With the major averages now down 10% or more in the past week, analysts say that investors should turn to the unlikeliest of places -- namely Time Warner Cable ( TWC) -- to ride out the storm. The cable industry has become attractive to investors as economic pressures continue to increase, with Time Warner Cable emerging as the favorite, thanks to a sizeable one-time payment due before the end of the year. Some cable stocks have already displayed strength amid the market volatility of the past year. While the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite have crumbled over the last nine months, Comcast ( CMCSA), the largest U.S. cable operator, which closed Tuesday at $17.15, has gained 2% during that time frame. Cablevision ( CVC) shares rallied 30% in August after the announcement of a dividend payment, although the stock has lately come back to Earth. Looking ahead, the transition to digital television in February is expected to be an important catalyst for Time Warner Cable and the cable industry as a whole. Additionally, analysts expect that margins and video share should rise along with increases in broadband market share. On the surface, Time Warner Cable does not appear to be the most logical pick to endure the market downturn, considering the cable operator, which closed at $21.55 Tuesday, has seen 20% of its share value chopped off this year. However, analysts say both Comcast and Time Warner Cable have diverged to a surprising degree, considering both have similar quality assets, similar capital structures and a similar exposure to the weakest housing markets in the U.S. "For investors looking to mitigate macro-economic risks facing the broader cable group -- including the deepening local advertising deterioration -- the relative valuation gap between Time Warner Cable and Comcast may represent an attractive lower-risk opportunity to participate in the sector," says Craig Moffett, analyst with Sanford Bernstein, in a note. The firm recently named Time Warner Cable as its top pick in the telecom, cable and satellite group for the fourth quarter.
Analysts are quick to point out that the divergence in both stocks comes as Comcast has benefitted greatly from a reinstated dividend payment and the announcement of a large share repurchase program. In February, Comcast announced plans for a quarterly dividend -- its first since early 1999 -- totaling 25 cents a share annually. Comcast also said it would repurchase approximately $7 billion of stock by the end of next year. What makes Time Warner Cable so attractive going forward is its own hefty dividend payment expected before the end of the year. In May, Time Warner Cable announced it would separate from its parent Time Warner ( TWX). Prior to the spin-off, Time Warner Cable will declare a one-time dividend of $10.27 to all shareholders. With an ownership stake of 85.2%, Time Warner is set to receive $9.25 billion of the total $10.9 billion payout. While the turmoil in the credit markets would certainly raise concerns over Time Warner Cable's ability to fund the large dividend payment, the company has already secured financing for nearly half of the $10.9 billion payout, thanks to a $5 billion debt offering made in June. Time Warner Cable spokesman Alex Dudley said that a consortium of banks are set to fund the balance of the payment. "Obviously, the debt markets are not in great shape by any stretch," says David Joyce, media analyst with Miller Tabak, who has no share ownership of and does no investment banking for Time Warner Cable. "However, the separation isn't slated to happen until the end of this year or may spill into January. There are still a few months for the Federal Reserve's efforts to open up the credit markets again in order for Time Warner Cable to take on that extra debt. I don't see that as being a stumbling block."
What does seem to be restraining investor enthusiasm is the addition of some 80 million new shares of Time Warner Cable's stock. As part of the separation agreement, Time Warner will exchange its 12.4% interest in Time Warner New York, a subsidiary of Time Warner Cable, for 80 million newly issued shares of Class A common stock. "Investors continue to worry about an excess supply of Time Warner Cable shares ... but the transaction displaces equity for debt in the capital structure," writes Moffett. "As a consequence -- even after accounting for the resulting changes in share count, minority interest, interest expense and income taxes -- Time Warner Cable's equity becomes more attractive on all equity-based valuations, including price-to-earnings multiples and free-cash-flow yields." Time Warner Cable is also compelling because of its ability to add subscribers despite slowing economic conditions and increasing competition from Comcast, AT&T ( T) and Verizon ( VZ), the latter of which is set to challenge Time Warner Cable on its home turf in New York City. When it comes to adding subscribers, Time Warner Cable reported a net addition of 896,000 revenue-generating units in the first quarter of 2008 and another 656,000 net additions in the second quarter. "They've definitely been outperforming expectations this year on the addition of revenue-generating units," says Joyce. "Those have come at the cost of marketing, so their
earnings before interest, taxes, depreciation and amortization margins have been under some temporary pressure for the first half of this year and possibly throughout the whole year. But again, it is an investment in long-term growth because they have been surpassing expectations on bringing new customers in."
Joyce argues that Time Warner Cable should continue to retain subscribers -- which is key, given economic uncertainties -- thanks to a mix of cutting-edge technology in the cable industry and exceptional customer service, which has already fueled a good turnaround since the company took on some of Adelphia Communication's assets following its filing for Chapter 11 bankruptcy in 2002. "Time Warner Cable is a very healthy company," Joyce asserts. "There are a lot of propriety products and services. Customer service is of paramount importance in this day and age, when they've got a new competitor with a 'me-too' product, meaning Verizon's FiOS service. The company has been on a good turnaround both from their legacy systems and their marketing and their products they've gotten also from acquiring Adelphia."