Cox Bid Sheds Little Light on Adelphia

Cable shares have rallied since Monday's surprise offer, but one big player remains in limbo.
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Cox Communications (COX) may have gotten a lowball buyout offer, but Wall Street has found reason to cheer anyway.

On the bright side, Monday's bid by closely held majority shareholder

Cox Enterprises

to buy up publicly traded shares in the cable operator is a sign of an insider's confidence in the strength of the cable business. Shares across the industry have risen since then, particularly at industry leader


(CMCSA) - Get Report

and smaller shop




But that cheer has been muted by some other implications of the deal -- particularly for shareholders of bankrupt cable operator Adelphia Communications.

Cable stocks have been mostly on the upswing this week, after the Monday morning announcement of Cox Enterprises' $7.9 billion buyout offer. Reflecting a widespread hope that Cox Enterprises, or CEI, will raise its $32-per-share offer, Cox Communications' stock traded at $33.32 Tuesday, up 21% from its Friday close of $27.58.

Certainly, analysts are hoping the offer sets some sort of floor for the beaten-down cable sector.

The bid is "a tremendous vote of confidence from CEI," writes Banc of America analyst Doug Shapiro in a Tuesday note. "CEI has historically been a very conservative company that has closely guarded its investment grade credit rating. However, it is taking on substantial leverage to do this deal, sending its debt below investment grade, and is substantially increasing its exposure to cable. We believe this is about as clear a signal as one could ever hope to get that it considers public market values too low."

That's good news, of course. As Shapiro points out, cable stocks are near their all-time lows, judging by their enterprise values as a multiple of 12-month forward earnings before interest, taxes, depreciation and amortization. They're also near all-time lows relative to valuations of Standard & Poor's Industrials. (Shapiro has a buy rating on Cox and a $37 price target; his firm has done recent banking for Cox.)

Mixed Bag

But saying that stocks aren't likely to fall any further isn't the same as saying they'll rise. And on that front, the outlook is mixed. The consensus is that Cox has some of the highest-quality systems in the industry, if not the highest. That, acknowledges Shapiro, can lead to the bearish argument that any prices set by this private market offer -- Shapiro calculates a $3,500-per-subscriber figure, based on 2005 estimates -- sets a disappointing ceiling for the rest of the industry.

No, replies Shapiro. Unlike most other benchmark-setting bids by private market buyers, CEI's offer doesn't offer a control premium -- a reflection of the value a buyer thinks it can extract from a business once it takes over. The offering price, Shapiro says, reflects public shareholders' poor negotiating position and CEI's opportunistically low bid.

Yet in a brief comment, Credit Suisse First Boston's Lara Warner terms the offer (which she calculates at $3,700 per sub) "not a bullish indicator," but simply an opportunistic move. Warner has a neutral rating on the stock and a $32 price target; her firm has provided recent investment banking services for Cox.

Either way, the waters are still muddy for Adelphia shareholders, who -- while holding out for an outright sale of the cable operator in the hopes of maximizing the return on Adelphia's assets in its bankruptcy proceeding -- have watched the public market value of cable operators slowly decline this year.

Back in April, some analysts speculated that Adelphia could reap as much as $4,000 per subscriber, though Adelphia's management itself, which had been pushing to stay independent, valued the company at $3,333 per subscriber.

As analysts pointed out this week, a CEI bid for the balance of Cox would reduce the likelihood of, and the available money for, any Cox bid for Adelphia, removing one of the likely buyers for at least parts of Adelphia.

Adding Value

The diminishing chance of a bidding war for Adelphia, says Shapiro, is a positive for the sector, making it more likely that operators will be returning free cash flow to shareholders rather than on an expensive acquisition.

But another analyst, UBS's Aryeh Bourkoff, spotlights how the proposed CEI buyout illustrates the tension between cable operators' need to invest for the future and cable investors' heightened desire nowadays for increased payouts.

CEI said Monday that the competitive environment "convinces us that future investments in the cable industry are best made through a private company structure."

Reading between the lines there, Bourkoff says CEI will likely take some of Cox's free cash flow to more aggressively roll out advanced services, giving Cox leverage against satellite operators and telcos in their drive to attract high-paying, loyal subscribers with similar service bundles.

Such spending appears counter to the current cable investor mood. That is to have operators, after years of spending money on upgrading systems, start returning more cash to shareholders, either as dividends or through stock buybacks. Bourkoff praises Cablevision for aggressively rolling out its own bundle, and questions Comcast for not being aggressive enough. (Bourkoff rates Cox and Comcast neutral, and has a buy on Cablevision; his firm has done recent banking for Cox and Comcast.)