Volatility in NTL On Recent News

NTL Incorporated (NTLI) shares have sold off the last few days, giving back most of the gains achieved after several management presentations at media conferences in the US during September.

Investors responded favorably to the presentations in which management indicated that 3Q06 results would be satisfactory. This was welcome news following published reports of the cooling of interest by private equity firms in an NTLI takeover.

The last few days NTLI sold off ahead of and in response to news out of its UK competitor, Carphone Warehouse (CW). CW initiated the latest broadband pricing war in the UK when it began an offer of “free broadband” if a customer was taking certain telephony products. The latest news out of CW is that it is buying AOL UK, an internet access business with about 2 million subs of which 1.6 million receive broadband via DSL. CW also announced that it added 150,000 broadband subscribers under its free offer in the latest quarter.....

I think another factor in the sell-off was the announcement on Monday that Setanta sports would launch a channel on UK TV provider Freeview that would televise the attractive package of Premier League soccer matches that Setanta won the rights for earlier this year. This puts Premier League games on NTLI’s two primary TV competitors as Sky has many subs directly related to its long running rights package.

Analysts do not think the sell-off in NTLI shares in response to the news out of CW warrants the sell-off. They point out that consolidation in the UK broadband marketplace eventually should lead to more rational pricing. Additionally, the rate of growth in broadband subs for CW slowed considerably in the quarter. It is not clear what the reason is for the slower growth. One analyst noted that it could be a sign of cooling demand (good for NTLI), increased competition from Sky’s new free offering (bad for NTLI), or a temporary step back by CW until it can access more of the new subs directly rather than over BT’s network (good and bad for NTLI).

The fact that I have been in and out of NTLI several times over the past couple of years indicates my ongoing interest in the stock. By most valuation measures it is the cheapest major cable stock in the world by a significant amount. However, the UK market is arguably the world’s most competitive for the triple play product bundle.

My primary concern at the moment is that the budget that management has for 3Q06, which they are signaling they have met or exceeded, won’t be good enough for the investment community. NTLI needs to show that sustainable mid-single digit revenue growth is in the cards. Without that prospect, I don’t think the street will pay for the massive free cash flow even though it enhances shareholder value as it builds.

For the time being I remain skeptical of the growth potential and on the sidelines but that could change, which explains why I keep updating you on this stock that goes nowhere.

Thoughts on NTL Management Presentation

NTL Incorporated (NTLI) CEO Stephen Burch made a presentation at Jefferies 4th Annual Communications Conference. The company made no comments and took no questions related to the status of negotiations with private equity firms over the possible takeover of NTLI. Based on press reports there is clearly something going on related to private equity. Whether a deal emerges is anyone’s guess but tope tier private equity firms are putting a lot of effort into structuring a deal which would seem t to place great pressure on the Board to provide something for shareholders if no deal is struck.

The presentation focused on business fundamentals including progress on merger synergies, improvements in NTL customer service, and rebranding to Virgin. Management comments on all fronts were constructive. One key

takeaway is that the new senior management team comes across as confident and competent. Sadly, that is an improvement over the prior regime.....

On synergies, Burch repeated the £250 million target by year end 2007 comprised of £200 million in operating expense savings and £50 million in capital spending savings. O numerous occasions regarding several different aspects of synergies Burch said the plan was ahead of schedule. Free cash flow at the current run rate is over £200 million so the magnitude of synergies are enormous. No wonder private equity is interested.

On customer service, Burch showed stats indicating an improvement for NTL and said that the original goal of matching merger partner Telewest by year end would be met in October. He admitted that improved perception by consumers and media will lag the improvement. He also reminded investors that customer service improvement have an economic benefit by reducing churn and upselling additional products.

On Virgin, Burch was very enthusiastic about the rebranding which will occur in 1Q07. He stated several times that all aspects of the rebranding strategy are set to roll out but that it would be delayed until early 2007. The combination of Virgin’s stellar brand reputation in the UK and NTL’s very poor reputation create substantial upside for NTL but not without risk.

Overall, I concur with Burch’s statements that while competition is tougher than ever in the UK TV, telephony, and broadband markets, NTL is a stronger company than it has ever been. Producing top line revenue growth, increasing ARPU, and hitting margin targets are no sure thing but the stock is cheap indicating that expectations are low.

With no private equity deal and no sweetener from the Board, the shares have 10-20% downside. A sweetener without a deal ought to keep the stock close to current levels, limiting downside to 0-10%. A private equity deal ought to be at $32 or better, providing 18% upside or more. I think odds strongly favor a deal or no deal with a sweetener so I am sticking to my long position in NTLI.

NTL Sees Renewed Interest From Private Equity Firms

News broke yesterday in London that NTL Incorporated (NTLI) was again subject to takeover interest from private equity firms. Later in the day, Bloomberg reported that the company was in talks with a consortium of four private equity firms and the talks were beginning to focus on price.

I covered these developments in two posts that went up at StreetInsight.com during the day. I thought clients might be interested in seeing those posts in chronological order to see how the story and my thinking was developing.

