Description

INTRODUCTION:
NTL is a cable MSO operating in the UK. As of 9/30/05, the company served approximately 3.10 million residential subscribers, offering a package of video, broadband and telephony services as part of the cable "triple-play." Unlike their US counterparts, UK cable MSOs such as NTL and Telewest have a long history of providing telephony service - a result of having built their networks using paired coaxial and twisted copper cables. NTL also serves the enterprise market and has a small, deteriorating carriers business.

NTL MARKET STATISTICS & MULTIPLES:
Share Price: $58.35
Shares: 85.2
Market Cap: $4,971
Net Debt: $2,623
EV: $7,594
PV of NOL: $722
Adjusted EV: $6,872

2006E Subs: 3.24 million
2006E Revs: $3,498
2006E EBITDA: $1,230
2006E FCF: $318

EV / EBITDA: 6.2x
EV / EBITDA (excl NOL): 5.6x
EV / Subs: $2,344
EV / Subs (excl NOL): $2,121
P / FCF: 15.6x
P / FCF (excl NOL): 13.4x

INVESTMENT THESIS:
On October 3, 2005, NTL agreed to acquire Telewest (TLWT) in exchange for $16.25 in cash and 0.115 share of NTL per 1.000 share of TLWT. Telewest is the other major UK MSO which operates a similar network under a similar strategy as NTL in a contiguous, non-overlapping geographic segment of the UK, and had arguably achieved better traction in their operating results than NTL. In addition to its distribution assets, Telewest owns the "Flextech" portfolio of content assets - more on this later.

This merger has long been speculated (and hoped for) by shareholders in both companies given the overwhelming logic of the combination (economies of scale, non-overlapping contiguous regional coverage, similar and compatible network architecture) in the face of what is becoming an increasingly competitive operating environment across the UK. Furthermore, there is significant overlap among the large equity holders in each company (Huff, Franklin, Oaktree, Fidelity, Glenview) - theoretically facilitating agreement on a deal.

Pro forma synergies - consisting predominantly of cost-cutting and capital spending efficiencies - are estimated by the investor community at £150 - £250mm per year, with a PV of £1.5bn (~$2.625bn) as estimated by NTL management. The deal is expected to close in early Q1'06 after review by the Office of Fair Trading in the UK and, if necessary, the Competition Committee. While competition and detractors (BSkyB, BT) are likely to raise objections, it is believed that there is fairly little regulatory risk to the deal - again given the heightened level of competition in the UK, plus the fact that NTL and TLWT are non-overlapping so the merger does not actually change the competitive landscape in any given region.

Below are the current standalone market statistics and multiples for Telewest:

TELEWEST MARKET STATISTICS & MULTIPLES:
Share Price: $22.37
Shares: 245.9
Market Cap: $5,501
Net Debt: $2,888
EV: $8,389
PV of NOL: $910
Adjusted EV: $7,479

2006E Subs: 1.94 million
2006E Revs: $3,003
2006E EBITDA: $1,049
2006E FCF: $411

EV / EBITDA: 8.0x
EV / EBITDA (excl NOL): 7.1x
EV / Subs: $4,324
EV / Subs (excl NOL): $3,855
P / FCF: 13.4x
P / FCF (excl NOL): 11.2x

However, you can further adjust for Telewest’s ownership of content assets to arrive at the pureplay cable multiples. Telewest owns content assets in the form of its "Flextech portfolio" – consisting of 100% of Flextech (entertainment) and Sit-up (home-shopping) and a 50% interest in UKTV (entertainment) in partnership with the BBC. Books on the Flextech portfolio were reportedly distributed by Telewest’s bankers to a number of strategic and financial bidders prior to the announcement of the merger with NTL and garnered significant attention – press reports speculated interest from BSkyB, Viacom, ITV, RTL Group, Channel Four Television Corp, Time Warner and Cinven, among others. After the deal was announced, the Flextech assets were taken off the market – though supposedly BSkyB had ultimately bid as much as £1.2 billion (and was turned down due to BSkyB’s already dominant control over several premium UK content assets). If you back-out a £1.0 billion valuation (~$1.75 billion) for Flextech and back out its minimal free cash flow contribution of $6.0 million ($48.7 million EBITDA less $42.7 million Capex), you arrive at the following pro forma multiples:

TELEWEST MARKET STATISTICS & MULTIPLES – BACKING OUT FLEXTECH:
Adjusted EV: $7,479
Flextech EV: $1,750
Adjusted EV excl Flextech: $5,729

