Oldie but a goodie. This piece was written up last August..but the long term story is still the same. It is the outlook on the European cable scene as per a certain broker (can't divulge name due to copyright infringement paranoia). Nice to read such an upbeat write up during tough mkt times like these:
Global Cable: Significant Growth, Significant Potential
In the big picture, there are really two dominant themes going on in the cable industry these days: a shift towards digitization and an attempt by companies to add incremental revenue streams to a fixed cost infrastructure. Both of these developments are leading to a significant change in the way cable companies do business and customers receive services. They are also producing a number of particularly interesting opportunities for investors.
To give you some background on why a lot of this growth is taking place, and these opportunities are arising, one must understand that historically in most European countries, cable companies have been starved for content and as a result, have charged fairly low monthly rates. Now, however, significantly more domestic and international content is being brought into the markets - an advance that is allowing companies to fundamentally transform their top lines without adding very many costs. Although, of course, these companies do have to pay for the programming, the cost to them is about 40 cents on the dollar, so they end up keeping about 60 cents. Therefore, this is a very high margin business that continues to see tremendous growth across Europe.
Another rapidly evolving part of the cable business is the direction companies are taking with residential telephony. As many people know, this has been a huge success in the UK, where Telewest (TWT.L:224 1/4)+*@ and NTL (NTLI.O:95 1/4)*@ both currently have over a 30% penetration rate. In fact, Telewest all by itself now has about 1.3 million phone subscribers, so anyone who might have been wondering whether Europeans would be willing to take phone service from a cable company shouldn't be questioning that - it's a proven thing. When one looks at this business on the European continent what one finds is that rates are actually typically higher than in the United Kingdom, and therefore when these companies start to focus on other regions in Europe there is a lot of potential.
A third innovation in this industry is what companies are doing with business telephony. Again, to use the United Kingdom to extrapolate a little, what we have seen in the UK is that small and medium businesses that are passed by cable systems are a "gimme" in terms of getting telephony business. This makes sense - in residential areas the only competitors are typically the PTTs (the European equivalent of the RBOCs). Therefore, if a cable company passes local businesses in the residential neighborhood, they likely get the same market share as they do of the area's homes, because there is no other player like a Colt (CTM.L::1253) (who focuses more on the downtown businesses) to compete with.
The last thing that has happened to this industry is the progress that has taken place with the internet. In our opinion, high speed internet access on cable is a significantly stronger product than anything a phone company either has or is contemplating. Furthermore, we believe that being able to provide full motion video is going to be a very major competitive advantage.
So essentially what has been going on with these businesses is that up until recently there has been a set of cable companies operating in most of the European countries that have been making decent money selling low cost programming. Now, however, what these companies are doing is bringing in high cost programming as well as offerings in residential telephony, business telephony and the internet - all without having to add much infrastructure. As a result, once these companies get past the initial capital that is required to set these operations up, they have a tremendous ability to make high margins and take market share from competitors that only sell one product. The cable companies therefore can go out to customers and say "if you take my phone and my video we will give you a bigger discount than if you subscribe to the services of this other business that can provide only one or the other." They therefore are far and away out-growing and out-competing the other businesses that are constrained by a single product.
With all of that in mind, it is easy to see why there are some significant opportunities out there for investors. Among our favorite ideas right now are UnitedGlobalCom (UCOMA.O: 69 3/4)+*@, Telewest Communications, and Primacom (PCAG.O:24 7/8), a company we have only recently begun following.
UnitedGlobalCom: Closing the Value Gap
The old UIH is now called UnitedGlobalCom, or UCOMA. If one looks at this business and marks to market the European operation which is United Pan-Europe Communications and marks to market its Australian / New Zealand and Latin American operations, all at what one thinks is a sensible valuation, then at our target price of $80 for UPC, UCOMA - UPC's parent company - would have about a $130 dollar 12-month target price. Just to put that in perspective, the stock right now is trading in the $70 range, so there is quite substantial upside to this name.
Some may ask what is going on here, and why the discount is so big, and others may say that there is a big discount and there has always been a big discount, so why buy this stock? My reaction to these questions is that with this company's stock there are two forces pulling in opposite directions, leading to an overly inexpensive price. The first factor, which is pushing UCOMA's share price up, is that the company is relatively inexpensive relative to its underlying asset value. The issue that is keeping this stock from realizing its potential is that the company was trading at around $7 less than twelve months ago, and is now selling in the mid-$70 range. Therefore, everyone that looks at this stock's chart pulls it up and has a heart attack. The reason that we think even in the $70s that this is not a completely "the market has lost its mind" kind of price is that at $7 twelve months ago, everyone was looking at a low-rate cable company that had only a few channels and made only a few dollars. What the company has since done in its major metropolitan areas, however, is to roll out a more expensive channel, start offering both business and residential telephony services and start a data business. Therefore, the company has gone through a fundamental transformation where the stock price of twelve months ago really is irrelevant to what the company has become today. We think despite its rapid rise that this company has continued momentum and is closing the value gap. In line with this, we would call this stock one of the least expensive of any of the cable companies that you can buy in Europe.