At 9:29 Eastern, I posted:

The Times of London is reporting that private equity is approaching NTL Holdings (NTLI) again. This likely accounts for the recent strength in the shares following mixed second-quarter results. On the second-quarter conference call, the CEO was very clear that the company was open to any approaches that would enhance shareholder value. At the time, I wrote that this was the most explicit statement the company had made on the topic.

The reason that was important is because the company apparently rejected a $32 offer last winter. According to today's news reports, several large shareholders are submitting a letter to the company asking why that was done. This looks like a well orchestrated one-two punch to me.

Today's reports suggest a $19 billion value for NTLI. With $11 billion in debt, that works out to just $24-$25 per share. I suspect if the board would play ball, a negotiated deal could get done in the upper $20s or better. NTLI's outlook is not as good as it was last winter due to intense competition in the U.K. broadband market.
NTLI is a good candidate for private equity as merger synergies and a slightly growing top line lead to very significant free cash flow generation in 2007 and beyond. Some analysts have estimated that free cash flow could be around $800 million. NTLI also has content assets worth around $1.5 billion and NOLs valued at $1.7 billion.

As a frustrated shareholder, I'd be fairly happy with a deal around $30.

At 2:45 Eastern I posted:

Bloomberg is now reporting that NTL Holdings (NTLI) is in talks with a consortium of private equity firms regarding a buyout. The report suggests the talks have advanced to the stage where discussions are focused on price.

Last winter, NTLI rejected what it called unofficial approaches from private equity which valued the shares at $32. It is possible, even likely, that a deal would now be struck at a price below that level given the increased competition in the U.K. broadband market this year and NTLI's mixed results so far in 2006.

Richard Branson is now the largest shareholder in NTLI due to the takeover of Virgin Mobile that closed at the beginning of July. I believe his holding is around 14%. Obviously, his views will be important.

I plan to sit on my NTLI and await further developments. I have been selling some NTLI warrants which are illiquid most days. My warrant position is tiny relative to my common stock position.

NTL: Not Bad But Could Have Been Better

I’d classify the 2Q06 earnings and conference call from NTL Incorporated as mixed. Mixed is not quite good enough for the short-term as that means there some issues. For NTLI shares to jump over the low expectations built into the stock, a clean quarter is required. I don’t think we will get that until 4Q06 and 1Q07 but management did a good job of explaining its strategy and setting expectations for 3Q so I think the shares will hold in their current range. I plan to hold my position.

Financial results were quite close to expectations with pro forma revenue of EBITDA of £884 million and £293 million. Revenues were about £10 million light as lower than expected customer counts were offset by higher than expected ARPU. EBITDA was also a little light but was within the lower end of the range of estimates. Any EBITDA shortfall was in the content and business segments which are much less important than the consumer/cable segment which accounts for over 75% of the company’s revenue.

The real problem which prevents me from classifying the quarter as “good enough” is lower subscriber counts than expected. NTLI lost 19,000 customers against expectations for a gain in 5,000 range. Management repeatedly called the loss “mechanical” referring to an internal plan to focus on more profitable, triple play subscribers. An unexpectedly large increase in ARPU appears to support management’s contention but given the intense competitive environment in the UK, investors are unlikely to believe management’s confident long-term projections until subscriber counts stabilize and grow.....

Underlying subscriber metrics were mixed. Digital and analog TV figures were better than expected while broadband gains were significant but below expectations. Telephony, the weakest area in recent quarters, again lost a small number of customers.

Positives in the quarter included ARPU of £42.21 vs. expectations for £41.50 to £41.85, better than expected RGU’s per customer, and higher than expected triple play penetration. Each of these measures supports management’s strategy and projections, but to reiterate, investors require stable customer adds in order to have confidence in the long-term free cash flow generating ability of NTLI.

And free cash flow ultimately is the story here. In a slide used on the call, management outlined that current run rate free cash flow is £224 million or over $400 million. This is before any of the £200 million ($360 million) in operating synergies are realized. Those should be fully in place for 2008. Given this free cash flow profile, one analyst asked about the interest of private equity. Management was very clear that they are open and receptive to any approach that would enhance shareholder value. I found this statement to be clearer than prior comments.

The bottom line is that despite a low bar, NTLI wasn’t quite able to get over the hump this quarter due to worse than expected subscriber counts. These trends aren’t likely to reverse in 3Q so I don’t expect a quick rebound in NTLI shares. However, management did its best job ever on the call of explaining in great detail exactly what it was doing to meet its financial and subscriber goals and was able to show initial progress in bringing NTL up to Telewest standards. As long as this progress is consistent, eventually the free cash flow story will find investors. I remain impatient and a little worried but long.

NTL 2Q06 Earnings Preview

NTL Incorporated (NTLI) reports tomorrow morning. This stock has been my personal Waterloo but I think that investors are overly pessimistic especially in light of the significant free cash flow the company can generate in a no growth environment. The bar is set quite low for the quarter given the lousy action in the stock and all the competitive announcements coming out of the UK. An in line report should be enough to pop the stock but NTL has missed on more than one occasion in the past couple of years.

