All Eyes on Time Warner Cable

You know it’s a bull market for cable stocks when a new one trades for the first time. It took nearly seven years this time, from the 2/4/00 IPO of Mediacom to the 1/5/07 debut of Time Warner Cable. TWCAV traded on a when-issued basis at first (as TWCA.PK as of Feb. 21) as it approached its full trading status set for the beginning of March.

Now the challenge: After the two cable IPO windows in 1986 and 1999, the stock market tanked terribly. The role of reverse indicator is not fun, but — at the risk of violating the golden rule of prediction-this time could be different. The public isn’t putting any gas (i.e., money) into the new vehicle. The shares are a spin-off from the Time Warner parent to the creditors in the five-year Adelphia bankruptcy. Traders are making a market as frustrated creditors finally convert their equity back into cash.

Initially, it appears TWC came into the world fully valued, at $41.65 (the Feb. 20 high). That works out to 11x projected 2007 cash flow (EBITDA) of $4.8 billion, and $4,329/subscriber. But it is, after all, incorporating New Adelphia, which, in cable language, translates into Plenty of Potential. There was never anything wrong with Adelphia’s markets, just delays in development, extended by the corporate governance scandal. That’s a springboard for TWC to deliver internal growth and higher operating margins.

It’s odd to think that anyone other than Comcast can be the bellwether of the cable industry, but all eyes are turning to the newest player on the field for leadership in valuation metrics. As a pure MSO with a solid growth component in the undervalued Adelphia systems, Time Warner Cable is likely to carry the industry’s highest multiple of cash flow in the public market. Its cash flow is capable of expansion to $6.3 billion by end-2008, which would lower its current multiple of 11x ’07 to under 10x ’08. That would elevate per-subscriber value from $4,329 to $4,701, and the stock price to $50. You would get the same result by applying a 12x multiple to the ’07 numbers.

Time Warner Cable figures to be an aggressive acquisitor of voice customers and other cable systems. Even stock prices of overbuilders (Knology and RCN) have risen strongly in the last 12 months, possibly anticipating a long overdue next wave of industry consolidation. The PK Worldmedia MSO stock average was +45% from last summer’s June 27 low to the Feb. 16 close. That compared with the +20% move of the Digital Life stocks (Google, Yahoo, Apple etc.) over the same period. It’s as if, exactly four years after the infamous perp walks of the summer of 2002, Wall Street was hit by a cable epiphany: Could the telcos and Internet media eat crow instead of cable’s lunch?

Analyst/investor Paul Kagan, chairman/CEO of PK Worldmedia, Inc., Carmel, Calif, owns shares of Time Warner, Time Warner Cable, Comcast and Mediacom. He was a valuation expert witness during the Adelphia bankruptcy case, representing Adelphia equity investors. Information in his columns is not intended to be a solicitation to buy or sell securities.