Stock Multiples Are Running Low7/11/2004 8:00 PM Eastern
Cable analysts have recently noted that trading multiples (enterprise value divided by annual cash flow) for some of the biggest cable companies are nearing mid-1990s lows, as investors become increasingly more skittish of telephone-company competition.
In a research report, Citigroup Smith Barney cable and satellite analyst Niraj Gupta wrote that the largest MSO in the country, Comcast Corp., is trading at 9.1 times estimated 2004 cash flow and 8.2 times estimated 2005 cash flow.
Cox Communications Inc., one of the most respected cable operators on Wall Street, is currently trading at 8.4 times 2004 cash flow and 7.5 times 2005 cash flow.
Merrill Lynch & Co. media analyst Jessica Reif Cohen stated that since 1999, historic trough valuations for Comcast and Cox have been 9.6 times cash flow and 8.5 times cash flow.
WORSE TIMES BEHIND
“These valuations compare to those during the mid-1990s, when the industry faced two rounds of rate rollbacks, a massive upgrade cycle and had only one product, basic cable,” Reif Cohen wrote.
Those multiples are not quite at all-time lows — that was about 6.5 times during the mid-1990s — and they are way off from the historic high of 1999, when the cable sector traded at an average multiple approaching 16 times cash flow.
But perhaps more disconcerting is that the spread between cable multiples and that of their biggest competitors — the regional Bell operating companies — is closing fast.
In a research report, Gupta wrote that the current multiple spread between cable and the RBOCs is about 4.1 multiple points, as low as it has been in the past five years. On a forward year cash-flow basis, those spreads are even closer at just 3.1 multiple points, with Comcast (2.7 multiple points) and Cox (2 multiple points) trading at even tighter spreads.
Reif Cohen wrote that while cash flow has declined at SBC Communications Inc. and Verizon Communications Inc. — two of the more aggressive RBOCs in discounting high-speed data service — by 3% to 4%, their trading multiples are in the 8 times to 9 times estimated 2004 cash-flow range.
SBC has been on a run since the San Antonio, Texas-based RBOC announced it would launch a $4 billion to $6 billion upgrade plan over the next five years, building a fiber-to-the-premises (FTTP) network to new homes.
With existing homes, SBC would deploy a fiber to the node architecture, with each node serving 300 to 500 homes.
While the SBC announcement struck fear in the hearts of cable investors, Reif Cohen said that the plan is not as threatening as it appears to be.
Reif Cohen estimated that spending $4 billion to $6 billion over five years translates into a $1 billion annual investment by SBC. Assuming a blended cost of $500 per home to build fiber to the node and $1,200 per home for fiber-to-the-home, Reif Cohen estimated that SBC could upgrade about 1.3 million to 1.6 million homes per year.
While that may seem impressive, Reif Cohen estimates that it will take a very long time for SBC to complete the upgrade, given its 30 million home footprint.
“At this run rate, and assuming constant costs, it will take SBC nearly two decades to upgrade its entire network to deliver the promise of FTTP,” Reif Cohen wrote.
But Gupta was less optimistic, adding in his report that while the threat of RBOC entry into the video business hasn’t materialized after 15 years of speculation, this time it’s different.
And that difference, Gupta said, is cable telephony.
Gupta estimates that cable telephony will be available in 50 million homes nationwide by mid-2005, an obvious threat to the RBOCs’ core base.
According to Gupta, the recent efforts by SBC and Verizon — which claims to be building a fiber-to-the-home network in undisclosed locations in nine states — are being made to protect their respective telephony customer bases.
Adding to the benefit is that more fiber will help lower maintenance and operating costs, improve the speed of their digital subscriber line high-speed Internet services and make it easier to offer video.
While Gupta believes that cable will ultimately win the battle, he and other analysts wrote that the convergence of RBOC and cable multiples are practically inevitable.
Soleil Securities analyst Laura Martin wrote that she expects the gap to close, “but that the direction of the multiple convergence is within the power of these companies and will be based on their individual pricing and capital investment decisions. We think that cable will garner a long-term premium valuation multiple to the RBOCs.”
|How the Cash Flows|
|MSO and RBOC Cash-Flow Multiple Valuations|
|Company||Stock Price||EBITDA 2004E||2005E||EV/EBITDA 2004E||2005E (6/29/04)|
|Source: Citigroup Smith Barney