Analysts are looking for revenues of just over £890 with EBITA between £285 and £305. NTLI is adopting the customer acquisition strategy of its more successful merger partner, Telewest. This mean the emphasis is on growing revenue generating units per customers as opposed to growing customers.. Consequently, the key customer metrics to watch is RGU adds. Analysts are looking for 150,000 with total customer adds of around 5,000. NTLI is still tightening its credit standards which could have a negative effect on customer adds. The other important metric is average revenue per user. The UK might be the most competitive telecom market in the world with numerous offers of “free” broadband within larger bundles. Investors are very concerned that NTLI will lose customers and see significant pricing erosion. Management has been publicly confident that its bundling strategy and focus on customer retention will allow ARPU to remain stable or even rise slightly. For 2Q06, analysts are looking for a slight uptick in ARPU to £41.80....

Other important measures to watch are subscriber additions for video, digital video, broadband, and telephony. Analysts estimates call for 5,000, 50,000, 150,000, and 5,000, respectively. The broadband number will be most closely watched given the multiple “free” broadband offers that apparently attracted customers during 2Q. Management has stated that these offers do not effectively target NTLI’s customers.

Finally, I hope that management will formally increase its synergy targets in terms of magnitude and timing. This would be a nice boost for investor confidence in free cash flow generating capabilities.

I am a nervous long ahead of the quarter.

NTL Update and Response to Sky's "Free" Broadband Offer

NTL Holdings (NTLI), have been under severe pressure lately due investor fears about the intense competitive environment for broadband in the UK. As the largest cable company in the UK, NTLI has significant market share in broadband. Even though about 70% of its subscribers take the triple play bundle of cable TV, broadband, and telephony, investors are concerned that collapsing broadband pricing in the UK will lead to a loss of NTLI's broadband subs and/or a sharp drop in its monthly revenue per user (ARPU).

These fears really began to gain steam a few months ago when Carphone Warehouse began to offer free broadband with its wireline and wireless phone subscriptions. The offer did not target NTLI's customers, and really wasn't all that attractive to them, but investors saw it as the first shot in a broadband pricing war. Since then NTLI has said on a few different conference calls that it had seen little impact on its sub base or its ARPU from the Carphone offer. Yet the shares kept sinking....

The Sky Is Falling?

Fears continued to rise in anticipation of Sky's entry into broadband, which was announced last week. Sky is the dominant TV company in the UK. I had thought that NTLI shares already discounted Sky's likely offering, but I was proven wrong as NTLI shares sank further after Sky's announcement. Sky revealed much more aggressive pricing that the market expected and showed a willingness to incur much higher losses to gain market share than analysts had expected. Sky will offer free broadband to its subscribers with some limits on speed and usage. It will make the same offer to new customers. Credit Suisse responded to the news with a research note headlined: "The Sky Is Not Falling," but investors clearly remain concerned.

Bundles Help, But Are Not a Cure All

Aryeh Bourkoff of UBS notes that only about 10% of NTLI's broadband customers are not bundled. These subscribers are the most likely to switch. Aryeh also notes that even if none switch, NTLI may be forced to respond with lower pricing. He calculates the damage could be severe in terms of EBITDA destruction in a worst case scenario of falling subscribers and falling ARPU. This is no doubt correct, but it is probably partially in the stock after the recent decline.

NTL Responds

Today, NTLI responded to Sky's offer by announcing a series of bundles. Most importantly, NTLI will begin to offer customers a quad lay bundle that includes wireless telephony along with broadband, cable TV, and wireline telephony. NTLI can differentiate itself in many ways but thanks to the Virgin Mobile acquisition it is the only company that has all four products in its bundle. Other attractive features of NTLI's new offering include a lack of hidden charges for line rentals from British Telecom and the elimination of installation charges. Finally, NTLI's offering are very simple. Take two products for 20 pounds, 3 for 30, 4 for 40. Some investors will view NTLI's actions as just another sign of a price war but I think those views will be offset by others who recognize that NTLI's competitive position is stronger than they realized.

What About The Stock?

Ultimately, the only way for NTLI to fight back against the sellers of its stock is to make its numbers and prove it can produce the massive free cash flow previously expected. Shareholders could also be rescued by a return of interest by private equity buyers. Private equity apparently offered NTLI in the $30s last winter. There are still lots of private equity deals in European cable at substantial premiums to NTLI's current trading price. And remember, NTLI has some huge shareholders like Richard Branson and William Huff who don't like to lose.

Attractive Value vs. Weak Fundamentals

An investment in NTLI comes down to value against weakening fundamentals. Usually weakening fundamentals will win that debate. Nevertheless, I am going to hold NTLI because I think the company may provide some comfort on the fundamentals when it reports earnings in August. In addition, valuation has gotten awfully cheap in all but a worst-case scenario.

Private Equity to the Rescue?

Oh yeah, if there any private equity firms out there looking at NTLI and reading this blog, now would sure be a good time to show some interest. And don't forget to leak it to the press.

