Virgin Media Back on Track

Virgin Media (VMED) had a tougher than expected 2011 as the crisis in Europe included the UK economy. In addition, competition picked up as all of the company’s cable, satellite, and telecom competitors responded aggressively to the macro weakness. This environment led VMED to increase capital spending amid discounting form some competitors while its own subscriber growth slowed. Investors worried this was the beginning of period of slower growth and profitless prosperity for VMED as the company would need greater capital and marketing investment merely to maintain the current business model.

I was patient with VMED even as the stock slid from the low $30s to the low $20s because the excellent management team realizes the company maintains a key competitive advantage: the best broadband network in the UK. Earlier in 2012, the company clarified its capital spending plans and the stock appeared to bottom. Coinciding with its earnings report yesterday, management provided a complete strategic update that further explained how the company would sustain growth in operational and financial measures. The plan is to invest in the network by upping broadband speeds and enhancing the cable TV experience with Tivo’s (TIVO) best in class user interface.

This is exactly what I have thought the company should do. It is following a similar approach to DirecTV DTV) by focusing on higher end customers. In addition, VMED is offering a clear upgrade path for its customers to entice them to buy more services and move to higher priced offerings. The focus on broadband is something that is beginning to occur in the US cable industry. Broadband internet is taking over from cable TV as the lead product. Investors do not appreciate this shift or cable’s clear leadership and competitive advantages in broadband.

VMED’s new strategy should produce better growth beginning this year while maintaining the high free cash flow generation that supports aggressive share buybacks. I think the stock can head back to the low to mid-$30s, especially if worries about Europe’s economy begin to recede.

Disclosure: VMED is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a long only registered investment advisor. VMED, DTV, and TIVO are net long positions in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, a long/short equity hedge fund focused on media, communications, and related technologies. Steve also owns a stake in Entermedia’s investment management company and has personal monies invested in the
Funds.

Discovery Leads Solid Media Earnings But Virgin Media Mixed

Given the increased importance of macro issues on the stock market and record high correlations among individual stocks, I am expanding media company earnings analysis this quarter to touch on all companies and major trends, not just Northlake positions.

Several important media companies reported earnings since yesterday's close, kicking off about a dozen reports from the media world this week and next. After the lousy news from Time Warner Cable and Cablevision last week, investors were anxious to learn if a wholesale trend change toward the bears was underway. So far, that is not the case as Discovery Communications (DISCA/DISCK), Comcast (CMCSA/CMCSK), and Time Warner (TWX) affirmed healthy industry trends. DISCK and CMCSK shares are responding well to earnings. TWX is weak but that is due to issues unique to the company (weak ratings at key cable networks). Management commentary on industry trends is constructive.

Comcast met expectations pretty much across the board. This comes as a great relief following back to back misses and poor guidance from TWC and CVC. The only notable weakness in the report was phone subscriber additions. This was a problem area for TWC but Comcast management noted that their promotional push was back to school and stressed video and high speed data. Both those sub numbers looked good.

While Comcast's results come as some relief, investors are likely to remain on edge with cable and satellite stocks. Comcast is a long-term laggard on cable operations. As a result it has low hanging fruit that is allowing it to sustain mid single digit revenue and EBITDA growth and positive subscriber momentum even as the industry is mature and fully penetrated, feeling pressure from lack of household formation (household counts may actually be reversing), and cord cutting fears rise. DirecTV reports tomorrow, which will help to round out video trends in the near-term. Too soon to call the coast is clear but I think Comcast remains the domestic cable company of choice for investors.

DISCK reported a strong quarter boosted above Street expectations by the recent deal with Netflix. Taking away Netflix, results were pretty much right in line with street estimates and guidance. Guidance for 2011 was upped to reflect the Netflix deal. Critically, domestic advertising trends exceeded guidance, coming in up 11%. Furthermore, management guided to mid-teens growth for the fourth quarter and indicated no cancellations so far of first quarter 2012 upfront commitments. Analysts were still skeptical of advertising trends, which will remain the primary issue for the big entertainment companies that own the leading cable and broadcast TV networks. National TV networks is the primary business of most entertainment conglomerates these days.

