fwiw ...
-----
March 9, 1999
The Smart Money's on Cable
By Paul R. La Monica
SmartMoney
IMAGINE YOU'RE having lunch with Paul Allen and Warren Buffett. You listen to Allen, sipping on a mocha latte, rave about how his Portland Trail Blazers basketball team has the best record in the NBA. Buffett, putting the finishing touches on an Omaha steak, is wondering if everyone would be interested in going to one of his Dairy Queen restaurants for dessert.
Finally, after moments of awestruck silence you gather up the nerve to ask them your big, yet simple, question: "Where do I invest now?" They look at each other and, without the slightest hesitation, reply in unison, "Cable."
Yes, the cable industry has recently attracted some of the world's savviest investors. In the last year, Allen's Vulcan Ventures has spent more than $6 billion in several deals and now has a base of 2.5 million cable subscribers. Last month, Buffett disclosed that he owns an 8% stake in TCA Cable TV (TCAT), a cable company based in Tyler, Texas. And of course, there's the blockbuster AT&T (T) - Tele-Communications (TCOMA) deal, which closed today.
Consolidation in the industry is definitely heating up. Last week, Adelphia Communications (ADLAC) agreed to buy Century Communications (CTYA). This comes just a little more than a week after Adelphia announced it was purchasing privately held FrontierVision. The price tags are soaring on the deals as well. Frederick Moran, a Wall Street Journal All-Star analyst with ING Baring Furman Selz, estimates that Adelphia is paying about $3,200 per Century's 1.6 million subscribers. Allen has been paying about $3,800 per subscriber in some of his acquisitions. Previous deals had been rarely higher than $3,000 per subscriber.
All of this activity has been brought about by the $1 billion investment Microsoft (MSFT) made in Comcast (CMCSK) in 1997. "There has been a recognition by [Bill] Gates, Allen and AT&T that cable has the broadband pipeline for delivery of Internet and other new services," says Moran. So there is a lot at stake for technology companies and clearly some of these firms are willing to pay whatever it takes for access to more cable subscribers. Cable stocks, as well as other tech stocks, are trading at historically high valuations and as long as they remain a viable currency, it would seem that more deals are likely.
With that in mind, we looked for other consolidation candidates. We came up with three: Media One Group (UMG), Cablevision (CVC) and Buffett's favorite, TCA.
Media One Group
Media One, formerly known as U.S. West Media Group, is the third-largest cable company in the country with more than five million subscribers in major metropolitan markets such as Boston and Atlanta. And like other cable operators it is rapidly branching out into new businesses. The company is expected to have 25,000 residential phone service subscribers by the end of this year (it had 10,500 as of year-end 1998) and is also expected to offer long distance services within the next few months. Media One now has 84,000 high-speed data subscribers and is expected to add another 100,000 subscribers by the end of this year.
But despite the company's size and nearly $35 billion market cap, Moran says Media One is more likely a takeover target than a buyer because it is the only major cable company that doesn't have a large shareholder with a controlling interest. It's no wonder then the stock is up 24.6% year-to-date and 53% since November. Allen has been mentioned in rumors as a likely buyer of Media One.
However, there is a risk with Media One. Compared to other cable companies, its near-term fundamentals are among the weakest. Due to tough comparisons, analysts expect growth in EBITDA (earnings before interest, taxes, depreciation and amortization) to be relatively flat in the first half of the year. But thanks to the new businesses a double-digit increase in EBITDA is likely for 2000, according to a recent report by Jessica Reif Cohen, a Wall Street Journal All-Star analyst with Merrill Lynch. That's encouraging news, assuming Media One remains independent that long.
Cablevision
If you live in the New York area, it might seem like Cablevision is as big as the monolith from 2001: A Space Odyssey. It owns Madison Square Garden, the New York Knicks basketball team and the New York Rangers hockey team, Radio City Music Hall, and the Wiz chain of electronics stores. It is rumored to be looking at the Yankees or the Mets. If the Statue of Liberty was for sale, Cablevision Chairman Charles Dolan would probably be making an offer.
But Cablevision really isn't that big. Its market cap of $7.4 billion is much lower than the market value of Media One, Comcast and Time Warner (TWX), which competes with Cablevision in several markets in metropolitan New York. If anyone were to buy Cablevision, Moran says the most likely candidate would be AT&T. That's because AT&T now owns approximately a one-third stake in Cablevision as it has inherited TCI's shares of the company. And what makes Cablevision attractive (definitely not its mediocre sports teams) is its base of 3.4 million subscribers in the lucrative New York area.
Whether or not Dolan would consider a sale is the big wild card here. However, even if the company stays on the independent track, it still looks like a good value. In a recent report, Merrill's Cohen placed an $85 price target on Cablevision stock. That's 23% higher than the current stock price. Not bad when you consider that the stock has already enjoyed a nearly 38% runup so far this year. And Cohen says her estimate is based purely on the fundamentals. She expects cash flow to increase 11% this year and bases her price target on a multiple of 16 times 2000 EBITDA, which is in line with multiples for other cable companies.
TCA Cable
TCA Cable is definitely the odd man out in this industry. For one thing, the company pays a dividend. Sure, the yield is tiny (just 0.73%), but of all the other major cable operators, only TCA and Comcast offer dividends. Then there's another oddity. TCA can actually be valued with a P/E ratio. Most cable operators are leveraged to the hilt and have large depreciation and amortization expenses. That is why analysts usually use price-to-EBITDA or price-to-cash flow ratios to value them. But TCA's long-term debt is just 58.6% of capital (that's low for cable companies) and it is expected to earn 97 cents a share this year. Finally, TCA focuses on less populated markets, with 865,000 subscriptions in mainly rural and suburban areas in Louisiana, Arkansas and Texas. Take all that into account and you can see why the down-to-earth Buffett would pick this cable company over some of its more glitzy competitors.
John Corcoran, an analyst with Stephens Inc., says he does not think the company is an imminent takeover play as the larger entities seem to be focusing on the biggest markets. But Buffett's involvement has raised the company's profile. Since his stake was disclosed on Feb.17, the stock is up nearly 23%. And Corcoran thinks TCA will eventually attract interest since it is a quality company that is generating a strong amount of profits. Earnings have increased at an average of 15% over the last five years and are expected to increase 14% this year and 16% next year.
Corcoran says TCA will probably continue to follow a disciplined acquisition strategy. Its operations are highly clustered so it is unlikely TCA will purchase a cable system that is not geographically close to its current base of subscribers. So far it has been cautious in regards to offering new services. TCA has slowly been rolling out high-speed data access and has a telephony affiliation with TCI. The company is far from being left behind in the cable revolution.
What's more, the stock trades at a discount to its peers despite having real earnings, a dividend and a lower amount of leverage (which makes it a safer cable play in the event of a spike in interest rates). TCA is trading at about 14 times Corcoran's 2000 EBITDA estimates while other cable stocks are trading at a multiple between 16 and 17. You have to figure that some sort of Buffett premium will now be attached to the stock since he is well known as a buy-and-hold investor. TCA will release its first-quarter results on Thursday. If the company has a strong quarter (analysts are expecting earnings per share of 23 cents), and makes Buffett look like a genius for the umpteenth time in his investing career, the stock could take off once again.
smartmoney.com |