Conference Call With NTL CEO

On Monday morning, UBS Cable Analyst Aryeh Bourkoff hosted a conference call with Stephen Burch, CEO of NTL Incorporated (NTLI). I thought the call went well although the stock went down on Monday and Tuesday. I continue to hold all of Northlake's long positions in NTLI and feel the stock offers incredible value at current levels.

There were several highlights on the call....

First, Burch remained quite positive on the progress of realizing synergies from the Telewest merger. He stated that "progress was even better than I hoped" and that the company would be able "to continue to move the time frame up" on cost savings. Second, beyond the cost savings, a key point of the merger was to use Telewest best practices to bring NTL's customer service up to par. NTL has a bad reputation in the UK and better customer service could help reduce churn and make it easier to win new subscribers. Burch said that his goals on answering customer calls, average hold time, completion rates on installs, and on-time installs would all be met "well before the end of the year." Putting Burch's commentary on these subjects into the larger picture tells me that the EBITDA and free cash flow growth that is cost driven is largely in the bag.

So what's troubling NTLI shares? Fears of competition in the UK. The majority of questions on the call concerned the competitive environment. Burch responded well but I would classify the questioning as skeptical as far as meeting NTLI's goals for slightly higher basic subscribers, much higher revenue generating units (RGUs), and especially stable to higher average revenue per user (ARPU).

Despite the repeated and skeptical questioning, Burch was very firm in the company's ability to compete and meet its goals. Of particular concern recently has been "free" broadband offerings from Carphone Warehouse and Orange. Carphone has already announced large subscriber gains from the promotions. Burch commented that the offers have had "no significant impact at this point." He said the offerings did not catch management by surprise and that the company had responded with a variety of offerings using TV as its key competitive weapon. He also said that as soon the Virgin Mobile acquisition closes on July 4th, the company would be ready with new bundles using the quadruple play. Burch kept making the point that in the past, NTLI was a reactive company, never taking the lead in the marketplace and often getting caught off guard. He said he is changing the culture and that in the future missteps in subscriber and financial results would no longer occur because the company was too slow.

Finally, there were many questions about potential private equity interest in NTLI. There were widespread reports at the end of 2005 that private equity groups had approached NTLI and some reports were specific about deal pricing in the low to mid-$30s. Burch attempted to dampen speculation but did admit that some contact had been made between private equity and Chairman Jim Mooney. He said that he and Mooney have agreed that Burch should run the company and any private equity discussion would be kept at the Board level. Burch did say he was a proponent of a private equity deal, although I think he meant he was indifferent as to how he and his management team would be rewarded when they met their financial and subscriber goals. I think his cautious comments toward private equity interest might have been responsible for the weak action in NTLI shares since the call.

The questions on the call underscored the debate over NTLI. On the one hand, private equity clearly realizes the value in NTLI's free cash flow generating ability over the next few years. On the other hand, many investors clearly don’t believe that NTLI will be able to meet its subscriber and financial goals. I think the current stock price already assumes that the company will miss its targets. Current estimates call for NTLI to have free cash flow of between $2.50 and $3.00 per share in 2007. That puts the free cash yield between 11-13%. I find that very cheap and over discounting the risks. I think private equity interest provides downside support and I am willing to show patience by holding or adding to current positions.

Unusual Options Activity in NTL

I am not sure what to make of this but last week two separate reports surfaced about heavy buying of NTL call options. Here is the comment that appeared on StreetInsight.com:

U.K. based media company NTL Holdings (NTLI-$27) is trading almost 8 times its average daily call option volume today, with over 9,000 contracts changing hands vs. an average of only 1,100. The July 25 and 27.5 calls are where all the volume is. It is worth noting that the July 27.5 calls have traded 6,000 contracts today with only 690 outstanding. The year high for NTLI is $31 and by the look of today's option activity it seems a push to that level expected.

I certainly hope the projection for a move to $31 is correct. Maybe some Monday news stories will shed light on what the buyer thinks they know. Regardless, NTL shares remain attractive and hopefully will begin to respond over the summer as the company starts to report earnings that show the cost synergies of the Telewest merger. As we wait, there is always the possibility that stories of private equity interest in NTLI will emerge. I think the prior stories, written earlier this year, were accurate.

NTL Earnings and Guidance Support The Bull Case

NTL Incorporated (NTLI) reported 1Q06 earnings as expected including the hoped for acceleration in cost savings synergies from its merger with Telewest. Investors are responding favorably to the report and follow-up conference call, moving NTLI shares 2-3% higher. I think the stage is set for NTLI shares to move into the mid $30s or higher over the next year as cost savings drive EBITDA and free cash flow growth, improved operational performance provides moderate organic growth, and the Virgin Mobile acquisition further leverages the emerging positive trends at the subscriber level. Additionally, renewed investor respect for U.S. cable stocks following excellent results from Cablevision, Time Warner, and Comcast is slightly lifting valuation for the group and provides a tailwind for NTLI shares. Also, I still think the rumored private equity interest in NTLI makes sense and that a deal could emerge. With downside protected by asset value, free cash flow, and stabilizing operational and financial performance and upside potentially very substantial, NTLI is one of my favorite ideas....