TWX was generally constructive on advertising trends even though it reported upper single digit ad growth and guided for the same in the fourth quarter. TWX networks are really struggling with ratings which is hurting ad pricing, particularly for scatter or spot buys. DISCK management indicated that scatter pricing was up 5-20% depending on the ratings of its networks. TWX was talking scatter being up just low single digits. I would not read too much on media fundamentals into TWX dropping almost 3% today. The company is clearly lagging its peers in national TV. However, the drop in TWX shares shows that media investors remain generally scared and skeptical and that presents challenges for the rest of the group.

Virgin Media (VMED) reported mixed results. Gross subscriber additions were excellent but churn rose leaving subscribers more or less in line. ARPU or revenue per sub was also good. VMED i still growing but seems to be spending more to sustain growth as operating profits were light of estimates. In addition, management indicated capital spending was headed higher, another sign of the business economics getting tougher. I think that the Street is being too negative on capex as management seems to be spending on success based capital related to the very well received new Tivo interface. There is also the issue of how much the weak UK economy is at fault such that better economic growth later in 2012 or 2013 will fix the "problem." I am willing to give VMED the benefit of the doubt for now as valuation reflects a weak outlook and share repurchases remain very aggressive providing good support for the stock and upside if earnings meet expectations in 4Q11 and early 2012.

We will learning a lot more in the next 24 hours. News Corporation reports after the close today. Scripps Interactive and DirecTV report before the open tomorrow and CBS reports after the close tomorrow.

Disclosure: CBS, VMED, and DISCK are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. CVC, CMCSK, DISCK, CBS, VMED, and DTV are net long positions in the Entermedia Funds. The Entermedia Funds are long/short equity hedge funds focused on media, entertainment, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds.

Mixed Results for Virgin Media

Virgin Media (VMED) reported mixed 2Q11 results. Financial performance matched expectations as revenue rose 2.2% and EBITDA gained 6.1%. The disappointment was on the subscriber side as overall subscribers fell slightly. Losses were seen in video, phone, and high speed data. Gross additions were not too bad but churn picked up. VMED's leading broadband and video platform is constantly improving the customer mix and driving subs to spend more money on services, driving revenue per subscriber higher so that modest growth is achieved even when subscribers are flat to slightly lower.

The big question for VMED is whether the poor subscriber performance is merely a function of the weak UK economy amid strict government austerity. If so, the story has not really changed and VMED's superior competitive positioning will reignite sub growth and sustain long-term financial performance once the economy improves (4Q11 or 1H12). Management is showing great confidence in the company by announcing a much larger and sooner than expected new share buyback program. The share buyback is quite accretive on a per share basis as 12% of the current shares outstanding will be retired in the next 18 months.

I suspect that 3Q11 results will look quite similar to 2Q. Wall Street worries a lot about subscriber numbers for cable companies so I expect the stock to be sluggish for another few months. However, the aggressive share repurchase should support the shares and limit downside.

I have great confidence in VMED's management team. Upgrades to the network and software interfaces give VMED the fastest and most reliable internet offering and the leading next generation cable TV product. Unfortunately, right now, those competitive advantages are only enough to hold the ship steady in stormy economic waters. Calmer seas lie ahead so holding the shares is the best option. Mid-$20s represents an excellent point for those who are not long VMED.

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

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.

Another Good Quarter for Virgin Media

Virgin Media reported solid third quarter results as management continues to execute very well at the operating level and take advantage of VMED's superior broadband network in the United Kingdom. Overall growth in revenue and EBITDA remains modest, rising mid to upper single digits. Free cash flow is growing double digits as capital spending intensity continues to wane. Free cash flow is key to the VMED as the company's balance sheet remains highly leveraged following a series of acquisitions and network upgrades by the prior management team. VMED stock benefits directly as excess cash is used to pay down debt and repurchase shares, effectively transferring the corporations value from bondholders to shareholders.

