Cable Operators

Sweet on COX

10/24/2004 8:00 PM Eastern

Cox Enterprises Inc. ended the speculation over whether it would sweeten its offer to take its Cox Communications Inc. cable unit private last week, upping its bid by $2.75 per share to $34.75 — a move some analysts believe will help increase valuations of other MSOs.

CEI, which owns 62% of Cox Communications, increased its previous bid of $32 per share for the 38% of CCI it doesn’t already own on Oct. 19. The deal represents an 8.6% premium to its previous offer of $32 per share in August and is valued at about $8.5 billion, up from the prior $7.9 billion.

Will Values Rise?
How the publicly-traded MSOs are currently valued:
Company Cash Flow Multiple Enterprise Value/Subscriber
Comcast 9.4 $3,228
Charter 10.6 $3,383
Cox 10.3 $3,987
Cablevision 9.0 $3,424
Mediacom 8.7 $2,508
Insight 9.4 $3,098
AVERAGE 9.6 $3,271
Source: Banc of America Securities estimates

Privately held CEI owns 78 radio stations, 15 television stations, and 17 daily and 25 non-daily newspapers across the U.S., including its flagship Atlanta-Journal Constitution.

The $34.75-per-share offer values Cox at nearly $4,000 per subscriber, a substantial premium to other MSOs in the sector.

For example, Comcast Corp., the country’s largest cable company with 21.5 million subscribers — more than three times Cox’s 6.3 million — is valued at about $3,228 per customer.

The average valuation for the sector is about $3,271 per subscriber.

CEI’s willingness to raise the price was seen by some analysts as a vote of confidence toward a sector that could use one, not a signal that third-quarter results would be dramatically lower than expected.

Cable stocks as a whole are down about 10% this year, despite robust revenue and cash-flow growth.

“We think the logic that the deal implies things are getting worse in cable is intellectually bankrupt,” wrote Banc of America Securities analyst Doug Shapiro in a research note.

Shapiro noted that the $34.75 price implies a valuation of 10.3 times 2004 estimated cash flow for Cox.

Using that multiple, Comcast is worth $37 per share (a 34.5% increase over its Oct. 21 stock price of $27.50) and Cablevision Systems Corp. is worth $27 per share (38.5% above its Oct. 21 close of $19.50 each).

LITTLE IMPACT SO FAR

So far, the cable sector has seen little effect from the deal.

Not including Cox shares — which rose 95 cents to $34.40 per share between Oct. 18 and Oct. 21 — cable-sector stock prices fell a cumulative $1.23 during the period. The biggest losers were Comcast, which lost 82 cents and Cablevision Systems Corp, which lost 63 cents in the period.

Oppenheimer & Co. cable analyst Tom Eagan said that investors are likely waiting for third-quarter results, expected to kick off Oct. 27 with Comcast.

Cox will also report its third-quarter results that same day, but will not hold a conference call with analysts.

While its publicly traded cable brethren wait for a boost to their stock prices, Cox is apparently relishing the idea that it will no longer be beholden to Wall Street.

Cox has chafed at the decline in its stock price over the past few years — the stock has dropped about 40% from its high of $58.35 in 2000 and was down about 20% this year prior to the August proposal — despite 16 consecutive quarters of double-digit pro forma operating cash flow increases.

DISNEY BID 'HURT ALL’

CEO Jim Robbins has expressed his exasperation on more than one occasion. At the National Show in May, Robbins said on a panel that Comcast Corp.’s bid for the Walt Disney Co. (which was dropped in April) “hurt all of us.”

Even in a carefully worded letter to employees issued Oct. 19 and filed with the Securities and Exchange Commission the same day, it appeared Robbins could hardly contain his glee.

“Eliminating the volatility of public trading values for our stock better positions us to run our company for the long-term benefit of our customers,” Robbins said in the letter. “We already have the right people, properties and technology, and now we no longer must be subject to Wall Street’s generally shorter-term thinking.”

Sanford Bernstein & Co. cable analyst Craig Moffett said he’s not surprised Cox would be pleased to not have to answer to Wall Street.

“Jim Robbins has got a business to run,” Moffett said. “He’s not going to miss screwing around with sell-side analysts like me.”

While Robbins won’t have to dance for Wall Street every three months as he has had to in the past, the MSO will still have to file its financial statements with the SEC because it has public debt.

The process to take CCI private could conclude fairly quickly — CEI has said it expects the deal to close in mid-December — and several analysts said that they expect further asset sales by CCI to help finance the deal.

CEI has already set up financing from three banks — $10 billion secured by Citigroup Inc., Lehman Bros. and JP Morgan — and expects to use the remaining $1.5 billion for working capital for the cable unit.

But many observers expect Cox to announce some kind of asset sale either before or slightly after the deal is closed, to raise money to preserve its investment-grade credit rating.

Although the deal is fully financed, the $10 billion financing could push Cox into junk-bond territory — it would raise its leverage ratio to 5 times cash flow, above the investment grade threshold of 4 to 4.5 times cash flow. Most analysts said that the most likely asset to sell would be its 25% stake in Discovery Communications Inc., with Liberty Media Corp. being the most logical buyer. Most analysts value Discovery at between $13 billion and $15 billion, making Cox’s interest worth $3.25 billion to $3.75 billion.

Liberty, which already owns 50% of Discovery, has said several times over the past few years that it would like to consolidate the networks.

The other partner in Discovery is Advance/Newhouse Communications, which holds the right of first refusal to Cox’s interest. If A/N passed on buying the Cox interest, Liberty would then have the option to buy the stake.

Merrill Lynch & Co. media analyst Jessica Reif Cohen, who values Cox’s Discovery stake at about $2.5 billion, said a deal for the network is likely.

“We believe CEI and Cox would seek to retain its investment-grade profile, and we believe Cox’s 25% stake in Discovery Communications is a prime candidate for sale as it is a nonstrategic equity investment and its cash flow is not consolidated,” Reif Cohen wrote in a research report.

LIBERTY: NO TALKS

Liberty spokesman Mike Erickson said that the media giant would love to own a larger stake in Discovery, but that it has had no discussions with Cox.

During an August conference call with analysts to discuss second-quarter results, Liberty CEO Dob Bennett said that CEI has said its proposal to take Cox Communications private was fully financed.

“They have advised us that their deal is fully financed, and that they have no obligation or need to sell their interest at the time,” Bennett said on the call. “But if they change their mind in the future, we expect that they will contact us.

“In the meantime, we will continue to work with our strong management team there and with our partners at Cox and Newhouse to make Discovery just as valuable as we possibly can.”

Cox Communications spokeswoman Ellen East said the company does not anticipate any asset sales. But she also said Cox has said in the past it would swap its Discovery interest only for cable systems.

Moffett said maintaining the investment-grade rating probably is not as important to Cox for two reasons: it would no longer be publicly traded and it doesn’t have a burning need for capital.

“It’s possible they could decide it’s worth doing a deal for Discovery if they can tip the deal from being below investment grade to above investment grade so they can save money on interest costs,” Moffett said. “It’s not like the debt they are taking on is a necessary evil. I think they’re probably perfectly happy to take on debt.”

Moffett added they could eventually pay off that debt through free cash flow generated by the business.