On November 25, 2013 Seeking Alpha's Market Currents had the following news:
- Wells Fargo analyst Marci Ryvicker looks at what a joint Comcast (CMCSA)/Charter (CHTR) bid for Time Warner Cable (TWC) would look like, with speculation of such a deal ripe (see here and here).
- "There has been much TWC M&A speculation ever since Dr. John Malone took a 27% stake in CHTR in March of this year. Since that time, our view has been (and continues to be) that a break up (rather than an outright purchase by one player) of TWC is most logical; so, we were not surprised by recent press reports suggesting that CMCSA and CHTR might be working together to generate a joint bid for the cable company."
- On the value, she writes: "We calculate ~$1.4B of annual synergies for a CMCSA-TWC partial bid, and ~$700M for CHTR for a CHTR-TWC partial bid, leading to a potential bid of $160 for TWC shares."
Whenever I see the name Dr. John Malone in the news, my mind automatically turns to M&A as Dr. Malone is a grand master in the M&A chess game. I have been watching his moves for over 20 years now and he never disappoints. His specialty is in buying beaten down companies and using leverage (other people's money) to restructure and either merge them or sell them off, usually at a considerable profit. In this case, he is even better situated as very few people know the cable TV business better than Dr. Malone, as he is a pioneer in the industry, having served for twenty-four years, from 1973 to 1996, as President and CEO of Tele-Communications Inc. (TCI). After going public in 1970, the company grew rapidly, and became the top cable provider in the United States. It was purchased in 1999 by AT&T, whose cable television assets were later acquired by Charter Communications and the Comcast Corporation. It seems that Dr. Malone is coming back to his roots in this potential deal.
Now let us analyze Time Warner Cable through a stringent free cash flow analysis and determine what it may be worth per share to Comcast or Charter.
This analysis will use the following six free cash flow ratios:
- Price to Mycroft Free Cash Flow
- Mycroft/Michaelis Growth Rate
- Free Cash Flow Payout Ratio
- Free Cash Flow Reinvestment Rate
Those new to this analysis can find an introduction by going here that will explain in detail how each of these ratios is calculated. When used together, these unique ratios will generate a quantitative picture of a company's underlying fundamentals, including strengths and weaknesses.
The "2014 Mycroft Free Cash Flow Per Share" estimate in the table above for Time Warner Cable is generated by taking the trailing twelve months (TTM) free cash flow result and then adding my Mycroft/Michaelis Growth Rate into the equation in order to generate forward looking estimates for 2014. That growth rate is generated by using my FROIC ratio (Free Cash Flow Return on Invested Capital). Basically FROIC tells us how efficient operations are as it zeros in on how much free cash flow is generated for every $1 of total capital employed. Time WarnerCable has a FROIC of 7%, which means that for every $100 of invested capital, it generates $7 in free cash flow. Now my Mycroft/Michaelis Ratio takes that 7% and multiplies it by the firm's free cash flow reinvestment rate. The reinvestment rate that I use is a free cash flow reinvestment rate instead of the standard one used by analysts that simply uses net income:
Free Cash Flow Reinvestment Rate = 100% - (Free Cash Flow Payout Ratio).
Free Cash Flow Reinvestment Rate = 100% - (Total Dividend/Total Free Cash Flow).
By replacing net income in the payout and reinvestment ratios with free cash flow, I am thus able to make my analysis more precise by incorporating capital spending (Cap Ex) into the equation.
Therefore from this, we can determine that Time Warner Cable has a reinvestment rate of 67% and went on to use 33% of its free cash flow to pay out its dividend. Thus by taking 7% (FROIC) x 67% = 4.69% (rounded off at 5%). From there we add the dividend yield of 2% and we have a Mycroft/Michaelis growth rate of 5% + 2% = 7%.
Time Warner Cable's Mycroft Free Cash Flow per share of $8.52 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 7% or 1.07). Once we have our result, we then take its current market price of $132.20 and divide it by $8.52 and get a Price to Mycroft Free Cash Flow result of 15.52. I consider a Price to Mycroft Free Cash Flow per share result of less than 15 to be good for purchase, and anything under 7.5 to be excellent.
The higher you go above 15, the more overvalued a company becomes. I use a Price to Mycroft Free Cash Flow per share result of 22.5 as my sell price, and 45 as my short price.
An appropriately priced stock should trade around a Price to Mycroft Free Cash Flow per share result of 15. This benchmark result was determined by backtesting.
Buy (opinion) = A Price to Mycroft Free Cash Flow per share result of less than 7.5 is considered excellent (50% below the initial Hold level), and anything under 15 is attractive.
The result I give as my Buy opinion in the table above uses a Price to Mycroft Free Cash Flow per share result of 7.5.
Hold (opinion) = 15 to 22.5 (I use 15 in the table).
Sell (opinion) = 22.5 or higher (50% above the initial Hold level). (I use 22.5 in the table).
Short (opinion) = 45 or greater. The Price to Mycroft Free Cash Flow per share result of 45 was determined by going back to the peak of the market (in the year 2000) and averaging the Price to Free Cash Flow per share results for the key players at that time. (I use 45 in the table).
Time Warner Cable with a Price to Mycroft Free Cash Flow number of 15.52 may be considered a hold.
The CapFlow ratio result that you see in our first table above is an original ratio I created in order to tell me how much Capital Spending is used as a percentage of Cash Flow. A result of less than 33% is considered ideal and with Time Warner Cable coming in at 59%, means that only 41% of the company's cash flow is actually free cash flow and can be used to buy back stock, which I am a big fan of.
In conclusion, it is clear that Charter Communications needs Time Warner Cable as its FROIC is about a third of Time Warner Cable's. On the other hand, the smart move for Comcast would be to go after Time Warner Cable alone as its numbers show that it would be merging as equals. If I were Dr. Malone, I would try to buy Time Warner Cable on my own, but I doubt he would want to get into a bidding contest with Comcast. As for Time Warner Cable, I feel that Wells Fargo analyst Marci Ryvicker's estimate of a $160 per share bid may prove to be too low as I think that Time Warner Cable would be fully valued at $191.70, which is my 2014 sell price opinion on the stock (found in the second table above). That would be equal to 22.5 times my Mycroft Free Cash Flow Per Share and be 50% above my hold price. It will be very interesting to see how this turns out when(if) all is said and done.