I spend much of my time in search of companies that possess
robust growth prospects. But I'm also content to occasionally focus
my energy on companies that are unlikely to grow meaningfully. The
catch: these companies must be able to generate a huge amount of
from their sales base in a consistent manner. Or they need to own a
set of assets that would be highly coveted by other firms in an
I think I've found a company that checks off both of those boxes.
generates stunning amounts of
free cash flow
. And recent events make me think the company may soon receive a
from a rival or a private-equity (PE) firm.
An industry that has peaked
It's no secret cable companies face myriad threats. Some consumers
have balked at $100 monthly bills and are now content to simply
surf the web for their evening's entertainment. (In the case of
Cablevision, we're talking about a $150 average monthly bill.)
Other consumers are ditching their cable providers for
satellite-based providers such as
(which, incidentally, can consider me a very happy new customer
after making a recent switch).
But rumors of cable's demise are greatly exaggerated.
The vast majority of consumers are sitting tight, continuing to get
cable service along with Internet access and phone service -- all
from a company with which they already have a longstanding
Simply put, cable companies such as Cablevision, which already has
3.6 million customers, are hard-pressed to find any new customers
at this point in their life cycle. At the same time, they are not
likely to see their customer base materially shrink, either. So
their real focus is on squeezing out profits from every bill. And
boy, is Cablevision profitable...
In 2010, for instance, Cablevision generated $7.2 billion in
revenue and $2.6 billion in
. This worked out to be 36% EBITDA margins, which is quite
impressive in any industry, let alone one that is mature and
subject to fierce competition.
In recent quarters, investors have grown concerned that rising
costs to ESPN and other networks will materially weaken results.
The comparisons with 2010 are imprecise because Cablevision spun
out its ownership of AMC Networks (Nasdaq:
) this summer, but it now looks as if Cablevision could generate
roughly $6.6 billion in sales and $2.2 billion in EBITDA in 2011.
This means the EBITDA
is dropping to 33% -- still a very solid number.
But forget EBITDA. The real metric investors should focus on is
free cash flow, which is likely to exceed $600 million this year.
sport a free cash flow
above 14%, which is among the highest free cash flow yields you
will find anywhere. (To get to this figure, you simply take the
projection -- $600 million -- and divide it by the stock's
cap -- which is about $4.17 billion.) As a point of reference,
rivals such as
Charter Communications (Nasdaq:
sport free cash flow yields of around 10%.
The robust free cash flow is currently being deployed to share
buybacks. The total share count likely fell by roughly 20 million
shares to 280 million shares in 2011.
The pieces are in place
Investors increasingly sense that something is afoot at
Cablevision. In 2010, the controlling Dolan family -- which owns
20% of the company -- decided to spin off sports-focused
MSG Networks (NYSE:
. And as noted earlier, Cablevision spun out AMC Networks this past
summer. The company is clearly streamlining in anticipation of
Just last month, Cablevision's long-standing Chief Operating
Officer Tom Rutledge left the company. This has led to
that the Dolan family would like to put Cablevision up for sale.
Indeed, shares initially slumped on word that the company had lost
a long-standing respected leader, but as the
thesis started to ripen, shares have rebounded. (Rutledge
subsequently was named the new
of Charter Communications.)
Shares of Cablevision have fallen from a peak of $38 in February
2011 to a recent $15. Subtract the $12 value associated with the
spin-off of AMC Networks this summer, and we're really talking
about a fall from $26 to $15.
At current prices, the Dolan family has several choices...
First, the Dolan's can apply the $600 million in annual free cash
flow directly toward stock buybacks, reducing the share count by
nearly 15% every year.
Second, they could take the company private themselves (as they've
tried to do before). Cablevision's stock is worth about $4.2
billion and its
is about $10.3 billion, adding up to an
of $14.4 billion. Let's suppose the company was offered to be taken
private for $17 billion, implying an equity valuation of $6.7
billion (17 - 10.3 = 6.7).
If this math is correct, then investors would be looking at a 61%
premium to the current share price. Don't scoff. This is target is
less than what Cablevision was worth early in 2011.
The third option:
Time Warner Cable (NYSE:
or another such entity could also offer a similar price and pull
off an accretive deal.
Cablevision has the industry's best demographics, due to the
relative affluence of its Long Island, New York, New York City and
New Jersey customer base. Time Warner and others have long coveted
that footprint and the $150 monthly bills that this demographic
What are the odds the Dolan family will put the company on the
block? "The sale of Cablevision, in some respects, is both natural
and perhaps, inevitable. We may only be arguing about timing,"
notes Smith Barney's Jessica Reif Cohen. She adds that shares
should trade up to $21, even without a sale, as that translates
into a 10% free cash flow yield where its peers trade.
Risks to Consider:
Further economic weakness in 2012 may lead more consumers to
"cut the cord," which would reduce Cablevision's customer base and
substantial free cash flow.
Action to Take -->
Buyout or not, this is a cheap stock when you measure the
against the company's impressive free cash flow. The Dolan family
may simply stay the course and pay off debt while buying back
stock. Even if this happens, Cablevision's enterprise value would
steadily fall, making the highly-prized customer base an even more
. If we apply Smith Barney's $21 target to Cablevision, then this
works out to be about 40% upside.
-- David Sterman
David Sterman does not hold positions in any securities
mentioned in this article. StreetAuthority, LLC does not hold
positions in any securities mentioned in this article.
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