Adelphia/Time Warner
--interesting details ...
[Adelphia management may or may not want a sale; they will accept bids; apparently two of the debtor groups prefer a sale. Management gets millions if Adelphia emerges from bankruptcy, but the Board of Directors hasn’t put an incentive in place for them if Adelphia is sold. Offers will probably be made. One of them is led by the guy who just got Telewest (cable) in the U.K., and promptly moved headquarters to the U.S. Liberty Media and IDT Corp. have a small percentage interest in Telewest. Ntop has responded to an RFP from Adelphia re providing cable telephony.]
The Dick Parsons Project
By Roben Farzad
Smart Money
July 28, 2004
IS TIME WARNER (TWX) about to make another boneheaded acquisition?
It's a possibility that has some investors nervous.
Time Warner, which on Wednesday reported strong second-quarter earnings and raised its full-year guidance, is strongly considering a buyout of Adelphia (ADELQ.PK), the bankrupt cable operator, according to analysts and published reports. Some say Adelphia, whose founders now face up to 30 years in prison for fraud, could fetch as much as $20 billion.
Analysts see the nation's fifth largest cable operator ending up in the hands of Time Warner or industry leader Comcast (CMCSA), which has already proven its acquisitions acumen with a successful integration of the old AT&T Broadband. Comcast, however, would almost certainly run into significant antitrust hurdles with a straight-up buyout offer. That leaves Time Warner, quietly the No. 2 U.S. cable player, in the pole position.
Cable represents some $8 billion, or 21%, of Time Warner's $40 billion in annual revenues, and Adelphia's operations could add $2 billion to 3 billion to that total — a tantalizing prospect, to be sure. But can the debt-plagued Time Warner, which still tastes acid reflux from its disastrous merger with America Online in 2001, really afford to buy Adelphia? And should it?
The pro case is surprisingly compelling.
Let's start with the glass-half-empty approach. The Time Warner-America Online merger in 2001 jam-sandwiched together a company with some $30 billion in debt — at a time when its market capitalization was plunging. But Time Warner has since retired $7 billion of that debt, improving its balance sheet and cash flow. The company now has $6.2 billion in cash, according to its latest balance sheet filing, up from $2.1 billion a year ago. How did this come about? Divestitures, board room purges, a name change — Chief Executive Dick Parsons, who took the reins in January 2003, has thrown himself headfirst into turning the company around. He has generally received kudos thus far.
Even so, the company still has nearly $23 billion of debt outstanding; its interest expense is 14% of its earnings before interest, taxes, depreciation and amortization. Such staggering obligations ought to give a company pause before plunging into another expensive acquisition. Indeed, investors have already grown wary: The spread between Time Warner's corporate bond yields and Treasury yields has increased in recent weeks as traders price in the additional debt issuance and cash burn needed to finance an Adelphia buyout.
On top of this, Time Warner is already in the running for film company Metro-Goldwyn-Mayer (MGM), which analysts say could command $5 billion. So, yes, at first glance Time Warner's infatuation with Adelphia does conjure an image of a broke, deadbeat dad ogling a Porsche. But delve deeper into the numbers, and it's clear that Parsons could conceivably improve Time Warner's financial position with an Adelphia acquisition. Rival Comcast owns 17% of Time Warner Cable (which was previously owned by AT&T Broadband), and Time Warner wants to cut those ties cleanly. The price tag: $6 billion to $7 billion.
Credit-rating firm Fitch sees Time Warner potentially satisfying the obligation by transferring certain Adelphia assets to Comcast in lieu of cash. Morningstar media analyst Jonathan Schrader does, too. "Time Warner can buy Adelphia and do a fair amount of asset swaps," he says. "It can swap Adelphia assets with Comcast, which wants economies of scale and knows such assets don't come on the market very often."
Another scenario has Time Warner taking Time Warner Cable public by merging it into Adelphia, which would then provide Comcast a liquid means to sell its stake. Time Warner has been eager to IPO its cable business for some time now, say analysts.
Either way, Time Warner surely doesn't want to fork over most of its cash balance to Comcast in order to sever the relationship. "It's about which option causes the least amount of pain," says Schrader. (Schrader doesn't own shares of Time Warner; Morningstar does no investment banking.) Fitch, meanwhile, says Time Warner could acquire Adelphia to pay off Comcast and still maintain its BBB credit rating.
Now for the glass-half-full case. The cable business isn't getting any friendlier. Time Warner has no choice but to remain aggressive, regardless of the problems in its other units. Time Warner Cable already has a footprint in 27 states. But the cable business is all about location, and operators are presented with few opportunities to pounce on clusters that make absolute geographic sense. On a local level, Time Warner's Los Angeles presence would be particularly bolstered by Adelphia's operations in that rich market.
Nationally, Time Warner Cable needs to add subscribers to compete in a cutthroat media distribution environment in which scale is everything. In addition to Comcast's 21-million-strong presence, satellite providers are also jostling for market share. The bigger they are, the better they're able to negotiate with content providers like Disney's (DIS) ESPN and Viacom's (VIA.B) MTV to secure those channels on their systems. Adelphia sports more than five million subscribers nationwide, nearly half of Time Warner's current base. Time Warner Cable could use the added bargaining leverage.
Moreover, cable is where it's at for Time Warner these days. Wall Street sees cable as the company's prime growth source, at least in the near term, with revenue and operating income (before depreciation and amortization) growing in the low double digits year-over-year. The biggest driver may be digital cable, which promises wider margins than analog cable. Time Warner Cable added 260,000 digital subscribers during the past two quarters. Some 42% of its cable subscribers now pony up for higher-margin digital cable, helping Time Warner Cable to become the largest single contributor to operating income (before depreciation and amortization) for its parent company. (Time Warner's television network unit is second, followed by the once-hot America Online unit, which lost 668,000 subscribers during the second quarter.)
The Holy Grail for cable operators is two-way digital, which provides users with a margin-rich menu of digital cable television, high-speed Internet service, Internet telephony and content-on-demand. Right now, virtually all of Time Warner's cable systems are upgraded to provide that service, with 19% of eligible homes (and growing) subscribing to high-speed Internet.
Here, Adelphia seems especially tantalizing: More than 90% of Adelphia's cable systems now offer two-way digital service, compared with only two thirds at the start of 2003. While Adelphia still has lower-than-average profit margins, it's seeing success convincing subscribers to shell out for high-speed Internet, having nearly doubled such users since its disgraced former managers left the company.
On a more intangible level, an Adelphia coup for Dick Parsons would go a long way in burying the AOL past, especially if the deal can actually afford Time Warner more financial flexibility. (We'll leave the nuts and bolts up to some creative investment bankers.)
As for that acid reflux? Well, those bankers cost millions; a bottle of Pepto sells for four bucks. |