2006E Subs: 1.94 million
2006E Revs: $2,237
2006E EBITDA: $1,001
2006E FCF: $405

EV / EBITDA (excl NOL and Flextech): 5.7x
EV / Subs (excl NOL and Flextech): $2,953
P / FCF (excl NOL and Flextech): 7.0x

Finally, if we examine what the pro forma combined company looks like, we arrive at the following multiples:

NEWCO MARKET STATISTICS & MULTIPLES:
Share Price: $58.35
Shares: 113.5 (28.3 created via TLWT @ 0.115 conversion ratio)
Market Cap: $6,621
Net Debt: $9,507 ($3,996 New Debt issued to satisfy $16.25 per TLWT share cash obligation)
EV: $16,128
PV of NOL: $1,632
Adjusted EV: $14,496
Flextech EV: $1,750
Adjusted EV excl Flextech: $12,746
PV of Synergies: $2,625
Adjusted EV excl Flextech & Synergies: $10,121

2006E Subs: 5.18 million
2006E Revs: $5,735
2006E EBITDA: $2,231 (cable only; for simplicity I am assuming operating synergies do not begin to accrue until 2007)
2006E FCF: $363 (cable only; for simplicity I am assuming operating synergies do not begin to accrue until 2007; backing out new debt at 9%)

EV / EBITDA: 7.2x
EV / EBITDA excl NOL: 6.5x
EV / EBITDA excl NOL & Flextech: 5.7x
EV / EBITDA excl NOL, Flextech & Synergies: 4.5x

EV / Subs: $3,114
EV / Subs excl NOL: $2,799
EV / Subs excl NOL & Flextech: $2,461
EV / Subs excl NOL, Flextech & Synergies: $1,954

P / FCF: 18.2x
P / FCF excl NOL: 13.7x
P / FCF excl NOL & Flextech: 8.9x
P / FCF excl NOL, Flextech & Synergies: 1.7x

You can see that on an EV / EBITDA basis, if you believe in the execution story on synergies, you are arguably buying UK cable assets at a very cheap, compelling 4.5x pro forma multiple. With the Flextech valuation seemingly market-tested, this is a very cheap way to create strong FCF-generating cable assets that should be able to quickly delever, again depending on the speed and execution of realizing corporate synergies.

In addition, there are rumors of private equity players waiting in the wings to purchase the entire combined company after the merger closes, though Bill Huff’s public stance suggests he is loathe to sell at anything less than a very rich valuation. Still, this possibility both buttresses the downside risk and offers “homerun” possibility on the upside for investors.

RISKS:
The key risks to this investment are as follows:

1. Competitive landscape – the competitive dynamics in the UK market are extremely competitive. First, there is BSkyB, the satellite provider of video services which is 36% owned by Rupert Murdoch’s News Corp and seemingly has a defensible foothold among “high value” subscribers given its historical dominance and “gateway” role in terms of providing premium content, including many popular US television and film entertainment properties as well as sports franchises, to the UK market. In addition, BSkyB recently announced an agreement to purchase UK broadband provider Easynet and thereby begin its foray into triple-play services.

In addition, the incumbent telecom provider, British Telecom (BT), as part of its own triple play, has announced plans to begin offering TV-over-DSL services; essentially, their video offering amounts to an a la carte, VOD-like model as opposed to a traditional continuous-time broadcasting model. On top of that, the competitive landscape is further complicated due to the overwhelming success of Freeview – a government-subsidized alternative whereby customers who make a one-time purchase of a Freeview set-top box (c. £50.00) are subsequently able to receive over 30 digital-quality channels at no monthly cost. Freeview has quickly captured a significant portion of the “low value” subscribers that BSkyB and cable had previously thought were “easy pickings” for their entry-level subscriptions, removing a large part of the previous cushion on video’s growth story. Finally, there is the “unbundling” phenomenon in the UK which the regulatory agency, Ofcom, has been quick to support.

2. Merger risk – again, while most parties believe there is very little regulatory risk associated with the merger, if for whatever reason the transaction were to be significantly delayed or, worse, ultimately fail, it would be a crushing blow and have negative implications for remaining exit opportunities for investors. Again, we believe the risk here is low.

3. Synergy execution risk – again, the “cheapness” of the stock is somewhat a function of how much one believes in management’s ability to effect their synergy targets.

Catalyst