Cable Industry Consolidation Is Heating Up

John Malone has used a series of acquisitions to create a powerhouse in the media, communications, and entertainment industries. He also took a 27% stake in Charter Communications (NASDAQ: CHTR  )  so he can consolidate the cable industry in the U.S. Recently, he has eyed Time Warner Cable (NYSE: TWC  ) , the second-biggest U.S. cable player, as a potential target. Comcast (NASDAQ: CMCSA  ) has also shown intent to acquire Time Warner Cable to strengthen its leading position in the cable industry.

Potential synergies from a Time Warner Cable deal
Time Warner Cable ranks second in the U.S. cable industry with 11 million subscribers, only behind Comcast which has around 22 million subscribers. Charter Communications comes in at third place with 4.2 million. If Comcast successfully buys out Time Warner Cable, the merged company's total subscriber count will reach 33 million and it could easily scale up its footprints in both the Los Angeles and New York markets. If Time Warner Cable becomes part of Charter Communications, Charter Communications will serve around 15.2 million subscribers and replace Time Warner Cable as the second-largest U.S. cable company.

Many media executives think that a Charter Communications and Time Warner Cable merger could produce as much as $700 million in annual synergies that would include lower programming costs, lower capital spending, and reductions in other operating expenses. 

Charter Communications will rely on a lot of leverage for this acquisition
Charter Communications is a much smaller company than Time Warner Cable. In order to make an acquisition, Charter Communications will have to rely on a lot of leverage and issue a lot of stock which will dilute existing shares. Currently, Charter Communications has around $14.3 billion in debt and a high net debt/EBITDA leverage ratio of 6.1. Time Warner Cable has nearly $24 billion in net debt.

Thus, if Time Warner Cable is acquired by Charter Communications, Charter Communications will be saddled with as much as $64 billion in debt, including $25 billion of existing Time Warner Cable's debt, $14 billion of Charter's debt and the new $25 billion of new debt financed for this acquisition.  With a combined EBITDA of $10.5 billion , the leverage ratio will still be very high at 6.4. Comcast, on the other hand, has a much more conservative balance sheet considering its EBITDA. Comcast's net debt/EBITDA comes in at only 1.93.

Consistent cash return to shareholders
Shareholders of both Comcast and Time Warner Cable have been quite happy with their consistent cash returns.  Since the beginning of the year, around $3 billion has been returned to Comcast's shareholders, which includes $1.5 billion in dividends and another $1.5 billion in share buybacks. At the current trading price, Comcast offers investors a decent dividend yield at 1.60% while Time Warner Cable gives its shareholders a higher dividend yield at 2%. 

Looking forward, I expect that Comcast will return the $2 billion left in its share buyback authorization, giving investors an additional yield of 1.50%. Time Warner Cable has also accelerated its cash return to investors. For the full year, it plans to repurchase at least $2.5 billion worth of shares, creating a high buyback yield of 6.7% for its shareholders. 

The rumor was that Charter Communications would offer Time Warner Cable around $135 per share. The bid of $135 per share offer does not sound very compelling. At $135 per share, Time Warner Cable would be valued at only 8 times its EV/EBITDA, or earnings before interest, taxes, depreciation, and amortization. At an EBITDA multiple of 8, Time Warner Cable is in-line with Comcast's valuation but much less expensive than Charter Communications' EBITDA multiple of more than 10.1. With the highest dividend yield and buyback yield, a reasonable leverage ratio, fast-growing operating performance and a leading position in the U.S. cable industry, I think Time Warner Cable deserves a higher EBITDA multiple. 

My Foolish take
Whether Comcast or Charter Communications is the buyer of Time Warner Cable, its shareholders will end up with some cash and some shares of the acquirer. I think Time Warner Cable's shareholders might be better off if the company is acquired by Comcast rather than Charter Communications, because Comcast has a stronger balance sheet, a much lower leverage ratio, a similar valuation, and a commitment to return cash to its shareholders. 


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