Deal or No Deal: Dolan Bid May be Stymied

With approval from a special transaction committee of independent directors in hand, Cablevision Systems’ Dolan family may believe its $36.26-per-share offer to take the cable company private is a slam dunk.

But the $10.6 billion deal — and the hopes of founder and chairman Charles Dolan, as well as CEO James Dolan — could be stuffed instead by what appears to be growing dissent among shareholders who must sign off on the transaction.

According to Cablevision, the Dolan buyout would have to pass muster with a “majority of the minority” of shareholders not affiliated with the family. No date has been set at this time for such a vote.

One such shareholder — Mario Gabelli, chairman of Gamco Investors, which holds about 20 million shares of Cablevision stock, or 8.5% of outstanding shares — wouldn’t reveal his voting intentions, but appears to be on the fence. Gabelli could be a critical shareholder for the Dolans to court. According to merger documents filed with the Securities and Exchange Commission on May 2, one of the conditions of the Dolan deal is that “the total number of dissenting shares shall not exceed 10% of the issued and outstanding shares of Class A Stock immediately prior to the filing of the Merger Certificate.” According to Gabelli, that means the deal could be terminated if more than 10% of shareholders dissent.

The Dolan family currently owns 20% of Cablevision’s equity and 74% of its voting power.

Gabelli said the Dolans’ offer values the entire company at about $22 billion, or between 10.5 times and 11 times 2007 cash flow — a low mark, in his view, considering the other assets in the mix, including Rainbow Media Holdings and the Madison Square Garden unit.

“We think we’ve got $4.5 billion of value,” Gabelli said. “You are entitled as entrepreneurs to a piece of that. And I’m not opposed to giving a couple of billion, but I’m not so sure I want to vote in favor of $4.5 billion.”

Salvatore Muoio, principal and chief investment officer of S. Muoio & Co., a New York based securities-advisory firm which owns Cablevision shares, echoed the sentiment. “It’s not a layup that you vote for it, from my perspective,” Muoio said.

The Dolans received approval of their proposal from the special committees on May 2, the same entity that rejected the family’s past two offers to take the company private. As part of the deal, the Dolans will contribute about $2.1 billion in equity to the new private entity, funding the rest of the deal with $15.5 billion in debt financing from Merrill Lynch & Co., Bear, Stearns & Co. Inc., and Bank of America.

Investors such as Gabelli and Muoio have weathered past rough times at Cablevision, including subpar financial performance and the sometimes-erratic stewardship of James Dolan. Having stuck with the company through that, they are angered that the Dolans are attempting to take Cablevision private just as they were beginning to reap the benefits of the company’s recent stellar operating performance.

And they are also upset that going private would lock them out of the huge potential windfall of an eventual sale of the cable systems to Time Warner Cable or Comcast, two large multiple-system operators who would likely pay large sums to pick up Cablevision’s New York-area systems.

Granted, Cablevision shareholders have seen their holdings appreciate nicely in the past three years. The stock was up 23% in 2006 — a 66% gain, if a $10-per-share special cash dividend issued that year is factored in — and the shares have more than doubled in price, from $17.71 a share Jan. 2, 2003 to $35.90 a share on May 2, 2007.

Between 2003 and 2006, annual revenue grew 9% a year, from $4.2 billion to $5.9 billion. Annual adjusted operating cash flow rose 13.3% a year, from $1.1 billion to $1.8 billion.

That growth continued in the first quarter of this year, with cable revenue and cash flow up 15.4% and 12%, respectively, from the prior year. Free cash flow — cash flow after capital expenditures and interest payments are made — in the first quarter was $81 million, a $186 million swing from the $105 million free cash flow deficit in the same period last year.

It is that free-cash-flow growth, and expectations that it could expand exponentially over the next two years, that has some analysts doubting that the deal will be approved.

In a research report, Sanford Bernstein cable analyst Craig Moffett wrote that the Dolan offer — somewhere between 10.5 times and 11 times estimated 2007 cash flow — could be seen as well short of the true value of the company.

“Once again, Cablevision — or, at least, the Dolans — may prove to be victims of their own success,” Moffett wrote.

Pali Research media analyst Richard Greenfield was more blunt. In a report titled Just Say No to Chuck and Jim, Greenfield urged shareholders to vote against the deal, claiming that in a year the Dolan family could pay as high as $50 per share to take Cablevision private, based on his free-cash-flow estimates.

Greenfield estimated that Cablevision could end this year with $413 million in free cash flow, compared to the $75 million it generated in all of 2006. In 2008, Greenfield estimated that free cash flow will nearly double to $764 million.

“The Dolans want to harvest Cablevision’s free cash flow for their own personal benefit, while enabling themselves to capture 100% of the profits from an eventual sale to Time Warner,” Greenfield wrote in his report.

That “eventual” sale to Time Warner was also a concern to Muoio, who lamented the lack of a public “stub” in the deal. With such a stub, a portion of the company would remain public to allow current investors to participate in a future sale of the cable assets.

“It’s a great business, it’s got a long way to go, you’re just entering a phase where free cash [flow] is going to start to get a lot larger,” Muoio said. “You want to participate in that. You want to participate in the sale to Time Warner.”

Gabelli said that a public stub would be a major plus for shareholders but for one reason: the Dolans want nothing to do with the public markets.

“The Dolans don’t want to deal with the public [markets],” Gabelli said. “They love me, but they don’t love me.”

Gabelli added he is pleased with the returns he has received on his Cablevision stock — he claims he “stood up and cheered” after Cablevision declared the $10-a-share cash dividend last year — but the deal as it stands appears to heavily favor the Dolans.

This is the Dolan family’s third attempt in two years to take the company private. Its first offer in 2005, for $21 per share, was rejected as too low. In 2006, the family upped the ante to $27 per share and later increased its bid to $30 each, only to be rejected again by the special committee.

This time, Cablevision decided to go directly to the source in crafting another bid, reaching out to former investment banker Thomas Reifenheiser and State University of New York Chancellor John Ryan — the two members of the special committee — at the cable company’s annual board meeting in Palm Beach, Fla., in March, according to a report in The New York Times. In a private meeting, the Dolans pressed the two men for an indication of what price would ultimately be accepted. According to the Times, after consulting with investment advisers Lehman Bros. and Morgan Stanley, a $10.6 billion price tag was agreed upon.

Now all that is left is to reach the same consensus with shareholders.