Mediacom MCCC
March 09, 2006 - 7:54pm EST by
2006 2007
Price: 5.80 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 678 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Mediacom Communications is a mid-sized public cable MSO operating primarily in smaller cities and towns in the United States. Mediacom operates in a total of 23 states and is highly concentrated in relatively rural markets in the mid-American region; the Company¡¦s largest market is Des Moines, Iowa. As of December 31, 2005, Mediacom systems passed 2.81 million homes and served 1.42 million subscribers.

Share Price: $5.80
Shares: 117.0
Market Cap: $678.6
Net Debt: $3,042.4
EV: $3,720.7
PV NOL: $317.5
Adjusted EV: $3,403.2

2006E Subs: 1.43 million
2006E Revs: $1,185.6
2006E EBITDA: $435.1
2006E FCF: $9.2
2007E FCF: $35.5

EV / 06 EBITDA: 8.6x
EV / 06 EBITDA (excl NOL): 7.8x
EV / 06 Subs: $2,602
EV / 06 Subs (excl NOL): $2,380
P / 06 FCF: 89.3x
P / 06 FCF (excl NOL): 47.5x
P / 07 FCF: 19.1x
P / 07 FCF (excl NOL): 10.2x

From a fundamental valuation standpoint, it is not difficult to generate discounted cash flow valuations of c.$8 ¡V $10 per share. This can be done either through a traditional DCF in which the present value of NOLs ($1.7 billion of carryforwards as of year-end 2005) is added back to the enterprise value or by simply discounting the FCF to Equity at an equity cost of capital.

Critics of Mediacom argue it is overlevered (7.1x) and is comprised of sub-par rural cable systems which, to date, have produced weaker results than its larger brethren, e.g. Comcast, Time Warner Cable and Cablevision. While we acknowledge many of these criticisms, we also recognize the long-date call option that Mediacom represents. Effectively, Mediacom is a ¡§public LBO¡¨ with no near-term maturities and ramping cash flows. As the company begins to roll out its triple-play offering we think it could prove to be a rewarding leveraged equity bet ¡V particularly if cable sentiment improves.

Like all cable plays, Mediacom is pinning its hopes on the bundled triple-play of video, high-speed Internet and VoIP telephony. The theory (which is gaining traction at Cablevision given their 4Q05 results, for what it¡¦s worth) is that the triple-play serves as both an offensive and defensive strategic maneuver: (i) offensive in that it markets a bundled package of services that satellite players cannot offer (outside of tenuous co-marketing agreements with RBOCs in certain regions) and beats the RBOCs to market with a triple-play (ii) defensive in that it creates ¡§stickier¡¨ RGUs, reducing churn and increasing gross margins (i.e. de minimus incremental costs charged against the revenue generated by providing additional services to existing customers). The Company only recently began launching VoIP in its target markets, commencing telephony operations in Q305 and ramping to 22k telephony subscribers as of December 31, 2005.

Recently, Mediacom has struggled with one-off events such as the Hurricanes of 2005, which impacted the Company¡¦s footprint in the Southeastern US region (Florida, Georgia, Mississippi). Despite a challenged financial profile in 2005 (EBITDA decreased 3% y/y from $417.5 million in 2004 to $405.3 million in 2005), management gave fairly robust guidance for 2006, including revenue growth of 8 ¡V 9% and EBITDA growth of 7 ¡V 8%.

All things being considered, the liquidity profile and debt maturity profile of Mediacom¡¦s capital structure is fairly benevolent from an equity-holder¡¦s perspective. The Company has two near-dated bond instruments: (i) $172.5 million of HoldCo Convertible Notes due July 2006, far out of the money; and (ii) $400 million of Broadband OpCo Senior Notes due July 2013, which are trading on a YTC basis to their next call date in July 2006. Both of these securities should be easily addressable by the Company by either tapping a currently robust high-yield market and / or drawing on the Company¡¦s sizeable undrawn revolver balances; Mediacom has a cumulative $899.1 million of undrawn revolver capacity, including $597.3 million at its Broadband subsidiary and $301.8 million at its LLC subsidiary. After these two bonds, there are no outstanding maturities until February 2011, apart from limited amortizations on the Company¡¦s bank debt.

Mediacom shares have traded at a 52-week high of $7.51 (September 2005) and a 52-week low of $4.79 (November 2005). As highlighted above, we believe upside values for Mediacom are in the range of $8 ¡V 10. At the extreme, if you believe that Mediacom should trade cheap to Comcast equity (see discussion below), Mediacom¡¦s equity value could fundamentally be zero.

