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Cable Operators

'Private’ Eye on Comcast

5/25/2007 8:03 PM Eastern

Two influential stock analysts, lamenting the increasingly glaring discount in cable stock valuations, have offered up two distinctly different solutions to goose the sector.

One, by Citigroup cable and satellite analyst Jason Bazinet, was the more traditional ratings upgrade.

The other, by Sanford Bernstein cable and satellite analyst Craig Moffett, took a more risky tack: It suggests that the largest cable operator in the country, Comcast, abandon the public markets all together and take the company private.

ANEMIC STOCK VALUES

Both analysts operated from basically the same thesis — cable stock valuations, especially for the two largest cable companies, are anemic compared to their financial performance and relatively conservative future prospects.

Bazinet, in a report issued last Monday, upgraded Comcast and Time Warner Cable to “buy” from “hold,” increasing his 12-month price target on Comcast to $33 per share from $30 and boosting his target for Time Warner Cable to $44 each from $44.

While Bazinet cited several reasons for the upgrade — the success of the triple-play bundle of voice, video and Internet access; the nascent threat of telco video; and the minimal competition from other technologies, like WiMax and broadband over power line — he wrote that valuations were the main cause of his optimism for the sector.

“The crux of our bull-case, however, rest squarely on valuation grounds,” Bazinet wrote.

Moffett, in his tongue-in-cheek report entitled “Psst — Hey Brian (Roberts)” — suggested that the Comcast chairman and CEO and the rest of the Roberts family could take the company private mainly by ticking up leverage to 8.5 times cash flow from its current level of about 2.5 times.

By doing that — essentially adding another $72 billion in debt to the company’s current debt load of $30 billion — the Roberts family (which controls about 2.5% of Comcast common equity but 33.3% of its vote) could buy the outstanding shares of Comcast it doesn’t already own for essentially no money down.

Moffett illustrated his point by first looking at Comcast’s expected 2007 cash flow of $11.9 billion. Given that banks “are falling over themselves,” Moffett wrote, to lend to cable companies at up to 8.5 times cash flow, Comcast could theoretically increase leverage to $102 billion from its current $30 billion. That extra $72 billion in debt is just $10 billion short of Comcast’s market capitalization of $82 billion.

That additional $72 billion in debt would carry an interest burden of about $6.5 billion (assuming it was borrowed at a 9% interest rate). After the tax shield — interest on debt is deductible and for simplicity’s sake, Moffett assumed the 38% statutory rate — the incremental cash cost of the additional debt would be about $4 billion. Given that Comcast has already projected $2.7 billion in free cash flow (cash flow after capital expenditures and interest payments are made), the company would have to borrow an additional $1.3 billion in the first year to service the debt.

But, Moffett added, Comcast is also growing cash flow at a 15% annual clip. So even though its debt load would tick up again to about $104 billion, its debt-to-cash-flow ratio would fall from 8.5 times to 7.3 times in 2008.

“Psst — Hey Brian”
Sanford Bernstein cable and satellite analyst Craig Moffett mapped out a strategy that would allow Comcast CEO Brian Roberts to take the cable company private, growing equity value to $50 billion in five years. A snapshot of Moffett’s hypothetical scenario:
Source: Sanford Bernstein reports.
Comcast takes on $72 billion in additional debt, raising its leverage to $102 billion from $30 billion. The additional debt load represents a leverage ratio of about 8.5 times 2007 estimated cash flow, an acceptable level for most banks.
After tax breaks are considered, the additional debt carries an incremental cash cost of about $4 billion. Given Comcast’s estimated 2007 free cash flow of $2.7 billion, the company would have to borrow another $1.3 billion to service the interest in the first year.
By 2009, Comcast begins to use its free cash flow to pay down the debt, eventually taking down leverage to 5.3 times cash flow by 2012, five years after going private.
Also by 2012, and assuming a modest 8.3 times multiple, Comcast’s enterprise value would rise to $150 billion. Assuming debt of about $97 billion by that time, that makes the equity value of the company $53 billion.

DEBT GETS RETIRED

It gets even better in subsequent years, according to Moffett, because Comcast would begin to retire debt — by about $1 billion in 2009 and by $5 billion by 2012. Moffett estimated that by 2012, five years after taking the company private, Comcast’s leverage ratio would be about 5.3 times cash flow.

Also by 2012, enterprise value — market capitalization plus debt minus cash and cash equivalents — would have risen to about $150 billion (given today’s 8.3 times multiple, which Moffett called “anemic”) with debt of about $97 billion. That would value Comcast’s equity at about $53 billion.

Moffett added that if the Roberts family waits until 2008 to pull the privatization trigger, they could take the cable giant private without contributing a penny of their own equity. Moffett estimated that Comcast’s estimated 2008 cash flow could support up to $119 billion in debt, or about $89 billion above its current debt load. That is $7 billion more than its market cap, assuming no significant increase in its stock price.

“Go ahead, find me another investment that could return $50 billion of value creation in five years … for no money down,” Moffett wrote.

Moffett added that there are some glaring omissions in his analysis — mainly that he assumes no premium in a privatization offer.

But, in an interview and in his report Moffett said that he was trying to make a point, not suggest that the Roberts family try to take Comcast private.

“Cable stocks are, from a private-equity perspective at least, 'stupid cheap,’ ” Moffett wrote, adding that the gap between public and private market values is even greater now than it was prior to the 2006 cable rally, when cable equities rose about 40%.

The difference today, Moffett added, is maturation — as growth decelerates, capital requirements fall and the ability to support debt rises proportionately. And though the public markets have funded the heavy cost of building out the cable network, the deployment of digital set-top boxes and cable modems and the rollout of phone service, they don’t appear to be willing to do so now, with most of the heavy lifting finished.

“And so, with each passing year, cable franchises get to be more, and more, and more attractive as candidates for privatization,” Moffett wrote.

Moffett added that cable companies don’t have to take such drastic measure to experience high returns.

September