Nearly twenty years after selling his Tele-Communications cable empire to AT&T, billionaire media mogul John Malone appears to be working hard to piece together a new cable dynamo, circa 2013. His Liberty Media holding company effectively acquired a controlling stake in No. 4 cable operator Charter Communications (CHTR -1.74%) in May 2013 for $2.6 billion. Now, media reports have speculated that Charter is out shopping for financing to make an audacious bid for No. 2 cable player Time Warner Cable (NYSE: TWC), a company more than twice its own size. So, should investors take a position?
What's the value?
Time Warner Cable has been refocusing its business on the core cable franchise and selling off non-core assets. An example is the multi-billion dollar sale of its interest in wireless spectrum assets to Verizon Wireless in 2012. It has also been pursuing greater geographic diversification outside of its strongholds in the New York and Los Angeles metro areas. Last year's acquisition of Insight Communications gave it a greater presence in several Midwest states. While subscribers to its traditional cable television segment have been declining, Time Warner Cable has been pushing so-called "triple play" packages of cable video, Internet, and voice services in order to shore up its overall customer base and improve pricing economics.
In fiscal 2013, Time Warner Cable eked out a top-line gain of 4% despite a slight decline in its overall subscriber base to roughly 15.1 million customers. The company's adjusted operating profitability also registered a modest decline. This was due to rising programming and customer service costs for its expanded network of properties which includes two new regional sports networks in the Los Angeles market. On the upside, though, Time Warner Cable's operating cash flow continues to exceed its capital needs by a solid margin. This allows it to aggressively deliver on its stock repurchase plans.
Handicapping the chasers
Given tough competition from the satellite television duopoly of DirecTV and Dish Network, as well as newer video-on-demand providers like Netflix and Hulu, further consolidation in the cable television segment seems to be the most likely path forward. Charter would certainly be throwing down the gauntlet with a bid for Time Warner Cable, a move that would likely cost more than $60 billion when outstanding debt is included. However, a combination would also give the combined company greater leverage in negotiations with content providers, an increasingly acrimonious source of disputes that often lead to temporary programming blackouts and lost revenues.
For its part, Charter has generated slightly higher top-line growth than Time Warner Cable, with a 7.4% increase that was aided by its July 2013 acquisition of Cablevision's Optimum West unit for roughly $1.6 billion. Like its larger competitor, Charter's profitability has been hurt by higher costs in the key areas of programming and customer service operations. While it has been successful at packaging services and increasing its average customer pricing, up 3% during the period, competition has made it difficult to pass along cost increases to the end consumer.
Of course, No. 1 cable operator Comcast (CMCSA -0.88%) might also want to put its hat into the merger ring. While a Comcast/Time Warner Cable tie-up would undoubtedly set off antitrust alarm bells, given a combined market share of over half of the cable industry, the current administration has allowed mega deals to proceed in a wide range of industries over the past year, from breweries to airlines.
However, Comcast is the one player that doesn't need to increase its size to remain competitive, given that its cable television subscriber base of roughly 22 million would remain the industry's largest even with the successful completion of a Charter/Time Warner Cable combination. Indeed, the company's cable unit has been performing well in FY 2013 with a top-line gain of 5.8% and a slight increase in its adjusted operating profitability, which tops the results of both of its smaller competitors. Comcast also successfully completed the acquisition of the remaining interest in NBC/Universal earlier this year, which provides ample cross-selling opportunities between its cable and broadcast networks.
The bottom line
With a market capitalization of roughly $37 billion, Time Warner Cable is a big nugget for anyone to swallow, but John Malone certainly has the resources to get a deal to the finish line. Charter also has very valuable net operating losses, totaling more than $7 billion at present, which it could use to shield the future operating profit of the combined enterprise. However, given Time Warner Cable's already significant move in anticipation of possible deal-making activity, further upside is likely capped and an investor's best bet is probably to watch this drama from the sidelines.