NTLI's 1Q report was a little confusing as the company provided reported and pro forma earnings and sequential and year-over-year comparisons to account for the mid-quarter closing of the Telewest deal. After adjusting for cost that shouldn’t recur once the merger integration is completed in late 2007, it looks tome like NTLI reported 1% revenue growth and 2% EBITDA growth. While this is nothing to be excited about, it should be the base off which growth accelerates due to cost savings and better operating performance.

On the cost savings front, management brought forward the full realization of the £250 million in synergies by 15 months by targeting 1Q08 as the first quarter of full benefit. In Q&A, management went a little further and said that hope to "do better and ado it sooner." I think that will be the case as management seemed quite confident in its formal presentation and Q&A. NTLI has an unfortunate recent history of missing expectations. I think the new management team wants to play UPOD. By the way, at a 6 multiple £250 million is worth $2.7 billion to NTLI's enterprise value or almost $10 per share.

Equally important, 1Q saw continued stabilization of operating and subscriber trends in NTLI's consumer business, especially at the previously struggling NTL standalone. For the second consecutive quarter, ARPU, subscriber additions, and churn all were at least as good as expected. This is a reversal from consistent underperformance through most of 2005. With new management now focused on bringing best practices from Telewest's better performing operations over to NTLI, an improvement in organic revenue and EBITDA growth to the mid single digits is plausible.

On other topics, management noted that much discussed "free broadband" offering from Carphone Warehouse has yet to to hurt NTLI. Management feels this product is aimed at low end customers as opposed to the higher ARPU customers of NTLI and Sky. No free cash flow guidance was provided nor was use of free cash flow discussed. NTLI will considerpartners as it decides how to develop and realize value from its content assets. Trends in the commercial business remain relatively weak but could show improvement long-term as data revenues ramp.

NTL March 2006 Quarterly Earnings Preview

NTL Incorporated (NTLI) shares have held onto most of their gains following the early March closure of the company's merger with Telewest. Since that time, the company has also formally announced its merger with Virgin Mobile that is schedule to close in June.

NTLI reports tomorrow and the focus will be on cost reductions related to the Telewest merger. So far, management has provided guidance for £250 million in savings, £200 for operating expense savings and £50 million in capital spending savings, all to be fully achieved in 2008. Articles appeared in the UK press over the weekend indicating that the company may announce as many 6,000 job cuts in conjunction with its 1Q06 earnings report. In April, at the National Cable Television Association show, NTLI management hinted that cost savings could be larger and be achieved sooner than its prior guidance. On tomorrow's conference call, investors will expect confirmation, a detailed update on synergies, and full year 2006 guidance for revenues, EBITDA and key subscriber metrics.....

Investors will also be looking for an update on the Virgin Mobile merger. I doubt if management will offer much insight since this deal won’t close until June. However, details on the prospects fro rebranding the entire enterprise under the Virgin brand and the upside potential form being able to offer a wireless telephony product could be forthcoming.

Other topics of interest could be plans for the new company's substantial free cash flow and an update on private equity overtures that were apparently made at premium prices late in 2005. I've always thought that, ate the earliest, private equity would not make a move until after the Virgin and Telewest deals both closed. NTLI management has been quite confident recently and the company has a new CEO so I suspect they would resist any deal short of the upper $30 range.

As for the quarter, I can’t get a good handle on the numbers because there are very few analysts that write on NTLI (a positive attribute for longs) and the Telewest merger occurred during the first quarter. In general, I expect both NTLI and Telewest to continue on recent trends. For NTLI that means flattish growth in revenues and EBITDA with slightly positive subscriber additions. ARPU trends have been poor lately, mostly in the telephony business and recent competitor moves in broadband will make this is a key measure. For Telewest, recent trends have been stronger and I expect to see a continuation of low single digit top line and EBITDA growth with decent subscriber additions and stable ARPU.

Finally, news broke Friday that NTLI was shut out of the bidding for Premier League soccer rights. I had been hoping that NTLI would win some rights so that the company could break Sky's stranglehold on soccer-centric subscribers. The market doesn’t seem to mind NTLI's loss, probably because the pricing of the rights came in well ahead of expectations. Since I view NTLI as a free cash flow story, I'd rather forgo the rights than overpay.

Cramer Mentions NTL and Yours Truly

Jim Cramer mentioned NTL Incorporated (NTLI) bullishly last night on Mad Money, including a mention of my analysis on StreetInsight.com that is also posted here.

With Cramer putting the stock in the news, I wanted to mention that the company recently announced it will report before the open next Tuesday, May 9. Additionally, at least one analyst has mentioned the possibility that the results of round-two bidding for Premier League soccer rights could be announced before NTL reports. Both of these events could move NTLI shares.

