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TheStreet Open House

John Malone's EBITDA Empire Strikes at Time Warner Cable

NEW YORK (TheStreet) -- If John Malone can successfully broker the takeover of Time Warner Cable (TWC) using Charter Communications (CHTR) and a possible contribution from either Liberty Media (LMCA) or SiriusXM (SIRI), or both, the billionaire could end 2014 as the most aggressive investor in the world, surpassing even Warren Buffett's Berkshire Hathaway (BRK.A) in putting his money to work.

But the empire that Malone is attempting to assemble using Liberty Media is dramatically different than what Buffett has built at Berkshire Hathaway. Investors who own shares in any of Malone's targets, whether it is Sirius, Charter or Time Warner Cable, should familiarize themselves with Liberty Media as they could soon own a piece of the cable and entertainment conglomerate.

While many of Liberty's assets generate significant earnings before interest, taxes, depreciation and amortization and cash flow (EBITDA), they have been notably light on the GAAP profits and cash balances that are a staple at Berkshire Hathaway.

Consider Charter Communications, a minority Liberty Media investment that is now campaigning for Time Warner Cable.

The company has unveiled an unsolicited $60 billion-plus takeover bid for Time Warner Cable that includes an offer of $83 a share in cash and a remaining component in stock. One might expect that Charter would be solidly profitable and generating significant free cash flow to finance the cash component of its Time Warner takeover offer.

That's not the case. Charter Communications hasn't earned a GAAP profit in any of the past three years. Its free cash flow generation has fluctuated between $130 million and $400 million in recent years. As of the third quarter, the company had $41 million in its bank account. That's not small potatoes, but it hardly seems grounds for a $60 billion takeover.

The company does stand out on other financial metrics.

Charter generated nearly $2 billion in operating cash flow and nearly $3 billion in EBITDA. Given losses during the financial crisis, the company also carried about $7 billion in net operating loss carryforwards, a potentially valuable way to create tax synergies with any asset it acquires.

What's amazing about Charter's lack of significant net income and free cash flow is that the company operates in the notoriously capital intensive cable industry. There are few sectors that investors should pay more attention to items like depreciation, amortization and capital expenditure, which are all discarded from metrics like EBITDA and operating cash flow.

At Liberty Media, the numbers are slightly better, especially if one assumes the company was to acquire full control of Sirius. According to some analyst projections, the combined company could generate in excess of $2 billion in EBITDA and over $1.2 billion in free cash flow.

In a joint bid, tax-related synergies between Sirius and Liberty Media could also allow Charter to raise an additional $2 billion to fund its prospective purchase of Time Warner Cable, according to Bank of America Merrill Lynch estimates.

Nevertheless, were Charter or a consortium of Liberty and Sirius to win Time Warner Cable, the deal will hinge on EBITDA, synergies and the utilization of NOLs to create tax benefits. A deal would also require a mix of stock and cash that will put shareholders under Malone's umbrella.

Buffett and his lieutenant Charlie Munger at Berkshire Hathaway have long criticized investors' reliance on EBITDA. Berkshire Hathaway has also employed a far less aggressive stance when pursuing takeover targets, for instance working to maintain top bond ratings through an acquisition.

The company generally likes to sit on a cash balance of about $30 billion, in the case of a downturn or unexpected crisis, and will seek to reinvest or spend its annual cash build-up. Finally, Berkshire celebrates capital expenditure and is relatively tame in the world of mergers and acquisition, cutting only a few deals in excess of $10 billion. Malone and Liberty Media are far more aggressive in M&A efforts and far more reliant on paper profits and financial engineering.

It's unclear whether Time Warner Cable, under Charter's ownership, would be able to maintain its capital expenditure, or whether the deal would hinge on achieving savings across the business.

Time Warner Cable, late on Monday, characterized Charter Communications' bid as "grossly inadequate."

"Not only is the nominal valuation far too low, but because a significant portion of the purchase price would be in Charter stock, the actual value delivered to TWC shareholders could be substantially lower given the valuation, operational, and significant balance sheet risks embedded in Charter's stock," Time Warner Cable said in a statement.

For now, that seems like a clear-eyed analysis of what Charter presently has to offer. It will, however, be interesting to see if Malone, Charter and Liberty Media can engineer a deal that would be tenable to management and ordinary investors. Charter did say on Monday its $60 billion offer was fully financed, indicating some investors are willing to put their money behind Malone's ambitions.

-- Written by Antoine Gara in New York.

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