Finance

Malone Back Home in U.S. Cable

Industry Pioneer Takes $2.6B Stake in Charter, Spark Street Speculation 3/24/2013 8:00 PM Eastern

Liberty Media chairman John Malone re-entered the U.S. cable market in a big way last week, agreeing to invest $2.6 billion in Charter Communications, and taking a 27% stake in the Stamford, Conn.-based MSO.

But as with all deals involving the cable legend, Wall Street and the cable industry are wondering what his next step may be.

Liberty agreed to purchase 26.9 million Charter shares at $95.50 each and 1 million warrants from three of the MSO’s stockholders — Apollo Management, Oaktree Capital Management and Crestview Partners. After the deal is closed, expected in the second quarter, Liberty will control 27.3% of Charter stock, Apollo will no longer be a shareholder and Crestview and Oaktree will hold 7.4% and 2.2%, respectively.

As part of the deal, Liberty agreed not to increase its Charter stake above 35% before January 2016 or above 39.99% thereafter.

The price represents a 6% premium to Charter’s share price on March 15. But already, the deal seems like a bargain for the Denver-based media giant — Charter’s stock was up by nearly $16 per share (17%) in the days after the deal was first said to be in the works, after The Wall Street Journal on March 18 reported that the two parties were in talks. Charter stock closed at $102.36 per share on March 21, up 14% ($12.64 each) from its $90.09 per share price on March 15.

ACQUISITION VEHICLE?

Most of that increase was due to speculation as to what Malone, the former chairman of Tele-Communications Inc., would do with Charter. Several analysts have speculated that he could use Charter, whose 4.2 million subscribers are primarily located in secondary markets in the Midwest, Southeast and Southwest portions of the country, to acquire other smaller independent operators.

“We foresee plenty of scale opportunities for geographically contiguous system swaps and acquisitions over time, given the broad Charter footprint,” ISI Group media analysts Vijay Jayant and David Joyce wrote in a recent report.

Morgan Stanley media analyst Ben Swinburne added in a report that the investment could merely be Liberty taking advantage of a unique opportunity.

“[I]t is not often 25% of a publicly traded U.S. cable operator comes to the market,” Swinburne wrote. “Moreover, while Charter [stock] is up 170% from its post-bankruptcy exit, it is a unique opportunity within cable given its current market share and a less competitive broadband footprint. Charter has all the elements of a [Liberty] investment, leverage- able cash flow and a tax shield.”

Swinburne was less focused on any possible acquisitions binge, adding the combination of Liberty and Charter may have more of an impact on programming costs.

CONTENT COST FALLOUT

“One area to watch is this content cost pressure, and whether a Liberty-backed Charter might take a more aggressive approach to negotiations, including dropping full suites of channels or pushing for sports networks to tiers,” Swinburne wrote. “Charter does not have the size to drive these structural industry changes on its own, but it could attempt to tilt the balance of power.”

For the time being, Liberty is keeping its plans close to the vest.

“We are pleased with Charter’s market position and growth opportunities and believe that the company’s investments in its high-capacity digital network, which provides digital HD and on-demand television, high-speed data and voice, will benefit its customers and shareholders alike,” Malone said in a statement.

In an interview with cable business news channel CNBC last week, Liberty CEO Greg Maffei said the deal represented an opportunity for the Denver media giant to invest in a growing company at an attractive price.

“It’s rare when you have an opportunity to buy a significant stake and have the influence that Liberty would like to have and will have at Charter,” Maffei told CNBC.

Maffei added that Liberty will keep its eyes open for additional opportunities, including acquisitions.“If opportunities arise for incremental acquisition, that’s only a further benefit,” he told CNBC.

Under deal terms, Liberty will receive the right to elect four members to Charter’s 11-member board. In a statement, the company said it has already made its selections — Malone, Maffei, Liberty Global chief technology officer Balan Nair and Barnes & Noble chief financial officer Michael Huseby. Malone also is chairman of Liberty Global, the largest MSO in Europe with about 19.8 million customers in 13 countries. Liberty Media also owns a large interest in book retailer Barnes & Noble. Huseby, who joined B&N in March 2012, is the former CFO of Cablevision Systems.

Charter has gone through a dramatic transformation since it emerged from Chapter 11 bankruptcy protection in 2009. Armed with a cleaner balance sheet, the MSO hired former Cablevision Systems chief operating officer Tom Rutledge as CEO in December 2011. Since then, Rutledge, considered one of the top cable managers in the industry, has peppered Charter management with former Cablevision executives.

He quickly revamped Charter’s channel packages and offerings, increasing the number of HD channels, eliminating its lowest broadband tier and beefing up customer service. With the lowest penetration rates for video (34.2%) and high-speed Internet (30%) in the industry, many analysts believe that Charter has the greatest potential for growth among the top MSOs.

ALREADY DEALING

But just what Malone will do once the deal closes remains to be seen. Charter and Rutledge have already proven they aren’t afraid to do deals — the MSO agreed to purchase Optimum West, the former Bresnan Communications, from Cablevision in February for $1.6 billion. And there seems to be opportunity for further consolidation, either through swaps and sales with the five largest MSOs that account for more than 80% of the estimated 56.4 million U.S. cable customers, or the thousands of other smaller independent operators that make up rest of the industry.

Or they may decide to do nothing. As Pivotal Research Group principal and senior media & communications analysts Jeff Wlodarczak put it, the purchase will allow Liberty to participate in both U.S. and international cable and the potential upside in Charter stock if it lives up to its vast potential.

“Do I think they are likely to be acquisitive now that Malone [and] Maffei are involved?” Wlodarczak wrote in an email. “Yes, if they can get the right price. They are not going to expand just to expand.”

TAKEAWAY

Is John Malone’s move to take a $2.6 billion stake in Charter a signal that further deals are in the offing?

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