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May 23, 2005

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.

Posted by Steve Birenberg at May 23, 2005 03:36 PM in NTLI