However, given the long-dated optionality discussed above, this stock is unlikely to take such a dramatic nosedive barring a paradigm-shifting negative catalyst in cable stocks. The famous example of an underwater cable equity trading on option value is Charter, which trades at $1.14 per share and is greater than 10x deep through the capital structure on an EV / EBITDA basis. Using Charter equity as a basis for comparison, it is hard to see Mediacom (with better liquidity, better maturities and overall much less ¡§hair¡¨ on the situation) trading below an absolute downside of $4 ¡V 5 over the next 12 months.

Below a certain trading level, it is likely that buyers will start to step in again on this name as the disparity between public market and private market cable valuation multiples widens. A recent example is the Charter asset sales in which Charter sold 316k subscribers, predominantly in West Virginia and Kentucky, for $896 million, or $2,835 per sub (EBITDA figures were not disclosed). At $2,835 per sub, Mediacom¡¦s shares would be worth $8.48.

1.) RBOC Competition and the Impact of the T / BLS Merger ¡V The silver lining to Mediacom¡¦s theoretically lower-value subscriber base in rural America is that it gives the Company a greater degree of insulation from RBOC entries into pay-TV. Given the enormous amounts of money that RBOCs are spending to put fiber into the ground, they are primarily targeting the more densely packed, higher-value MSAs (e.g. Verizon in New York City).

In recent headlines, the proposed AT&T / BellSouth merger is clearly incrementally negative for cable companies in that AT&T has a well-defined FTTC roll-out strategy for deploying TV-over-DSL whereas BellSouth had previously been noncommittal regarding its pay-TV plans. Nonetheless, pro forma for the merger the combined overlap of Mediacom¡¦s footprint with the AT&T / SBC / BellSouth footprint is c.40%. Currently, the largest single RBOC in Mediacom¡¦s footprint is Qwest with c.30%.

2.) Satellite Competition ¡V Mediacom basic subscribers have declined from a peak of 1.60 million in 2001 to 1.42 million at year-end 2005, largely attributable to aggressive competition from DISH and DTV. Given its historically superior video offering and minimal incremental fixed costs per subscriber, the satellite subscriber-based business model base is highly effective in competing for rural subscribers (whereas cable system economics generally thrive in tightly-packed urban environments), placing Mediacom in the crosshairs. Nonetheless, the pace of subscriber losses has decelerated dramatically, and Mediacom is placing its faith in the churn-reducing, value-enhancing capabilities of the triple-play to breakeven and / or possibly generate modestly positive net adds for the first time in several years in 2006.

3.) Highly Levered Balance Sheet ¡V Mediacom is currently levered at 7.1x Net Debt / 06 EBITDA, compared to a total enterprise value of 8.6x. This massive net leverage is difficult to swallow in both absolute terms and in the context of where Comcast equity trades (see below). Effectively, Mediacom equity should be viewed as a minority stake in a public, highly-leveraged LBO-like vehicle, and equity returns are likely to be similarly juiced.

This level of leverage makes it difficult to run valuation sensitivities on an EV / EBITDA basis, as an incremental 0.5x turns is worth $1.84 per share or 32% of yesterday¡¦s closing price. Additionally, the debt profile somewhat reduces the likelihood of an LBO or MBO, as there is limited financing capacity to layer incremental leverage onto the capital structure. Again, however, in light of the attractive liquidity and debt maturity profile, a leveraged equity bet in Mediacom arguably offers highly attractive upside optionality.

4.) Comcast Premium / Discount ¡V The crux of this argument goes something like: ¡§Comcast, the US cable bellwether, is trading at 7.0x on 2006 EBITDA. Why should Mediacom, in most respects a weaker company, trade at a premium?¡¨

In addition to the qualitative factors discussed above (i.e. rural insulation from RBOCs), one factor to keep in mind from a valuation standpoint is that Comcast effectively becomes a full c.40% cash-tax payer in 2006, which reduces EBITDA „» FCF conversion rates by c.15%. Mediacom, on the other hand, is unlikely to be a taxpayer for the next decade. On a P / FCF basis, Comcast currently trades at approximately 25.3x 2006 FCF and 21.5x 2007 FCF, in light of which Mediacom valuations appear more appropriate.

In reality, Comcast and Mediacom are almost certain to trade directionally in unison; Mediacom is unlikely to generate significant returns unless it is led by Comcast via a broad-based uptick in cable sentiment.

5.) Concentrated Ownership and Trading Illiquidity ¡V Cumulatively, management (27.3 million shares, 23.4%) and long-time holder Morris Communications, aka Shivers Investments (28.3 million shares, 24.2%) effectively reduce the float by 47.6%. As a result, daily trading volume is fairly light ¡V LTM average volume is 482k shares, which equates to $2.8 million at yesterday¡¦s closing price. Furthermore, the concentrated ownership significantly reduces the possibility of a hostile bid, to the extent that is a source of upside.


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