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This morning, Morgan Stanley has upgraded Time Warner Cable (NYSE:TWC) to Overweight from Equal Weight because of TWC's free cash flow and valuation in focus.

Time Warner Cable is the supplier of video, high-speed data and voice services in the U.S. Its systems are located in five areas: New York, Carolina, Ohio, Southern California and Texas. The company offers its residential and business service customers video, high-speed data and voice services over its broadband cable systems. It markets the services both separately and in "bundled" packages of multiple services and features.

Time Warner Cable's revenue has been growing quite nicely over the last 9 years. It is the same with operating income and net income, except in 2008.

USD million

2003

2004

2005

2006

2007

2008

2009

2010

2011

Revenue

7,120

8,484

8,812

11,767

15,955

17,200

17,868

18,868

19,675

Operating Income

1,302

1,718

1,786

2,179

2,766

-11,782

3,317

3,689

4,069

Net Income

664

726

1,253

1,976

1,123

-7,344

1,070

1,308

1,665

The reason for TWC to have negative operating income and net income in 2008 is because of a $14.8 billion impairment of cable franchise rights. This was a non-cash charge, so it has no impact on the company's cash flow. In fact, Time Warner Cable has been generating very consistent and growing cash flow.


(Click to enlarge)

Trailing 12 months, TWC's cash operations and free cash flow are $5.5 billion and $2.5 billion respectively.

However, the business is quite leveraged. As of June 2012, the long-term debt booked in the balance sheet was $25.3 billion, which was as high as 50% of the total asset. But with the stable cash generation, and with improving debt and solvency ratios, we can expect the current level to be comfortable for the company.

2007

2008

2009

2010

2011

Debt to equity

0.63

0.94

0.46

0.50

0.65

Debt to capital

0.39

0.48

0.32

0.33

0.39

Interest coverage

3.84

-6.56

3.87

4.07

4.31

Currently, TWC is trading at $94.46 per share; the total market capitalization is nearly $30 billion. With more than $25 billion debt and $3.2 billion cash, the enterprise value is nearly $53 billion.

The market is valuing TWC at 17.3x P/E, 3.9x P/B and 5.5x P/CF. It is just a bit cheaper than the industry average, of 19.8x P/E, 4.1x P/B and 5.7x P/CF. But it is more expensive than the company's average historical valuation, of 13.1x P/E, 1.8x P/B and 3.7x P/CF.

My take: Even Morgan Stanley pushes the price target on TWC from $96 up to $110 per share because the business has returned $5.5 billion in capital through dividends and buybacks, I would not consider buying TWC at the current price because of the following reasons:

  • Valuation close to industry average, but more expensive than historical level
  • High amount of debt
Source: Time Warner Cable: Should Investors Buy After Morgan Stanley's Valuation Upgrade?