I expect this value transfer thesis to remain in place through 2011 and can see the stock reaching the low $30s. there are a couple of risks to the story, one which was partially evident in 3Q results and the other which may emerge in the next few months. During 3Q, VMED subscriber growth in cable TV fell a little short of expectations. Pay TV in the UK is extremely competitive and Sky Broadcasting's satellite is the clear market share leader. Sky was unusually promotional during the third quarter and on the conference call VMED management said its October market share improved. Nevertheless, weak subscriber growth is a risk to VMED.

Closely related to the subscriber growth competition is the UK economic situation. The UK government is undertaking extreme austerity measures including massive layoffs of government workers. Austerity could lead to slower economic growth and higher unemployment and impact demand for all competitors in the UK's multichannel TV, high speed internet, and wireline and wireless telephony industries. VMED is major player in all of these industries. Thus far, the austerity measures have had no noticeable impact on demand for communications services but it is early.

Disclosure: VMED is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. Steve s sole proprietor of Northlake, an SEC-registered investment advisor. VMEd is a net long position in the Entermedia Funds. Steve is co-portfolio of the Entermedia hedge funds, owns a stake in the Funds investment management company, and has personal monies invested in the Funds.

Virgin Media: Corner Turned, Upside Ahead

Virgin Media reported its best quarter in several years. Mid to upper single digit revenue and EBITDA growth comfortably exceeded estimates and translated to a big beat in free cash flow. Subscriber additions were also good across the board with positive surprises for high speed internet and wireless and wireline telephone. TV subscribers were in line with estimates.

After several years of stumbling about and struggling with the integration of acquisitions, the relatively new, current management team of VMED is finally taking advantage of the company's premier broadband network. Along with today's announcement of financial results, VMED showed again the power of its network with an announcement that beginning in late 2010 it would be offering 100MB internet service.

Three issues have plagued VMED shares over the past few years. All of them are now receding, setting the shares up for a move into the low $20s.

The balance sheet was massively overleveraged with many maturities in the next few years. Through free cash flow and debt refinancing, leverage ratios are now manageable. More importantly, VMED replaced about 2 billion pounds of debt maturing in 2010 thru 2012 with new issues maturing in 2018 and 2019.

VMED was in a weak competitive position in TV competing against Sky on the high end and Freeview on the low end. Freeview remains a difficult challenge but upgraded technology – again a benefit of the network – and an improved regulatory environment have stabilized the business.

With TV no longer a drag, the company has been able to firm up average monthly revenue from its subscribers and exploit its leadership in broadband. As a result, total revenue and EBITDA growth are rising and are now at levels exceeding those of the largest US and European cable operators.

For the next couple of years, the improved financial and operational performance looks locked in. The balance sheet should continue to improve as free cashf low goes toward debt reduction. Eventually a significant dividend should emerge and a major share repurchase.

The risk of promotional and irrational competitive pricing remains but for the time being, as was the case recently, dips in the stock related to competitive fears should be seen as buying opportunities.

Disclosure: Virgin Media is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. Virgin Media is a long position in the Entermedia Funds. Steve Birenberg is co-manager of the Funds, has an ownership stake in the Funds investment manager, and has personal assets invested in the Funds.

Virgin Media: Back Long An Old Friend

I purchased a new position in Virgin Media (VMED) in all Northlake client accounts, including my personal accounts. Clients who have been at Northlake for awhile may remember owning Virgin Media previously, even as far back as when it was known as NTL.

VMED is the largest cable company in the United Kingdom, with its network passing about half of all households. Historically, the company has faced some challenges due to the dominance of Rupert Murdoch’s Sky satellite broadcasting (very akin to DirecTV in the US). VMED’s various strategic responses have included acquisitions and network upgrades which left the company saddled with too much debt. Today, under new management, the company is leveraging its ownership of the fastest, most reliable broadband network in the UK. VMED is once again enjoying modest growth in subscribers and revenue while expanding margins, divesting non-core assets, and most importantly, rapidly paying down debt.

The combination of operational momentum and improving financial strength should allow VMED shares to reach the low $20s if current estimates for 2010 prove accurate.

Disclosure: Virgin Media is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal account. VMED is a long position in the Entermedia Funds where Steve Birenberg is co-owner, co-manager, and has a personal investment in the Funds.