Finally, BSkyB reported this morning, and subscriber additions were at the low end of analyst estimates. Churn was also worse than analyst expectations. I am not sure if there is any impact over to NTLI as Freeview is the share gainer in U.K. multichannel television. My bullishness on NTLI is based on cost savings, free cash flow and potential private equity interest. Growth in revenue and subscribers will be quite modest.

News Wrap Up on NTL

Given Northlake's new long position, in NTL Incorporated (NTLI), I pay close attention to the press reports out of the UK. I follow them via Google News doing a simple daily search on NTL. Sunday's articles were particularly interesting. First, there is an interesting profile of Richard Branson's history with Virgin Mobile and some of his other investments. There is also a favorable profile of new NTL CEO Stephen Burch. If you are interested in the bear case for NTL and U.S. cable companies, this article outlines the potential pricing competition for triple play and quadruple play services. I touched on the pricing issues, especially for the low fixed cost business of high speed data and telephony on Media Talk in my Midwest Media Day summary when I reviewed the DirecTV meeting. Finally, there is an article outlining the fact that the Virgin Mobile deal terms include a requirement that Branson vote his shares with management in the event of a hostile deal. This could have relevance if strongly rumored private equity interest turns to reality.

NTL: The Numbers Supporting the New Buy

Last week, I re-entered NTL Incorporated (NTLI) from the long side after a several month absence. I outlined the rationale behind my decision to buy in this post but failed to provide a lot of numbers. So here goes…

NTLI has 283 million shares outstanding following a 2.5 to 1 split that occurred simultaneous to the closing of the merger with Telewest earlier this month. With the shares closing at $28.29 on Friday, the market cap is $8 billion. Aryeh Bourkoff of UBS is projecting yearend 2006 total debt of $10.4 billion and cash of $1 billion, leading to a total enterprise value of $17.4 billion. Without adjusting for NTLI's net operating loss carryforward or its content assets, the shares are trading at 7.6 times estimated 2006 EBITDA and 6.9 times estimated 2007 EBITDA.

In 2006, analyst estimates call for EBITDA of almost $2.3 billion at current exchange rates (all of the company's revenues are generated in British Pounds). Over 90% of EBITDA will come from the from the cable plant via the triple play offering of TV, telephony, and internet and the business and wholesale offerings. Content assets provide the balance of EBITDA. Unlike in the US, the UK cable industry has been a triple play offering since the plant was built out in the 1980s. In fact, telephony is the largest revenue generator for NTLI, producing approximately 30% of revenue. Cable TV is the second largest business at about 20% of revenue, with cable internet next at 15%. The remainder of revenue is generated by business services, content, and sales of network capacity to other carriers....

Overall, revenue growth is projected to be quite modest starting with growth near 5% in 2006 followed by a steady deceleration toward just 1% growth by 2010. Essentially, analysts are looking for subscriber growth in the low single digits and stable ARPUs. High speed data is the revenue growth driver with growth of 15-20% projected in 2006 before it slows to single digits in 2007 and beyond. Telephony is the drag on growth as the competitive environment with mobile and other wireline providers is causing reduced minutes of use and lower monthly bills. Cable TV will continue to experience a loss of analog subscribers who are replaced by upgrades to digital service. The operating plan for revenue and subscriber growth is to move to Telewest's best practices and try to duplicate the outperformance of Telewest relative to NTLI over the past few years. Toward this end, most of the operating management of the new company came from the Telewest side with 17 of the top 20 executives either new to the company or from Telewest.

NTLI will generate EBITDA growth over the next five years primarily by cost synergies. Management has publicly announced a cost savings target of $425 million annually in 2008. Analysts indicate that recently management has suggested this target could be low and the full savings could be realized sooner. In 2006, NTLI is projected to produce revenue of $6.4 billion, so achievement of the full cost savings target would enhance margins 660 basis points before considering some added costs associated with merger integration. In fact, this is what analysts are forecasting with EBITDA margins rising from 35% in 2006 to over 40% in 2008.

Capital expenditures are expected to be flat at around $900 million so free cash flow should growth at a healthy pace if the cost-driven EBITDA gains occur. For example, Aryeh Bourkoff's model calls for free cash flow of $527 million, $814 million, and $1.1 billion, respectively, over the 2006-2008 period. On a per share basis that works out to $1.85, $2.86, and $3.88. With the stock at $28, is it any wonder that private equity would be interested in NTLI?

As mentioned above, there is also value in the company's NOL's and content assets. NOL's total over $1.8 billion, or more than $6 per share. The content assets will generate about $140 million in EBITDA this year. These assets come from Telewest and were for sale prior to the merger. At the time, bids appeared to be in the area of 12 times EBITDA, about 5 multiple points above the current trading level of NTLI shares. In theory, this could provide another $2.50 per share of hidden value. It does not appear that the content assets are currently for sale but that could occur in the future. Adjusting for both the NOL's and content assets, NTLI shares are trading for 6 times 2006 estimated EBITDA and 5.5 times 2007 estimated EBITDA.

