Game of Homes
John Malone sure knows how to stir up a pot.
Just two months after closing on a $2.6 billion investment in Charter Communications, conventional wisdom holds that it isn’t if the Liberty Media chairman and cable legend is going to engineer a major cable acquisition — it’s when.
The market seems to agree, driving cable stocks, already up 20% from January to May, up another 15% since June, solely on deal speculation.
Initial speculation has fluttered around a possible Charter-Time Warner Cable deal, a transaction Charter seems to want more than its target. The deal would give obvious scale to Charter — adding TWC’s 12 million customers would vault it into the No. 2 spot among MSOs, with 16.5 million customers. Malone’s Liberty now owns a 27.3% stake in Charter, with the opportunity to grow that to 40% after 2016.
Not everyone is convinced. Bank of America Merrill Lynch media analyst Jessica Reif Cohen, skeptical of a TWC-Charter deal, wrote in a research note that the much-smaller Charter would need TWC’s assets to finance a transaction — and raise leverage from its current investment-grade level of 3.25 times cash flow to junk-bond territory of at least 5 times.
Pivotal Research Group principal and media & communications analyst Jeff Wlodarczak wrote last week that Charter could eke out a deal with TWC, but would likely have to go public to force management to respond.
And though access to credit markets is critical — especially for TWC, which has returned an average of 110% of its free cash flow to shareholders over the past two years, in part by borrowing — rising programming costs and the growing popularity of online video providers like Netflix and Amazon could make obtaining more scale a greater priority.
Blockbuster deals don’t have to be the path toward gaining that scale, though.
“We continue to believe that a wave of consolidation — perhaps in smaller pieces — is going to happen soon,” Reif Cohen wrote.
That could mean that operators like Cablevision Systems and the privately held Cox Communications (4.5 million customers) could be targets — and reports earlier last month said even Time Warner Cable was considering a smaller deal to get Charter off its back.
Comcast chairman and CEO Brian Roberts has largely sat on the sidelines, but as chief of the largest U.S. MSO, with about 21 million subscribers, he could be a factor in any deal that involves systems near its expansive footprint.
For now, though, there aren’t many counting Malone, known for being a relentless dealmaker, out. He has spoken before about how cable operators need to pull together to find ways to get new technologies — such as TV Everywhere, which has stumbled badly in some markets — to all of their customers.
As the theories fly — Will Charter buy TWC or will TWC buy Cablevision? — one thing is certain: any deal hinges on the timing, ego and ambition of six key executives.
The 72-year-old Liberty Media chairman roared back into cable distribution in March, announcing a surprise investment in Charter Communications, one of the industry’s hottest growth companies. Malone’s investment in Charter immediately sent speculation into overdrive, with several analysts predicting that the former Tele-Communications Inc. chief would usher in a new wave of consolidation.
Malone pulled no punches concerning his intentions. He has openly called Charter “a horizontal acquisitions machine.”
And he knows a little bit about acquisitions. The father of the modern cable industry — he transformed struggling Tele-Communications Inc. into a 17 million-subscriber powerhouse — Malone also helped shape modern cable programming, bankrolling several upstart networks like Discovery Channel, BET and countless others through Liberty Media. He also ushered in the last major consolidation wave, selling TCI in 1999 to AT&T for a then-record $49 billion. Through Liberty Media, he continued to acquire, grow, sell and spin off programming networks and in 2008, used Liberty’s position in a large chunk of News Corp. voting stock to secure a controlling stake in DirecTV (which Liberty spun to its shareholders about two years later).
In the meantime, Malone’s Liberty Global continues to consolidate the international cable market — last month it completed the purchase of U.K. MSO Virgin Media in a cash and stock deal valued at about $24 billion. Liberty Global now has about 25 million subscribers in 14 countries in Europe and Latin America.
Malone has said publicly that he has always regretted selling TCI, and though he has a stronghold in the international market in Liberty Global, has yearned for a footprint in the U.S. for years. Malone has said he believes the jewel in the distribution crown is broadband, which he has called the most addictive product in communications today.
“Cable technology is right now the most cost-effective way to deliver that growth in speed,” Malone told CNBC in April.
Greg Maffei has been John Malone’s financial engineer since he became Liberty Media’s CEO in 2006, after stints as chief financial officer at soft ware giants Oracle Corp. and Microsoft . He hasn’t let those financial chops go to waste — since joining Liberty, Maffei, 52, has engineered countless deals, including the spinoff s of Liberty Interactive, Starz and several online companies, as well as a $530 million investment in Sirius XM Radio in 2009 which has since grown into a stake worth about $11.5 billion.
As a key architect of the Charter Communications investment, Maffei is keenly aware of the MSO’s potential, telling CNBC shortly after the deal was closed in May that the current economic climate of relatively inexpensive debt and steady cable cash flows could suggest that a round of consolidation could be coming.
“Whether Charter is a consolidator or a consolidatee, we’ll see,” Maffei told CNBC.
Maffei threw some gasoline on the consolidation fires in June, when he reportedly approached Time Warner Cable chairman and CEO Glenn Britt to talk about industry-consolidation issues. TWC reportedly rejected those informal advances — one member of the cable financial community said Liberty had floated a deal that would pay TWC shareholders the full value of their stock (then trading at about $112 per share) in cash, plus a 30% premium in Charter stock.
