Watch Out For TWC-Charter Combo’s Post-Deal Debt Levels

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Downside
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Market
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Trefis
TWC: Time Warner Cable logo
TWC
Time Warner Cable

Charter Communications (NASDAQ:CHTR) is reportedly taking out bridge loans worth $13.8 billion in conjunction with its planned acquisition of Time Warner Cable (NYSE:TWC). [1] Charter could need to take on as much as $29.3 Billion in additional debt in order to finance the transaction. [2] The resulting debt levels of the post-merger entity could attain worrisome proportions.

Our price estimate for Time Warner Cable stands at $183, implying a premium of about 3% to the market.

See our complete analysis for Time Warner Cable

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Time Warner Cable announced last month that it had entered into a definitive agreement to merge with Charter Communications. [3] Under the terms of the deal, 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, NY-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] [4] In the pay-TV market, New Charter would account for 17% of the market share. [2] [5] Time Warner cable has said that the transaction will generate approximately $800 million in cost efficiencies every year. [2] Moreover, New Charter will benefit from the merger synergies, including combined purchasing, overhead, product development, engineering and IT.

Post-Deal Debt Level Could Become A Major Headache

The Time Warner Cable-Charter deal puts Time Warner Cable’s enterprise value at $78.7 billion. [2] Charter plans to borrow between $25 Billion to $29.3 billion, depending upon the stock-cash composition of the deal, in order to fund the purchase. [2] Time Warner Cable already carries debt worth $23.3 billion on its balance sheets while Charter’s pre-existing debt obligations amount to $13.9 billion. The companies estimate that New Charter’s total debt could cross $65 billion once the transaction is completed. The combined 2014 revenue for the merging companies sums up to $35.7 billion while combined adjusted EBITDA amounts to $12.9 billion. This results in a potential Debt-to-EBITDA ratio of 5.09 for New Charter. By comparison, the 2014 Trefis adjusted Debt-to-EBITDA ratios for pay-TV rivals Comcast (NASDAQ:CMCSA), DirecTV (NASDAQ:DTV) and Dish Network (NASDAQ:DISH) were 2.00, 2.58 and 4.97 respectively. Pre-merger Time Warner Cable has a Debt-to-EBITDA ratio of 2.82.

Following the merger announcement, Moody’s Investors Service has placed Time Warner Cable’s debt rating of Baa2 on review, stating that the merger will likely pull the debt rating down to “junk” status. [6] Time Warner Cable’s debt rating could drop two notches to Ba1 by the time the review is over. Charter CFO Christopher Winfrey announced last month that Charter had already received financial commitments of over $31 billion in relation to the merger. [7] Almost all of the debt Charter picks up for the transaction will be of “junk” status. Time Warner Cable paid more than $1.4 billion as Interest Expense on the company’s $23.7 billion debt last year. [2] Lower rated debt will cost more to service. Servicing around $65 million of “junk” status debt could become very troublesome for New Charter in the long run.

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Notes:
  1. Charter Said to Begin Offering Loans for Time Warner Deal, June 18, 2015, Bloomberg []
  2. Time Warner Cable’s SEC Filings [] [] [] [] [] [] []
  3. Charter Communications to Merge with Time Warner Cable and Acquire Bright House Networks, May 26, 2015, Time Warner Cable Press Release []
  4. NEARLY 1.2 MILLION ADDED BROADBAND IN THE FIRST QUARTER OF 2015, May 15, 2015, Leichtman Research Group, Inc. []
  5. MAJOR PAY-TV PROVIDERS ADDED ABOUT 10,000 SUBSCRIBERS IN 1Q 2015, May 14, 2015, Leichtman Research Group, Inc. []
  6. Time Warner Cable Deal Stirs Debt Concerns, May 26, 2015, Wall Street Journal []
  7. Charter Set for One of Biggest Junk-Debt Sales to Buy TWC, May 26, 2015, Bloomberg []