Telewest: Ignore the One that Got Away - Focus on the Value
Telewest obviously ended up being the bridesmaid and not the bride in the recent UK consolidation moves that ultimately took place between NTL and Cable and Wireless (CWZ.L:636). Telewest had expected to merge with Cable & Wireless and had been negotiating to merge with the company before NTL, with a little extra money in its pocket from France Telecom (FTE.PA:64.2), was able to come in and make the acquisition instead. Although we are disappointed for Telewest because we think that the acquisition would have made sense for the company, at the end of the day our price target and our buy recommendation on the shares are based on our expectation that the company stays independent.
Important to note is that in no way does NTL's merger with Cable & Wireless hurt Telewest from a competitive point of view because the UK cable companies do not compete with each other. So while this is an opportunity lost, it does not change our investment thesis on the shares. In our opinion Telewest is undervalued and is in position to be bought out by NTL. If it gets acquired for stock, we believe shareholders will benefit from improved efficiency and greater scale at the combined company, and if the company is acquired for a premium then shareholders get a premium by definition. So we believe that this stock offers investors 25-30% upside or more without any kind of promotional value and we also think that there is the potential for it to sell it's business to NTL. For anyone who raises concerns that this management team will not sell to NTL given possible hard feelings about what happened with Cable and Wireless, we would only remind them that about 50% of Telewest is controlled by Microsoft (MSFT.O:84 3/16)*and Liberty, both of which will not be concerned as much with management's feelings as they will about getting a good price.
Primacom: Positioned for Profits
Our last company to mention is Primacom, a stock we began following fairly recently. Primacom is a Germany cable company set up by a number of entrepreneurial Americans who went over to Germany, saw an strange situation, and decided to make a bet that the situation would go from what I would call anachronistic, into one that is rational.
A few years ago the German government decided that the best thing to do if they were going to make cable available to Germans was to let Deutsche Telekom (DTEG.F:37.65) do it. Therefore, Deutsche Telekom went along building a plant and spending money in order to be able to provide these operations, but didn't focus enough on marketing or programming. As a result, after a few years Deutsche Telekom was in a position where it had built a plant with a lot of capacity, but didn't have very many customers. As a result, the government came along and changed the structure of how the German Cable industry was being run so that numerous other players were able to piggy back off Deutsche Telekom's plant and supply the customers. This led to a situation a little bit like that of a reseller in the cellular business, where different systems were built in. But still this system was imperfect, and recently the European Union came in and said that this was problematic from a competitive point of view, and began to put pressure on the local PTTs (RBOCs) including Deutsche Telecom to sell all or at least pieces of their cable companies so that they become rational. In arranging this, the EU announced that bids were due on Aug 13th and there are now about 60 businesses bidding on these plants including companies like Microsoft, United Pan-Europe Communications, and NTL. It appears that when Deutsche Telekom splits its plants into nine pieces and sells them, whoever buys a piece of that plant is likely to buy the customer operations associated with it, and fuse them together. We think that this is going to transform the value of Primacom because they control a lot of customers in highly clustered areas and also have low leverage and a good management team. Our report, published July 28th and entitled Primacom AG: Assembling the Chess Pieces, walks through a lot of this in greater detail.
NTL: A League Leader
In looking at the way the cable business is evolving, the great debate really seems to focus on who has a better strategy - NTL or Telewest - or whether in the end they are both about the same. NTL's view, which is really CEO Barkley Knapp's design, is that the proper strategy for this business is to get people on your network at all costs, whether it be by discounting or in other ways. In the case of discounting, what is happening is that NTL is basically giving away 4-5 cable channels to get people on its network. Its pitch to customers is that British Telecom, or another company, charges the customer œ9 per month for phone service and that NTL will charge the customer œ9 per month for phone service, and also give the customer 4 or 5 free cable channels. It's really a no-brainer what happens as a result of this, and indeed NTL's penetration as a result of this strategy has been league-leading by about any metric.
I believe that they have exactly the right model and would venture to look at that with ISPs, with RCN Corp. in the US and for other businesses. I think it is worth making it as simple as possible and even offering pretty deep discounts in facilities-based businesses. What is more difficult for ISPs or long distance resellers, however, is if you discount to get people on the network they turn right back off. As a result, this kind of strategy only works in cases where companies can sell bundled services and move people up the food chain. All in all, we think NTL is a tremendous company offering significant opportunity for investors at these levels. If it can take its recently acquired Cable & Wireless business that had low 20% penetration (21% on cable and 26% on phone) up to its level of 43-44% penetration - not even going beyond that -- this merger pays for itself many times over. So in sum, we feel that the recent merger of NTL and Cable & Wireless has created a broadband juggernaut that really is without peers, and we think everyone considering purchasing the CLECs should be fully invested in Telewest and NTL before moving up into the more competitive CLECs arena. |