While that offer was not accepted, it did show the financial community that Liberty was getting serious about doing a deal, which has driven up cable distributors’ stock prices and thrust possible targets like Cablevision Systems and Cox Communications into the spotlight.
The guitar-shredding 57-year-old Cablevision Systems CEO and lead singer of JD & The Straight Shot has had a rough year after what has arguably been the most successful run in cable operations in recent memory. Along with former chief operating officer Tom Rutledge, Jim Dolan created the $99 triple play of video, voice and data, a move that led to industry-leading penetration rates in every subscriber metric. (Cablevision has 57.9% video, 55.8% high-speed data and 45.8% phone penetration in its New York metro market.)
But that success has come back to haunt the Bethpage, N.Y.-based operator — there is little room for growth, despite valiant efforts to rebrand and repackage its products. In the first quarter of this year, video customers fell by 5,000, high-speed data subscribers rose 23,000 and the phone rolls grew by 23,000. A 2010 experiment to spread its management philosophy outside metropolitan New York by buying the former Bresnan Communications (dubbed Optimum West) didn’t live up to expectations; the systems were sold to Charter Communications earlier this year for a tidy profit.
All those factors have some analysts guessing if the Dolan family (which controls about 73% of Cablevision’s voting stock) may finally be in a mood to sell the 3 million-subscriber MSO. Recent deals that spun off programming arm AMC Networks and the sports venues and teams housed within its Madison Square Garden unit have made Cablevision a pure-play cable operator, thus facilitating a deal.
Glenn Britt , the unassuming chairman and CEO of Time Warner Cable, has been anything but in the past few years. He has been at the forefront of controversial issues regarding programming costs — threatening to drop smaller networks and then delivering on that promise — as well as retransmission consent.
The nation’s second-largest MSO has also been active in the deal market, purchasing Insight Communications in 2012 for $3 billion and NewWave Communications for $260 million in 2011. The company also has moved into the regional sports network business, inking a $3 billion-plus TV deal for the National Basketball Association’s Los Angeles Lakers on its newly launched Time Warner Cable SportsNet and Time Warner Cable Deportes channels last year. Next year, TWC will launch a second RSN in Los Angeles, anchored by Major League Baseball’s Dodgers, in a rights deal valued between $7 billion and $8 billion.
But Time Warner Cable has stumbled operationally of late. Its basic-video subscribers have declined by more than was expected, as customers rolled off an aggressive discounting plan. While the company has made moves to right the ship, the 64-year-old Brit is rumored to be considering leaving after his contract runs out at the end of this year. The time may be right for the longtime Time Warner executive — he joined the former parent’s corporate finance group in 1972 — to make a career-defining deal.
Rob Marcus toiled for most of his career at Time Warner Inc. as a deal-maker — he was the chief architect of the Time Warner Entertainment partnership in the early 1990s and helped to dismantle it in 2006. Since joining the cable company as chief financial officer in 2008, though, Marcus has shifted gears.
After he was named chief operating officer in 2010 — and became a strong candidate to be chairman and CEO Glenn Britt ’s eventual successor — Marcus, 48, has focused on TWC’s balance sheet. Known as an ambitious and shrewd strategist, he has said publicly on several occasions that the media giant’s leverage ratio of 3.25 times cash flow, which puts it squarely in investment-grade territory, is sacred. That could put the kibosh on any big deals, especially one such as the recently-speculated acquisition by Charter. According to some analysts, a Charter deal would raise TWC’s leverage ratio to junk-bond levels.
That does not mean the company can’t or won’t do smaller deals — Marcus has touted the value of scale in the past — it just means these transactions must make financial sense. Marcus and the rest of the TWC team have oft en said that deals must pass a simple test: Will the return on an acquisition surpass the return on a repurchase of the MSO’s own stock? With a share price well north of $100 (shares closed at $111.98 apiece on July 5), that test may be easier to pass than ever.
Largely considered to be the best operations executive in cable today, the soft -spoken Tom Rutledge shocked many in late 2011 when he jumped from Cablevision Systems, followed by several of the company’s other top executives, to become CEO of Charter Communications.
Rutledge’s task at Charter is daunting: Although it has more potential for growth than any other cable operator, it also has the lowest penetration levels in every customer metric. But in his short time at the helm, the 59-year-old Rutledge has made a difference. He has repackaged Charter’s products and discontinued its lowest-speed tier of high-speed Internet service, which helped boost penetration levels in HSI and phone service to 34.7% and 18.7%, respectively, in the first quarter. That’s up from 32.5% for Internet access and 17.1% for voice a year ago.
Rutledge also has voiced the benefits of scale. Though he hasn’t publicly said whether Charter is embarking on an acquisitions spree, he has said the company will take advantage of opportunities as they arise. And Charter has done deals — it closed on the $1.6 billion acquisition of Cablevision’s Optimum West unit on July 1.
“If we can find other opportunities that are similar to Charter’s opportunities — and we can manage them and get them for an appropriate price — of course we’re interested,” Rutledge said on Charter’s first-quarter conference call with analysts in May.
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