Cablevision Is on the Verge of Unlocking Great Value

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Dave Sterman

NEW YORK ( StreetAuthority) -- I spend much of my time in search of companies that possess robust growth prospects. But I'm also content to occasionally focus my energy on companies that are unlikely to grow meaningfully. The catch: these companies must be able to generate a huge amount of profit from their sales base in a consistent manner. Or they need to own a set of assets that would be highly coveted by other firms in an industry.

I think I've found a company that checks off both of those boxes.

New York-based Cablevision ( CVC) generates stunning amounts of free cash flow. And recent events make me think the company may soon receive a very flattering offer from a rival or a private-equity (PE) firm.

An industry that has peaked

It's no secret cable companies face myriad threats. Some consumers have balked at $100 monthly bills and are now content to simply surf the web for their evening's entertainment. (In the case of Cablevision, we're talking about a $150 average monthly bill.) Other consumers are ditching their cable providers for satellite-based providers such as DirecTV ( DTV) (which, incidentally, can consider me a very happy new customer after making a recent switch).

But rumors of cable's demise are greatly exaggerated.

The vast majority of consumers are sitting tight, continuing to get cable service along with Internet access and phone service -- all from a company with which they already have a longstanding relationship.

Simply put, cable companies such as Cablevision, which already has 3.6 million customers, are hard-pressed to find any new customers at this point in their life cycle. At the same time, they are not likely to see their customer base materially shrink, either. So their real focus is on squeezing out profits from every bill. And boy, is Cablevision profitable.

In 2010, for instance, Cablevision generated $7.2 billion in revenue and $2.6 billion in EBITDA. This worked out to be 36% EBITDA margins, which is quite impressive in any industry, let alone one that is mature and subject to fierce competition.

In recent quarters, investors have grown concerned that rising costs to ESPN and other networks will materially weaken results. The comparisons with 2010 are imprecise because Cablevision spun out its ownership of AMC Networks ( AMCX) this summer, but it now looks as if Cablevision could generate roughly $6.6 billion in sales and $2.2 billion in EBITDA in 2011. This means the EBITDA margin is dropping to 33% -- still a very solid number.

But forget EBITDA. The real metric investors should focus on is free cash flow, which is likely to exceed $600 million this year.

This means shares sport a free cash flow yield above 14%, which is among the highest free cash flow yields you will find anywhere. (To get to this figure, you simply take the cash flow projection -- $600 million -- and divide it by the stock's market cap -- which is about $4.17 billion.) As a point of reference, rivals such as Comcast ( CMCSA) and Charter Communications ( CHTR) sport free cash flow yields of around 10%.

The robust free cash flow is currently being deployed to share buybacks. The total share count likely fell by roughly 20 million shares to 280 million shares in 2011.

The pieces are in place

Investors increasingly sense that something is afoot at Cablevision. In 2010, the controlling Dolan family -- which owns 20% of the company -- decided to spin off sports-focused MSG Networks (NYSE: MSG). And as noted earlier, Cablevision spun out AMC Networks this past summer. The company is clearly streamlining in anticipation of something.

Just last month, Cablevision's long-standing Chief Operating Officer Tom Rutledge left the company. This has led to speculation that the Dolan family would like to put Cablevision up for sale.

Indeed, shares initially slumped on word that the company had lost a long-standing respected leader, but as the buyout thesis started to ripen, shares have rebounded. (Rutledge subsequently was named the new CEO of Charter Communications.)

Shares of Cablevision have fallen from a peak of $38 in February 2011 to a recent $15. Subtract the $12 value associated with the spin-off of AMC Networks this summer, and we're really talking about a fall from $26 to $15.

At current prices, the Dolan family has several choices.

First, the Dolan's can apply the $600 million in annual free cash flow directly toward stock buybacks, reducing the share count by nearly 15% every year.

Second, they could take the company private themselves (as they've tried to do before). Cablevision's stock is worth about $4.2 billion and its debt load is about $10.3 billion, adding up to an enterprise value of $14.4 billion. Let's suppose the company was offered to be taken private for $17 billion, implying an equity valuation of $6.7 billion (17 - 10.3 = 6.7).

If this math is correct, then investors would be looking at a 61% premium to the current share price. Don't scoff. This is target is less than what Cablevision was worth early in 2011.

The third option: Time Warner Cable ( TWC) or another such entity could also offer a similar price and pull off an accretive deal.

Cablevision has the industry's best demographics, due to the relative affluence of its Long Island, New York, New York City and New Jersey customer base. Time Warner and others have long coveted that footprint and the $150 monthly bills that this demographic engenders.

What are the odds the Dolan family will put the company on the block? "The sale of Cablevision, in some respects, is both natural and perhaps, inevitable. We may only be arguing about timing," notes Smith Barney's Jessica Reif Cohen. She adds that shares should trade up to $21, even without a sale, as that translates into a 10% free cash flow yield where its peers trade.

Risks to Consider: Further economic weakness in 2012 may lead more consumers to "cut the cord," which would reduce Cablevision's customer base and substantial free cash flow.

Action to take: Buyout or not, this is a cheap stock when you measure the market value against the company's impressive free cash flow. The Dolan family may simply stay the course and pay off debt while buying back stock. Even if this happens, Cablevision's enterprise value would steadily fall, making the highly-prized customer base an even more undervalued asset. If we apply Smith Barney's $21 target to Cablevision, then this works out to be about 40% upside.

Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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  • This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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