Events: FV Update & Scenario Analysis
April 19, 2015
(CHTR pro forma for CMCSA, GreatLand and BHN transactions)
- NASDAQ: CHTR
- Recent PPS: $186.74 (Friday close)
- Shares Out: 172 million
- Market Cap: $32,119
- Total Debt: $26,233
- Enterprise: $58,353
- CMCSA PPS: $58.42 (Thursday: $59.67)
- TWC PPS: $149.61 (Thursday: $158.20)
DOJ. Late Friday, Bloomberg reported that the antitrust division of the U.S. Department of Justice is nearing a recommendation to block the Comcast/Time Warner deal (the “Deal”). CHTR, CMCSA and TWC closed down -1.9%, -2.09% and -5.43% on the news. On Saturday, the WSJ reported that CMCSA and TWC are planning to meet with the DOJ on Wednesday.
TWC Arb Spread. At Friday closing prices, the Deal is worth $167.96 per TWC share (all share consideration; 2.875 exchange ratio) for a gross arb spread of 12.27%. At Thursday’s close, the Deal was worth $171.55 for a gross arb spread of 8.44%.
CHTR Transactions. CHTR is party to three transactions tied to a successful Deal closing: 1) 1.3MM net sub purchase from CMCSA at 7.125X 2014 EBITDA; 2) 2.5MM sub spin (GreatLand) at 7.125X 2014 EBITDA, of which CHTR will own 33%; and 3) a 2MM sub purchase from Bright House Networks (BHN) at 7.6X 2014 EBITDA. (Please refer to page 6 of the BHN Deal presentation at the end of this write-up.)
Deal Outcome. I am not particularly adept at game theory and political analysis, thus I have very little to add on the qualitative front here. My good friend @well_mont (a very wise investor I would encourage all to virtually befriend) believes too much is riding on the deal for it to break, and that CMCSA’s pro forma broadband market power is exaggerated, as the broadband market already currently operates by local monopoly – seems logical to me. And while the current 12.27% gross arb spread indicates a relatively high probability of the Deal breaking, that spread could be somewhat artificially high given the forced selling on late Friday by event-driven hedge funds. As such, I would say the odds of consummation are roughly balanced.
Scenarios. I see the following scenarios playing out over the next 6 to 12 months, with TWC and CHTR as the two primary ways to “play” the situation:
- Deal Close – 50%
- As-Is: 25%
- Concessions: 75%
- Deal Break – 50%
- TWC Bid: 75%
- No TWC Bid: 25%
TWC. While a Deal Close scenario with concessions would likely depress Pro Forma CMCSA’s post-deal fair value, this can obviously be hedged via a CMCSA short position. So if the Deal closes within 9 months, in either form the TWC annualized return is approximately 16.36% from current levels.
If the Deal breaks, I estimate CHTR would bid between 7.5X and 8.5X 2014 EBITDA, or between $137.70 and $166.99 per TWC share. I do not believe TWC would accept $138, nor do I believe CHTR would bid $167; as such, the $152.35 mid-pt (8X) is a reasonable base-case TWC valuation in the event a CHTR bid is consummated. Using a 9-month duration, the annualized return is approximately 2.44% from current levels.
In the event CHTR refuses to bid higher than 7.5X for TWC, I believe 7.5X is a reasonable downside valuation for TWC given the BHN transaction was done at approximately 7.6X. Using a 9-month duration, the annualized return is approximately -10.61%.
Multiplying thru the various probabilities, the projected IRR is approximately 7.77% for TWC.
CHTR. In summary, CHTR is worth $183 on a standalone basis (i.e. all transactions fall apart and CHTR does not buy TWC); $238 pro forma for all announced transactions; and $207 on a standalone basis with TWC. For the sake of being conservative, I do not model CHTR in the event the Deal closes with concessions, as the FV begins to reach silly levels. On a probability-weighted basis, CHTR is worth $219.37; and using a 9-month duration the annualized return is approximately 23.29%.
Even adjusting for the fact that the TWC upside scenario is more certain on a trading basis due to the CMCSA hedge, the CHTR risk/reward is far more attractive at current levels.
CHTR FAIR VALUE
I believe the Deal Break TWC Bid scenario is understated given it assumes CHTR walks away from BHN. A pro forma CHTR/TWC/BHN would still be smaller than CMCSA, so it is not unreasonable to assume all three consolidate, in my opinion; as such, the overwhelming probability is that CHTR is worth at least its current $238.
The $238 PF CHTR Valuation makes the following assumptions (please see 17M CHTR ANALYSIS for greater detail):
- 2014-2020 Revenue Growth: 6%
- 2020 EBITDAM: 40%
- Interim CAPEXM: 16%
- Maintenance CAPEXM: 11%
- Interim Tax Rate: 10%
- Terminal PE: 15X
- Leverage Target: 4X
- Interest Rate: 6%
- 2015-2019 Cumulative Tax Benefits: $13.84B
At $238, the 5-year IRR is approximately 16.4% per annum.
In a blue sky scenario where CHTR grows the top-line by 7% per annum, maintains 4.5X leverage, averages a 5% interest rate and trades at 17.5X terminally, CHTR is worth approximately $313 for a 25% 5-year IRR.