenue and 8.5% increase in its adjusted diluted EPS. In the first quarter, Time Warner returned as much as $855 million to its shareholders, including $195 million in dividends and $660 million in share repurchases. In the past three years, Time Warner has paid consistently increasing dividends, from $1.60 per share in 2010 to $2.24 per share in 2012. Interestingly, the payout is quite reasonable at only 32.5%.
What makes me worried about Time Warner Cable is its high leverage level. As of March 2013, it had $6.94 billion in equity, nearly $3.3 billion in cash, and as much as $24.2 billion in long-term debt. Moreover, Time Warner Cable booked an additional $2.3 billion in short-term debt.
According to Business Wire, the company plans to have a good balance between subscriber quality and profitability, as well as subscriber growth and volume metrics. Looking forward, Time Warner Cable will concentrate its efforts on drawing higher quality and more profitable subscribers and having better residential business retention rates. Time Warner Cable is trading at nearly $103.40 per share with a total market cap of around $30 billion. The market values the company at 6.7 times its EV/EBITDA.
EV/EBITDA represents Enterprise Value/ Earnings Before Interest, Taxes, Depreciation, and Amortization. It takes into account the relationship between the market value, adjusted with cash and debt, and the cash flow position of the company.
Much cheaper than both Charter Communications and Liberty Media
Indeed, Time Warner Cable is valued at a much cheaper valuation compared to both Liberty Media and Charter Communications. Charter Communications is trading at around $116.60 per share with a total market cap of $11.80 billion. The market values Charter Communications a bit higher, at more than 9 times its EV/EBITDA. Liberty Media seems to have the highest valuation of the trio. At $125 per share, it is worth more than $15 billion on the market. The market values Liberty Media at more than 23.6 times its EV/EBITDA.
John Malone, the talented mind behind Liberty Media, has acquired 26.9 million shares and 1.1 million warrants, owning around 27.3% of Charter Communications. He would like to have up to four board seats on Charter's board, influencing the fourth-largest cable operator in the U.S., with 5.4 million residential and commercial customers. Consequently, Liberty Media has Charter Communications in its portfolio, including Sirius XM Radio and Live Nation Entertainment.
By increasing his stake in Charter Communications, John Malone is getting closer to his goal of global consolidation of the cable business. The investment community has speculated that John Malone might use Charter Communication as “an industry consolidator” for the U.S. cable business. Indeed, John Malone said that he would like Charter Communications to be “a horizontal acquisition machine.” Consequently, the talk to acquire Time Warner Cable is totally possible.
My Foolish take
Time Warner Cable could really be a good acquisition candidate for John Malone, through Charter Communications. If Time Warner Cable has a similar valuation to Charter Communications, Time Warner Cable could be worth more than $41.2 billion, or more than $140 per share, 36% higher to its current trading price. I personally think with a 2.80% dividend yield, Time Warner Cable could be a good long-term position for patient investors.
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