Cable operators have been reporting strong revenue and operating cash flow margins for the past three years, yet valuations for systems have been on the decline. While those numbers are beginning to rise — based on several recent transactions — two factors are driving increasing valuations: scale and new services.
Bond & Pecaro principal John Sanders said that average revenue growth for the major MSOs has averaged 13% since 2001 (15% in 2001, 15% in 2002 and 10% in 2003), while operating cash flow margins (cash flow as a percentage of revenue) have increased from 34% in 2001 to 37% in 2003.
Yet despite that growth — and the fact that free cash flow (cash flow after capital expenditures and interest payments are made) is becoming a reality for most MSOs — cable valuations have been disappointing.
“The average cable company on a private or public market basis is valued at 40% to 80% less than it had been,” said Sanders, speaking at the Broadcast Cable Financial Management/Broadcast Cable Credit Association conference in Atlanta last month.
The reason for those lower valuations is the specter of competition from direct-broadcast satellite service providers, uncertainty about the success of new services and the threat of increased regulation, Sanders said.
Kagan Media analyst Robin Flynn, however, said that valuations climb as scale and new services increase.
About $1.5 billion in transactions were completed in 2003.
“A lot of the consolidation in the industry is already done,” Flynn said.
At the same time, cash flow multiples for cable transactions decreased to 9 times, but that she said is more likely a factor of the size of the properties that were sold.
Flynn said that over the past five years, the average value per cable subscriber was $4,466 for systems with 500,000 or more customers, dropping to $1,731 per subscriber for systems with less than 5,000 customers.
“Size and scale are important in valuations,” Flynn said.
Perhaps more important is the level of service that cable operators provide.
Flynn said that over the past 10 years, a cable system with video-only service was valued at $2,200 per subscriber (or 9 times cash flow), while a system with core analog service, digital cable, high-speed data and telephony service was valued at up to $4,500 per subscriber (13.2 times cash flow).
The cost of debt is another factor in determining valuations — especially how much a buyer is willing to pay for a cable system. And even though interest rates are on the rise — after being at near all-time lows for the past few years — it shouldn’t have that much of an effect on valuations.
A greater influence, Sanders said, is whether cable operators can turn their new-found free cash flow into earnings.
“If you’re not getting returns greater than the cost of equity, you’re in static mode,” Sanders said. “Video has gotten a free ride for quite awhile. You’ve got to be profitable or you can’t stay in business. These are very good capital markets, but at some point you’ve got to start delivering net income.”