January 28, 2014

Two transactions involving cable companies – one agreed and the other contentious and doubtful of outcome – highlight both the sector’s attractions (as the high-capacity data conduit to consumers) as well as the demonstrable value of acquiring scale.

Many acquirers in the cable market see it as being lightly regulated (at least relative to telecoms), have conviction around network and operating synergy theses, and are of the view that (thanks to its relatively stable cash flows) the sector can attract and support large amounts of attractively priced debt.

Mr John Malone, who has a formidable reputation in the sector, has used Liberty Media (LBTY.A – NASDAQ) as a consolidation vehicle in Europe. He is nothing if not ambitious.

Liberty Media – which has a market capitalisation of $31 billion and an enterprise value of nigh on $76 billion – recently agreed terms on a purchase of the 71.5% of Dutch cable operator Ziggo that it did not already. This valued the enterprise at €10 billion, equating to a healthy multiple of 11.3x EV/EBITDA. That said, adjusting for an existing 28.5% stake (acquired in March last year) and projected synergies, the argument runs that this in fact represents a “real” multiple of 9.5x EBITDA.

Underpinning these high valuations is an evolving recognition that efficiently meeting the voracious consumer appetite for data requires a substantial landline pipe to the home (cable or fibre) and a broadband wireless connection to the smartphone. Landline and wireless in turn must connect to a high-capacity fibre backbone. Preferably all network elements can live under one roof. This crudely defined architectural reality is driving a renewed burst of consolidation wherein bundling (television, internet access, mobile), the marriage of access network to backbone, and a drive towards network scale and efficiency march side by side.

Other highlights of Liberty’s European strategy include the purchases of U.K.-based Virgin Media (at an implied enterprise value of $24.4 billion or 9.5x EV/EBITDA) and Belgium’s Telenet (at an implied enterprise value of €6.8 billion and, curiously, the same EV/EBITDA multiple of 9.5x). In Germany, where the deal market was more complicated, Liberty elected to put substantial capital to work behind Unitymedia.

Vodafone’s recent $15 billion purchase of Kabel Deutshcland at 14.3x EBITDA and 5.7x revenue is much of a piece with this pan-European consolidation theme.

We fully expect telecoms operators in Europe and the US to remain, or indeed become more, acquisitive in 2014 (regulatory and stock market landscapes permitting). Indeed at the time of writing both Liberty Global and Vodafone were believed to be circling Spanish cable operator ONO. The M&A multiples reflect firming interest in consolidation. 2013 saw a mean cable/telecoms EV/EBITDA M&A multiple of 8.9x – up substantially from the post-crisis range of 3.7x-7.0x. In 2013 the average M&A EV/EBITDA in the cable sector was 11.25x.

Graph 2 - EV-EBITDA M&A Multiples - Blog 28 January 2014Graph 1 - EV-Revenues M&A Multiples - Blog 28 January 2014
Some companies bought well over recent years. Cogeco, for example, has transformed itself by buying managed hosting and managed services businesses (Peer1 and QTI), fibre (MTO Telecom) and rural cable (ABB). The ABB acquisition was the largest deal by dollar value, and was an immediate contributor to a sag in the share price. Cogeco’s shares have since rebounded.

Graph 3 - Cogeco Share Price - Blog 28 January 2014
Our comment about “regulatory and stock market landscape permitting” becomes relevant and important in jurisdictions where giants seek to create behemoths.

Comcast (CMCSA – NASDAQ) looms over the U.S. cable market with an enterprise value of $180 billion ($120 billion of which is equity market capitalisation). Whilst Comcast commands a 2014 EV/EBITDA multiple of almost 8x, the sector trades as a whole at about 7.1x 2014 EV/EBITDA. In this context Charter Communications (CHTR – NASDAQ) – a $26.6 billion enterprise value firm ($12.4 billion market capitalisation) seeks to move into the ranks of the super-sized by buying the larger Time Warner Cable (TWC- NYSE), a firm with a $60.5 billion enterprise value and $38.6 billion of market capitalisation. The discerning reader will immediately see that Liberty Global and Charter are inspired by clement debt market conditions to load up with leverage to a much greater degree than their peers and, in the case of CHTR’s unwelcome bid for TWC, play small-fish-swallowing-big-fish.

At $US 132.50 CHTR is bidding 7.25x 2014 EBITDA (building in ~ $600 million of network and corporate synergies – not all of which can be achieved on closing): this is hardly much of a deal premium. A transaction in this form would result in Charter’s shareholders owning 55% of the new firm. One can therefore understand the reticence of the Time Warner board.

Indeed TWC has rebuffed CHTR, demanding $160 ($100 in cash and $60 in shares), which equates to about 8x EBITDA. This would also leave Time Warner shareholders owning 52% of the combined company. Any analysis of this potential deal has to factor in Charter’s significant tax assets, which may allow it to pay more than other bidders such as Cox (though it is also possible to argue that a private company can take a longer view about synergies and acquisition premia than a public company such as CHTR). Conversely, any analysis may also have to confront the fact that network synergies may not always be as achievable as imagined. Comcast – a firm that is, as was noted before, the gargantuan of the sector – reported Q4 2013 capital expenditures of $1.64 billion, above an expected $1.57 billion. This was a function of costs associated with deploying next generation technology and factors scale could not resolve.

At the time of writing, TWC shares were trading comfortably above $133. Some arbitrageurs feel that this places TWC in an invidious position: the share price is supposedly buttressed by the Charter offer, and Time Warner would risk kicking that support out if it remains steadfast in refusing the offer. A counter-argument is that almost all cable and media names have seen solid performance on the stock market lately and that there may in fact be much less deal premium in the share price than some hedge fund managers believe.

It is important to note that were Time Warner to successfully rebuff Charter then it would still – despite concerns regarding competition from large fibre-rich telcos (Verizon and AT&T) and pressure on television subscription numbers – remain a very substantial network with both significant scale and interesting commercial opportunities. In some ways Charter’s bid resembles Comcast’s 2004 highly-opportunistic, under-priced bid for Walt Disney. Disney “just said no” and a decade later its shares have effectively trebled. At a certain point – and this can be a topic of heated debate – incremental scale may not necessarily create more value.