Time Warner Cable plugs into consolidation war

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Time Warner Cable’s timing was not the best. It chose March 1 to become a publicly traded company – the week stock markets around the world fell sharply.

Time Warner Cable’s top management joked about their timing in a call to investors about the company’s growth prospects, led by the strong demand for its video, internet and telephone services. They also flagged up last year’s $17bn acquisition of Adelphia, the bankrupt cable operator, as a growth opportunity, which gave it a strong position in the key Los Angeles market.

Since then, they have no doubt been watching the hourly moves in Time Warner Cable’s shares. Launched at just over $39 per share, a week later they were trading at just under $37. So far, just 16 per cent of Time Warner Cable shares are traded. Its parent, media giant Time Warner, retains the other 84 per cent.

What will matter more than their short-term moves, however, is what happens to the shares over the next year or more. Although Time Warner Cable is the second-biggest US cable operator with over 13m television subscribers (Comcast is number one with 24m) at some point analysts anticipate the company will need to expand.

Cable companies already offer many of their TV subscribers high-speed internet access. Increasingly, they are selling a third service, telephone access, and mobile phone connections could follow. The popularity of such bundles, dubbed triple play, is leading telecom rivals like AT&T and Verizon to step up investment in television.

One benefit of scale is the ability to negotiate better terms for television content. For most cable companies, one of the biggest factors putting pressure on margins has been rising programming costs, and containing those is crucial.

“Time Warner Cable shares will be boosted this year through the effective integration of the Adelphia systems and the success of the triple play offering. This will be a prerequisite before its newfound currency can be used to ultimately consolidate the smaller cable companies in the industry,” says Aryeh Bourkoff, analyst at UBS.

He adds: “Being number two in cable will be less important in a few years. Time Warner Cable will need to be bigger to have a seat at the table with Comcast, AT&T and Verizon.”

Last year, cable companies such as Comcast and Cablevision were among the year’s top performers, with Comcast’s shares rising over 60 per cent. Investors, who had fled the sector amid fears of a price wars among cable, satellite and telecom giants, returned, drawn by the popularity of the service bundles.

This year, values have declined, but many analysts remain positive.

“We continue to be bullish on the operating fundamentals for the cable industry and believe that valuations for cable stocks have lots of upside to them,” says Katherine Styponias, analyst at Prudential Equity Group.

Even if markets continue to wobble on economic concerns, she said this might not be bad for cable. “Cable businesses tend to hold up very well in tough economic times as consumers rarely turn off their cable TV subscriptions as a way to save money,” says Ms Styponias.

Consolidation in the cable business is widely regarded as likely to start next year. Dick Parsons, chairman and chief executive of Time Warner, recently said he thought it was a “three- to five-year process.”

With many cable companies controlled by families or individuals, it is hard to predict what might trigger decisions to sell.

Cablevision, based in the New York area, has been a potential acquisition target for Time Warner for decades. Although Charles Dolan, whose family controls the group, came close to selling in the past there is no sign that he is willing to cede control.

There are other possibilities. Atlanta-based Cox Communications, one of the first to go private, might be a target.

Charter Communications, in which Paul Allen of Microsoft fame is the biggest shareholder, would also be a natural fit for Time Warner, not least because buying it would allow it to control all of Los Angeles, a city it now dominates following the Adelphia deal. Another possible target is Insight Communications, which is focused on the Midwest.

Time Warner Cable is already preparing for the battles ahead. “We are going to evaluate how we manage our capital structure,” John Martin, Time Warner Cable’s chief financial officer, said last week. “We are looking to maintain enough financial capacity to fund our current business plans, as well as keep enough flexibility to be able to go out and seize on any unique opportunities, should they present themselves.”

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