Finally, the company is still attempting to acquire Virgin Mobile. An offer is outstanding and analysts expect it to be consummated in April. It has been a complicated deal with Virgin's majority shareholder, Richard Branson, highly supportive of the deal and willing to take a discount price relative to the minority public shareholders. Assuming the deal is completed, NTLI will enhance its competitive position as the entire company and all of its service offerings will be rebranded with the highly valued Virgin name. Additionally, the new company will be able to offer a quadruple play including mobile telephony, potentially improving the ability sustain revenues and subscribers in the combined wireline and wireless telephony business.

I hope this additional background helps you understand why I see so much value in NTLI shares.

NTL Incorporated: New Purchase For All Clients

Last Friday, I purchased a new position in NTL Incorporated (NTLID – the D will be dropped shortly) across all Northlake client accounts. I think the stock has potential upside to at least $40 per share based on a successful merger with Telewest. The merger closed at the beginning of March. I define success as (1) the ability to produce several years of revenue growth in 3-5% range beginning in 2006 with growth at the high end of that range, and (2) the realization of cost synergies that will drive pro forma operating cash flow (EBITDA) margins from 35% in 2006 to 40% in 2008. If these goals are met, the company will produce about $2.4 billion, or $8 per share, in free cash flow over the next three years. With NTLI trading at $28.40 and debt at 4.6 times EBITDA, the free cash flow generation provides big upside to shareholders, and even if it falls short by $500 million still provides a cushion on the downside....

The reason I am stepping up NTLI now is because long-rumored interest from private equity players should come to fruition in the next month or two if it occurs at all. According to a recent research report from UBS cable analyst Aryeh Bourkoff, NTLI management has "acknowledged informal recent private equity interest." Bourkoff's report goes on to note that a March 1st UK Times Online report quotes NTLI Chairman Jim Mooney characterizing the value of private equity overtures as "not anywhere on the same planet."

Following yesterdays' news that Liberty Global (LBTYA) sold its slow growing French operations for 11 times 2005 EBTIDA, I can see where Mooney is coming from. If NTLI were to sell at 11 times 2006 EBITDA, the price would be $56, double the latest quote! I suspect that private equity views UK cable assets as more mature than cable assets in France, which would argue for a lower multiple at NTLI. Each multiple point is worth $8 at NTLI so there is a lot of wiggle room.

An educated guess places the informal interest from private equity in the mid-$30s or around 8.5 times EBITDA. This figure is unadjusted for up to $10 in hidden value for NTLI's content assets and NOLs. As you can see, if a private equity deal emerges, the upside is substantial.

I think NTLI has fundamental support around $25-26 if private equity walks away. This sets up a favorable risk reward-reward tradeoff if my analysis that NTLI would fetch at least $40 in a leveraged buyout is accurate. Furthermore, I think the shares could reach $40 on fundamentals alone if current projections for 2008 turn out accurately.

I'll post some more basic financial data on NTLI later this week. In the meantime, please scan through the Media Talk archives to review may previous postings on NTLI (there were a bunch of posts last December). You might want to review the more recent posts about a potential merger with Virgin Mobile as that possibility is on the front-burner. Finally, if you head over to Google News and type NTL into the search box, you will find it easy to read UK press reports about the company.

NTL First Quarter Earnings Recap

With all the market craziness and earnings reports, I failed to provide a follow-up regarding the first quarter earnings report for NTL (NTLI). As I expected, it was a sloppy quarter.

However, as I hoped, management confirmed its subscriber guidance which suggests the worst is past. In fact, subscriber growth in the first quarter was the one unarguable bright spot with high-speed data beating expectations, and telephony and analog and digital TV meeting expectations. Analog TV still showed a subscriber loss and digital TV gains were minimal, but the trends were in the right direction after several bad quarters.

I think NTLI turned the corner this quarter. I expect an announcement of a merger with the UK's other major cable company, Telewest, by the end of June. This merger has very positive financial implications for NTLI. Wall Street fears NTLI will overpay but I think there is plenty of booty to share. Should the deal fall through, NTLI likely will dramatically accelerate its share buyback. I think the shares are washed out and will hold a little longer pending the outcome of the Telewest merger talks. NTLI shares deserve to be trading in the $70s, up 15-20%. If they get there, the NTL Warrants should reobund sharply....

....While subscriber growth was a positive, the negative in the quarter was that average revenue per user (ARPU) fell to 40.86 pounds from an expected level of 42.00. There are two problems here that are issues for the entire U.K. telemedia sector: (a) Freeview is rapidly gaining market share at the low end, and Sky is responding with its own low-end offerings, and (b) fixed line telephony usage is falling due to continued adoption of wireless.

The TV problem is not so bad because multichannel TV penetration in the U.K. is low, so getting homes onto a multichannel platform has a benefit of setting them up to consider moving up to cable or Sky. The telephony issue is tougher and only the ability to offer a bundle is a real answer and probably not sufficient.

A lesser negative in the quarter was that NTLI's business division had declining revenues. This was expected and will continue throughout 2005 but declines should moderate in 2006.

