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July 25, 2006

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.

Posted by Steve Birenberg at July 25, 2006 09:17 AM in NTLI