« Back to Value as Economic Recovery Becomes More Sustainable | Main | Liberty Capital: New Buy Based on Asset Value and Narrowing Discount »

December 08, 2010

Virgin Media Still Looking Good

Last Friday, I attended Virgin Media's (VMED) analyst meeting in New York. Here are my thoughts:

Despite jumping from $15 to $27 since Janaury 2010, VMED still has excellent upside as free cash flow is set to accelerate and management appears very disciplined toward using it to pay down debt and repurchase shares. Given the company's still high debt leverage, both cash uses accrue to the benefit of shareholders. At the same time, the new management team has done a great of fixing a formerly troubled company and is now in a position to focus on growth initiatives in mobile and business services and invest in the cable TV business.

VMED will never be a high growth company but sustaining mid single digit revenue growth for the next several years seems plausible as the company takes advantage of its best in the UK broadband network and more aggressively targets the growth opportunity in business services and the Virgin Mobile wireless.

Mid single digit revenue growth should lead to expanding margins due to the operating leverage of a network based business. Free cash flow should grow even faster as interest expense falls. During the presentation the CFO noted that past missteps under prior management have left operating loss carryforwards such that "VMED will not pay taxes in my lifetime." As a result, growing operating income will not lead to higher taxes due. Rather, it will lead to growing free cash flow as interest expense falls through debt reduction.

The most impressive part of the presentation came when Morgan Stanley's analyst asked whether the company was ready to focus on its growth opportunities. The CEO responded that the growth opportunities were real but that the company had not yet earned the trust of its shareholders to change the investment thesis. Given how well the company and stock have performed in the last two years, this was a remarkably humble answer. It also plays perfectly into investors current preference for cable companies to return cash flow to shareholders. VMED has long been an attractive set of assets. After many false starts, it finally has a management team to match its best in the UK broadband network.

The only negative in the presentation is that due to the UK government's austerity budget, growth in 2011 is going to have to come from mobile and business where market share gains are possible. This shift could pressure EBITDA growth even as revenue growth continues around 5%. The reason is that mobile growth will come from new subscribers who require handset subsidies thus pressuring mobile margins. US wireless companies are very familiar with this dynamic. In 2010, VMED is likely to grow revenue 5%, EBITDA 15%, and free cash flow by 18%. In 2011, revenue may grow 4%, EBITDA 7%, and free cash flow by 20%. The risk is that investors sell the organic operating growth slowdown and ignore the free cash flow story.

The bottom line is that VMED still has plenty of upside, mid $30s target in 2011, and I remain very comfortable holding Northlake client positions. That does not mean that trimming the position as part of normal portfolio management and gain harvesting will not occur.

Disclosure: Virgin Media is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Virgin Media is a net long position in the Entermedia Funds. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in Entermedia's investment management company, and has personal monies invested in the funds.

Posted by Steve Birenberg at December 8, 2010 03:44 PM in VMED