As the nearly year-long auction of Adelphia Communications Corp. enters its final stretch, Sanford Bernstein & Co. cable analyst Craig Moffett has some advice for potential bidders: Don’t do it — at least not at the price they’re asking.
Adelphia, on the block since April, has set Jan. 31 as the date for final bids to come in. While the Denver-based MSO has not discussed possible pricing for its properties, its unsecured creditors have set an unofficial minimum price of $17 billion.
|<p>Subscriber Density</p>||<p>(Subscribers per square mile)</p>|
Time Warner Cable
Last September, Adelphia split itself into seven separate clusters to facilitate the auction and attract more potential bidders. Those clusters are: Los Angeles and West (1.5 million subscribers); Florida and Southeast (891,700); Buffalo and Connecticut (408,800); New England and Eastern New York (554,900); Cleveland and Ohio (638,200); Pennsylvania (518,000); and Virginia/Maryland/Colorado Springs/Kentucky (869,700).
While more than 50 interested parties have signed confidentiality agreements for the properties, Time Warner Inc. and Comcast Corp. have long been the front-runners and were expected to make a joint bid by the Monday deadline.
Moffett’s warning is based on an exhaustive research report that analyzed one of the lesser-known metrics in cable valuations: subscriber density, or the number of subscribers a cable company has relative to the square mileage of its footprint. Moffett argues that subscriber density is a key component in determining the true value of Adelphia — it’s a major driver of operating cost efficiency and capital efficiency, and therefore of the margins and returns on invested capital.
At 5.2 million subscribers Adelphia is the fifth-largest MSO in the country. But Moffett reports that it is near the bottom of the pack in subscriber density.
According to Moffett’s report, Adelphia averages about 93.1 subscribers per mile, seventh out of the top 10 MSOs. And to go with that low subscriber density are the lowest cash-flow margins in the industry — 26%, according to Moffett.
While the correlation between density and cash flow is clear — fewer subscribers per mile means less revenue and higher costs to bring service to those areas — it also has a direct link to direct-broadcast satellite penetration.
Of the seven Adelphia clusters, Virginia has the lowest density (22.1%) and the second highest DBS penetration (26.2%). Ohio, which has the highest DBS penetration (26.6%) has the third-lowest density (26.8).
Even if Time Warner and Comcast do win out in the Adelphia auction and split the company along their own geographic lines — Los Angeles, Buffalo and Cleveland for Time Warner Cable; Florida, New England, Pennsylvania and Virginia for Comcast — the reality is that adding those properties could hurt their respective new owners by lowering their overall subscriber density.
For example, the Pennsylvania cluster seems ideal for Comcast because it is located between Philadelphia and Pittsburgh, two of the MSO’s largest markets in that state.
“It’s only after you do a density analysis that it becomes obvious that those properties are effectively a bunch of farms that could [have] a very high cost to serve,” Moffett said in an interview.
Adding to the difficulty is that at $17 billion, Adelphia is valued at 14.7 times cash flow, a huge multiple compared to the rest of the industry, which is trading at cash flow multiples ranging from 8 times to 10.2 times. Comcast, which has about 4 times more subscribers than Adelphia, trades at about 9.3 times cash flow.
That could make a stock deal more difficult — paying nearly 15 times for a company when your own stock is trading at less than 10 times won’t go over well with investors — and also makes it nearly impossible for private equity players to guarantee their partners the 20% and above returns typical of such deals.
While Moffett said the prevailing wisdom is that Comcast or Time Warner could sell off the less-desirable systems, he said it is unlikely that they would be able to fetch an attractive price.
“In order to make those economics work, you have to be able to achieve a high enough price for the disposals that the net price of the parts you want to keep is acceptable,” Moffett said in an interview. “It’s not clear that the market is robust enough for the rural disposals to make that strategy work.”