Good subscriber growth, falling ARPU and weak trends in the Business division mean that NTLI revenue growth will be in the very low single digits for 2005. Margins are expanding as the company is benefiting from numerous internal projects to improve efficiencies from customer acquisition to customer service and billing, so cash-flow growth will be in the mid-single digits. With U.S. cable companies getting around 10% top line with some margin expansion it is easy to understand why NTLI trades at 6 times EBITDA vs. 8-9 times for Comcast (CMCSK).

Given the mixed results, why are we holding NTLI and/or NTLIW? Because the Telewest (TLWT) merger appears to be on the front burner and it has huge value creation potential for NTLI shareholders. Cost savings of $180 million a year could accrue to NTLI shareholders. Put a 6 multiple on that and you get over $10 per NTLI share.

Further, given NTLI's underleveraged balance sheet, an NTLI-TLWT merger that re-leverages the balance sheet can produce big financial leverage as free cash flow will be plentiful to rapidly paydown debt.

I expect an announcement on merger terms in the next few months. In the meantime, NTLI is aggressively buying back shares as part of its authorization to reduce shares outstanding by 15% in 2005. I think the risk-reward tradeoff is good heading into the merger announcement. If NTLI overpays or the deal falls through, we might sell at slightly lower prices, but if a decent deal is struck, upside could easily be 20% or more due to cost savings, free cash flow, and improved competitive positioning of the combined company.

Morgan Stanley Downgrades NTL

Morgan Stanley (MWD) downgraded NTL Incorporated (NTLI) from buy to hold yesterday leading to a decline in the shares. Sitting out the market's big turnaround lifted my frustration with the NTLI position. However, it is worth noting that the downgrade comes along with a $75 target, up 15% from current prices. I remain bullish as further outlined below...

Morgan Prefers Telewest to NTL

Morgan's downgrade was mostly due to a corresponding upgrade of the U.K.'s #2 cable company, Telewest (TLWT). Morgan prefers the near-term fundamentals at TLWT and on its valuation measures TLWT is slightly cheaper. Morgan's model shows very similar revenue growth in the core cable business for both firms at around 5%. Where they prefer TLWT is on the balance of each company's business, on margin assumptions in the cable business and on 2005 subscriber growth. To his credit, Morgan's analyst is making it very clear to investors that he prefers TLWT over NTLI. Just what a good analyst should do.

Telewest's Diversification Is Accretive to Growth

TLWT has a content division that is growing at a double-digit rate, while NTLI has a wholesale carriers business that is likely to decline sharply as old contracts come up for renegotiation. I think that Morgan's assumptions on NTLI's carrier business in 2005 and beyond are overly conservative, but the point is well taken that TLWT's diversification is accretive to its growth rate, while NTLI's is dilutive.

High Churn Leads to Low Confidence in 2005 Guidance

On the margin front, Morgan is worried that NTLI's aggressive rationalization of its call centers, so far flawless, will encounter issues as the final steps are taken. Basically, Morgan appears to be worried that the low-hanging fruit has been eaten and the remaining work is a lot tougher. Call-center rationalization also relates to the above-average churn NTLI has experienced as it has tightened credit standards and cut back on promotions. The high churn leads Morgan to have low confidence in management guidance for 200,000 net subscriber additions in 2005.

I'm betting that NTLI 1Q05 trends confirm management's subscriber guidance and rebuild investor confidence in the company's fundamentals. If this occurs, I think the major share repurchase funded by the sale of the company's broadcast tower business (management has promised to buyback 15% of the shares within 6 months) and the pending sale of its Irish cable operations for a better-than expected 8 times cash flow (NTLI and TLWT both trade at 5.5 to 6 times cash flow), will move the stock back into the mid-$70s.

Merger Is Still Likely

One other consideration is that a long-rumored merger between NTLI and TLWT is still likely and could be announced this quarter. Investors are nervous that as the buyer, NTLI will pay a premium to TLWT and transfer a significant portion of the accretion in the merger to TLWT shareholders. These concerns were further inflamed when rumors that TLWT was shopping its content division emerged. Initial price talk was higher than expected. So in one sense, NTLI shares are trapped in that as they underperform TLWT shares, fears about the merger price go up.

I find this logic convoluted for two reasons. First, according to analyst estimates, NTLI's share of cost synergies in the merger could be over $20 per share. If so, that leaves a lot of premium to give away before this merger is anything but a major winner for NTLI shareholders. Second, the top four shareholders in both companies are identical. Any merger is likely to be mostly a share exchange so the better the terms for NTLI, the better the major shareholders make out.

Next Few Months Are Crucial

The bottom line is that the next couple of months are critical to the NTLI story. Good news on the Ireland sale, an aggressive share repurchase, signs of improved operating fundamentals, and a fairly priced merger with TLWT all can serve as potential catalysts. If things fall right, valuation of U.K. cable can expand toward its U.S. peers and NTLI shares can climb into the $80s. Despite my frustration, I'm hanging on as that is a darn good return with downside protection offered by the share buyback.