Why We Are Revising Our Price Estimate For Time Warner Cable

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Time Warner Cable

Time Warner Cable (NYSE:TWC) announced recently that it has entered into a definitive agreement to merge with Charter Communications (NASDAQ:CHTR). [1] Time Warner Cable shareholders will be paid $195.71/share, $100 in cash and the rest in shares of a new public parent company, tentatively called “New Charter”, for each Time Warner Cable share outstanding. Charter had earlier agreed to buy Bright House Networks and the Syracuse based company will also be a part of New Charter. If the merger goes through, New Charter will become a formidable force in both the high speed internet and pay-TV markets. The newly formed company would represent 21% of the high speed internet market with Time Warner Cable, Charter and Bright House accounting for 13%, 6% and 2% respectively. [2] [3] In the pay-TV market, New Charter would account for 17% of the market share. [2] [4] Additionally, the market shares for New Charter will remain below the 30% unofficial limit in both markets and we believe this deal will face less regulatory scrutiny as compared to the now-defunct Comcast-Time Warner Cable deal. (Read more – Our Thoughts On The Time Warner Cable-Charter Merger)

Time Warner Cable has been doing well on its own too. The company reported extremely strong subscriber numbers in its last quarter. Time Warner Cable added 315,000 high-speed data subscribers in what was the company’s best quarter in terms of subscriber additions since Q1 2007. [2] The company also registered its first quarterly increase in its pay-TV subscriber base since the Q1 2009. Additionally, Time Warner Cable experienced their best quarter ever in terms of net subscriber additions in residential customer relationships, residential triple play and voice. Consequently, we are revising our price estimate for Time Warner Cable to $183.

See our complete analysis for Time Warner Cable

Relevant Articles
  1. Time Warner Cable Q1 Review: High-Speed Data Leads Revenue Growth, Company Gains Pay-TV Subscribers
  2. How Are Time Warner Cable’s Revenue & EBITDA Composition Expected To Change By 2020?
  3. What Has Led To A ~20% Increase In Time Warner Cable’s Revenues & EBITDA In The Last Five Years?
  4. How Has Time Warner Cable’s Revenue Composition Changed In The Last Five Years?
  5. How Much Can Time Warner Cable’s Revenues Grow Over the Next Five Years?
  6. What’s Time Warner Cable’s Fundamental Value Based On Expected 2016 Results?

Exceptional Performance In High Speed Data Segment

We estimate that high-speed data segment contributes close to 47% to Time Warner Cable’s stock value. The company has demonstrated rapid growth in this segment in recent years and its broadband subscriber base is around 12.6 million as of March 31st 2014, as compared to less than 8 million in 2007. [2] Time Warner Cable has been steadily increasing its Fee per Broadband Subscriber in the past few years. This figure has increased from around $42 per month in 2007 to over $54 in 2014. We have revised our estimates upwards for this driver of growth and we believe that this figure can reach $80 by 2021 as opposed to our earlier projection of $75. Similarly, Time Warner Cable’s market share in the high speed internet market has also gone up from around 11% in 2007 to 12.8% in 2014. We believe Time Warner Cable’s market share will continue increasing and reach around 13.8% by the end of our forecast period.

High-speed internet business has been the leading growth factor for cable companies for quite some time now. There is a boom in demand for high-speed Internet in the U.S. due to a growing need for speed and connectivity. Currently, high-speed internet penetration in the U.S. homes stands at 74%, leaving enough room for growth. [5] In the long run we estimate that high-speed internet will penetrate over 95% of U.S. homes. This will benefit the cable industry in particular as it accounts for approximately 56% of the U.S. high-speed internet market. [3] The use of multiple devices and higher penetration of smartphones are also aiding the overall demand for high-speed Internet. Smartphone penetration has seen rapid growth from 54% in December 2012 to nearly 75% in November 2014. Internet video, video-on-demand and online gaming account for the majority of Internet traffic in the U.S. Video streaming, for instance, requires high data volumes which explains why the reliance on fixed networks is far greater than that on mobile carriers. These factors will help Time Warner Cable in consistently gaining internet subscribers in the long run.

Lower Weighted Average Cost Of Capital

We have revised our discount rate (or weighted average cost of capital) downwards for valuing Time Warner Cable’s stock. This is the rate at which we discount the company’s future cash flows, and is the weighted average of its after-tax cost of debt and cost of equity. This figure is a measure of a company’s risk. Time Warner Cable justifies this revision as the stock’s beta has come down in the past year. Beta is a measure of company’s stock movement relative to broader market movement. Time Warner Cable’s correlation to the broader market has improved which means that the risk of fluctuations in its stock price has gone down. The company has also been able to stabilize its business and increase its revenues without taking on substantial debt. The company has actually managed to reduce its leverage and its total debt has gone down from $25.9 billion as of March 31st 2014 to $23.3 billion as of March 31st  2015. [2] This is a good sign as it reduces the risk in the company and warrants a revision.

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Notes:
  1. Charter Communications to Merge with Time Warner Cable and Acquire Bright House Networks, May 26, 2015, Time Warner Cable Press Release []
  2. Time Warner Cable’s SEC Filings [] [] [] [] []
  3. NEARLY 1.2 MILLION ADDED BROADBAND IN THE FIRST QUARTER OF 2015, May 15, 2015, Leichtman Research Group, Inc. [] []
  4. MAJOR PAY-TV PROVIDERS ADDED ABOUT 10,000 SUBSCRIBERS IN 1Q 2015, May 14, 2015, Leichtman Research Group, Inc. []
  5. The State of the Internet, Akamai []