How to Play the Potential Cable M&A Deal
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) has been trading higher on rumors rumor that billionaire John Malone, through Charter Communications (NASDAQ: CHTR) would like to take over Time Warner Cable. Charter Communications has also been on the rise after the rumor, climbing from $117.80 per share to as high as $130. If that happens, in the long run, a lot of synergies and benefits will eventually flow to John Malone’s powerhouse, Liberty Media, the 27% stake owner of Charter Communications.
Charter Communications to acquire Time Warner Cable?
Time Warner Cable is one of the biggest video, high-speed data and voice services providers in the U.S., serving around 15.2 million customers, including 14.7 million residential services customers and 563,000 business services customers. Most of its revenue, $18.18 billion, or 85% of the total, was derived from residential services, while the business services and advertising segments generated only $1.9 billion and $1 billion, respectively, in 2012 sales. In the residential services, the company generated as much as $10.9 billion in Video. High-speed data ranked second with more than $5 billion in 2012 revenue.
Many people have been concerned about the potential synergies between Time Warner Cable and Charter Communications. While Time Warner Cable concentrates operations in five main areas including New York State, the Carolinas, the Midwest, Southern California and Texas, Charter Communications spreads out across 25 states, with eleven key markets including Michigan, Alabama/Georgia, Michigan, California and Central States. However, it could be a cable industry consolidation deal with potential synergies in both operations and cost savings. Like Time Warner Cable, Charter Communications also derived as much as 48% of its revenue from Video while Internet contributed nearly $1.87 billion, or 25% of total sales in 2012.
If Charter Communications acquired Time Warner Cable, it would have to use a lot more outside equity or debt financing, as it is much smaller than Time Warner Cable. While Time Warner Cable is worth more than $32.7 billion on the market, with 12 million video subscribers, Charter Communications has only four million subscribers, with a market cap of only $12.9 billion. Both Charter Communications and Time Warner Cable had a large amount of debt and quite thin equity. The combined company would be likely to have $37 billion in debt and only around $7 billion in equity. According to Moody’s, John Malone might want to limit his dilution, so the financing for the deal would make the credit risk for bondholders riskier. If John Malone used debt financing for this acquisition, the combined company’s total debt could reach a whopping amount of about $60 billion.
Which one is a better buy now?
If Time Warner Cable could be a good target for John Malone, its peer Cablevision (NYSE: CVC) could also be a potential target. Cablevision had nearly 3.2 million video customers and more than 3 million high-speed data customers. Cablevision is bullish about WiFi’s future, thinking that it would still be one of Cablevision’s strategic initiatives. Around a million customers are using 80,000 Optimum WiFi access points. In the second quarter, the company expected to reduce its level of spending and increase its advertising revenue, leading to a double-digit sequential AOCF in the second quarter. The company had the weakest balance sheet among the three companies. As of March 2013, it had negative equity of nearly $(5.7) billion, $580 million in cash and investments, and as much as $9.8 billion in debt. However, billionaire Mario Gabelli likes Cablevision a lot. He believed that Cablevision could generate around $6.3 billion in revenue and around $1.6 billion in EBITDA.
Among the three, Time Warner Cable could be most likely the acquisition target because of its lowest valuation. At $112.50 per share, Time Warner Cable is worth around $32.7 billion on the market. The market values Time Warner Cable at only nearly 7.4 times its trailing EBITDA. Cablevision ranked second, with around a $5.1 billion market value. It is valued a bit higher, at 8 times its trailing EBITDA. Charter Communications is the most expensive company. At $127 per share, it is worth $12.85 billion on the market. It is valued at 9.5 times its trailing EBITDA.
My Foolish take
To play the buyout rumor, Time Warner Cable could be a good pick for average investors with its low valuation. If Time Warner Cable had a similar valuation to Charter Communications, it could be worth more than $144 per share, a 28% premium to its current price.
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