It’s Public: TWC Stock … Overvalued?

Time Warner Cable traded modestly in its first day on the New York Stock Exchange, gaining about 18 cents per share from its opening price of $38.75 each on March 1, closing the day at $38.93 per share.

Timing was most likely the biggest factor in the stock’s sluggish performance. It began trading just two days after a 416-point drop in the Dow Jones Industrial Average Feb. 27 and as cable stocks in general have been losing ground, with investors becoming wary of capital-expenditure increases and believing that shares are trading at fair value.

For example, Comcast, which rose about 60% in 2006, has dipped about 13% since it released its earnings on Feb. 1 and disclosed that capex will rise by about $1.1 billion in 2007.

Time Warner Cable officially became a public company on Feb. 13, the day that Adelphia Communications’ bankruptcy plan was approved. Time Warner Inc., which jointly purchased Adelphia’s assets with Comcast in July for $17.4 billion, had planned to spin off Time Warner Cable as part of the deal, through the already-public Adelphia shell.

As part of that deal, Adelphia creditors received 16% of Time Warner Cable’s outstanding stock, with the remaining 84% held by parent Time Warner Inc. It was expected that Time Warner Cable would have about 976 million shares outstanding, meaning its market capitalization based on the Thursday close is about $38 billion.

Time Warner Cable stock had been on the over-the-counter “when-issued” market since Jan. 5, trading as high as $44 per share during that period.

While the stock ended up trading much lower, it still is at a substantial premium to other large cable operators such as Comcast ($25.54) and Cablevision Systems ($29.49).

In a report, Pali Research media analyst Richard Greenfield wrote that he believes Time Warner Cable stock is overvalued, given its holding-company structure, the need for increased capital spending to upgrade the former Adelphia systems and the fact that only 30% of its subscribers are in the top 10 designated market areas (vs. 40% for Comcast).

Greenfield wrote that while investors may be expecting Time Warner Cable to grow at a faster clip that its peers in 2007, he believes the cable company will perform along the lines of other large cable companies such as Comcast and Cablevision.

In a conference call with analysts Feb. 28, Time Warner Cable executives said revenue and cash flow should rise by more than 30% in 2007 and that capital expenditures will rise between $600 million and $800 million for the year, mainly because of the integration of about 4 million new subscribers as a result of the Adelphia deal. Time Warner also estimated that it would generate between $800 million and $1 billion of free cash flow in 2007.

Time Warner Cable chief operating officer Landel Hobbs said the company’s “Start Over” program-replay service will be rolled out to a majority of its systems by the end of the year. Time Warner Cable also plans to add 200,000 digital telephone customers in the former Adelphia markets by the end of 2007, as well.

But the newly acquired systems are going to need a lot of work. While Time Warner Cable has made some integration headway already — it has converted 14 of 23 billing systems; migrated 80% of high-speed Internet customers to its product; completed most channel-lineup changes and made digital phone available to about 900,000 homes in acquired markets — operating performance at the new systems is significantly behind Time Warner Cable’s legacy systems.

That presents a big opportunity once the integration is complete, which is expected by the end of the year. To illustrate that point, chief financial officer John Martin pointed out that average revenue per unit at the new systems trails the legacy properties by about $18 per month; cash flow margins are 10 percentage points below the legacy properties; video penetration rates are 42% at the new systems, versus 56% in its other systems; and high-speed data penetration, at 17%, is 13 points below the rest of Time Warner Cable.

The numbers are even more dramatic at two of the largest properties Time Warner Cable acquired in the deal — Los Angeles and Dallas. Those two systems accounted for 80% of the 52,000 basic subscribers lost in the new properties in the fourth quarter, have video penetration rates of about 30% and have cash-flow margins 5 points to 10 points below the other new properties.

Hobbs said Time Warner Cable should begin to stem subscriber losses in Los Angeles and Dallas in the second half of the year.

“We’re placing a lot of focus on the acquired systems in L.A. and Dallas,” Hobbs said. “While these systems present the biggest challenges, they also represent significant long-term opportunity.”