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Banks' Return Is Key to Deal Market

System valuations are climbing, but a panel of cable investment bankers and private-equity managers last week warned that future merger and acquisitions activity will depend heavily on the return of banking institutions to the deal market.

At the Kagan Broadband Summit here last Wednesday, Kagan World Media senior analyst Robin Flynn estimated that cable systems are valued between $2,500 and $4,500 per subscriber, depending on their upgrade level and the number of new services they offer. That compares to the peak valuations of $5,700 per subscriber in 2000 and $2,300 per subscriber in 2002.

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For example, Flynn estimated that a cable system without broadband was worth about $2,300 per subscriber. Adding digital (and its corresponding cash flow) raises that valuation to $3,100 per sub.

A cable system with digital, residential high-speed data and telephony and commercial data and telephony was worth $4,500 per customer, Flynn estimated.

Waller Capital Corp. senior managing director Ian Crowe said the resurgence in the equity market is encouraging — cable stocks on average are up about 30 percent this year — but banks are still reluctant to back cable deals.

Crowe should know: He was vice chairman of TD Securities LLC, the investment arm of Toronto Dominion Bank, and had been involved in the bank's media lending business for about 25 years before he joined Waller earlier this year.

"The biggest issue is that the debt markets are tremendously impaired," Crowe said. "The big cable-lending banks, because of problems in telecom, have battened down the hatches for the whole sector, including cable."

While private equity has been extremely active in recent cable deals, Crowe said that debt financing is essential.

"The outlook on the debt market is still not that great," Crowe said. "The banks are very cautious. I think the debt markets are less optimistic than the equity markets."

To get banks back into the fray, said Crowe, the industry needs to resolve the heavy debt issues and accounting questions at Charter Communications Inc. and Adelphia Communications Corp. must emerge from bankruptcy, as expected, in about a year.

"The bottom line is there is a lack of liquidity," Crowe said. "This caution and this negativism can only raise prices and that is a bad thing. It's one thing if it takes 10 times cash flow to buy cable, but is it five turns of equity and five turns of debt, or is it eight turns of equity and two turns of debt?"

Cash flow is king

Michael Angelakis, managing director of Providence Equity Partners — a private-equity firm that has been extremely active in cable deals — said that per subscriber valuations are irrelevant. What private equity firms are really looking at are multiples of cash flow.

"Not every subscriber is created equal," Angelakis said. "We don't look at that [per subscriber] metric. To us, you can compare Motel 6 to the Four Seasons [Hotel], but does every hotel room cost the same?"

Providence has participated in several recent cable deals. It backed Bresnan Communications Inc. in its acquisition of 314,000 subscribers in Montana, Wyoming and Colorado from Comcast Corp.

Providence has also been active internationally — it was part of two separate groups that purchased Deutsche Telekom's cable assets in Germany for $1.6 billion and Dutch cabler Casema for $720 million earlier this year.

Angelakis also lamented the departure of the banks from cable deals. He estimated that about 116 banks were lending to cable a couple of years ago. Now, he said, less than 35 banks are lending to the sector.

"The institutional market is picking up about 66 percent of the debt facilities in the market today," he said. "That shift has certainly changed the way we look at financing these deals."

DH Capital Inc. principal Joe Duggan said that while some banks still participate in cable deals — like CIT Group, Wells Fargo, JP Morgan Chase and Wachovia — "the old-time lenders are gone."

TWC IPO trigger

Duggan said that the lack of inventory has hampered the deal market, adding that many of the available systems are unattractive rural operations.

"On the negative side of valuations, we have what I call the 'Axis of Evil'— rural, small headends, no access to [high-speed] Internet at a reasonable cost and satellite erosion," Duggan said.

But Daniels & Associates executive vice president Greg Ainsworth was optimistic that the deal market will rebound, especially in the wake of Time Warner Cable's upcoming initial public offering, expected in the fall. Last year only about 23 cable deals were announced, the lowest number since 1982.

Once that IPO — expected to raise $2 billion — is completed, Time Warner will likely use its new deal currency.

Ainsworth also said that large MSOs like Cox Communications Inc., which have largely held off on acquisitions as they focused on growing free cash flow (cash flow after capital expenditures and interest payments are made), are expected to re-enter the deal market with renewed vigor.

Crowe agreed.

"Time Warner will want to play catch-up," Crowe said. "A year from now, there will be a lot more deal activity."

That should also help valuations, he said. Currently, cable systems are selling for between 10.5 times and 11 times cash flow. As larger MSOs get back into the acquisition mode, those valuations could rise to 12 to 13 times cash flow.