Description

Shaw Communications

I believe Shaw Communications (SJR) is presently trading at a significant discount to its intrinsic value and provides a pretty high probability of a 150-200% return within 24 months with a solid margin of safety making any loss of principal very unlikely.

Shaw is a diversified Canadian communications company whose core business is providing broadband cable, Internet and satellite direct-to-home (DTH) services to about 2.9 Million customers. They also have a business segment they call “Big Pipe”, which is their North American Fiber Network. The company is headquartered in Calgary and is listed on the NYSE in addition to the TSE (SJR.B). They are the largest cable operator in Canada and enjoy monopoly characteristics like the US Cable operators – which makes it a very good business. And very cheap.

The company has been growing rapidly over the years, and, as is typical of fast-growing cable companies, they historically haven’t generated net income or even meaningful cash flow. For a terrific primer in the cable business, I’d recommend reading John Malone’s biography entitled “Cable Cowboy”. In essence, cable companies with their rapid buildouts and big depreciation expenses end up paying little in taxes until their growth slows. Shaw followed this path until 2002 when management, getting frustrated with their undervalued business, decided to focus on becoming a cash cow.

There are, broadly speaking, two businesses units in Shaw:

1. Cable, Internet & Big Pipe (CIBP)
2. Satellite (DTH)

CIBP is now cash-flow positive. The history of the FCF strides this business has made are as follows:

Year CIBP FCF

2001 (C$512 Million) loss
2002 (C$349 Million) loss
2003 C$177 Million (company guidance)
2004 C$270 Million (company guidance)

Here is the Satellite’s business’s historical and projected cash drain:

Year Satellite FCF

2001 (C$317 Million) loss
2002 (C$214 Million) loss
2003 (C$102 Million) (company guidance)
2005 (C$20 Million) (company guidance)

With the FCF of $250 Million in 2004 for the business (and growing), I’d estimate that by 2006, interest costs will drop by at least $40 Million (from debt pay down from FCF), capex will stay flat at $290 Million and revenue will rise by at least $200 Million leading to FCF of at least C$410 Million. Note that the $290 million of Capex is all growth capex. All maintenance oriented expenses are written off in the year expensed. So, if this were a business that simply stopped growing entirely, FCF would be over C$710 Million. In a business like Shaw with is recurring revenues and monopoly like characteristics, that’s worth a 15x to 20x multiple at least.

Shaw has about 232 million shares outstanding. A 15-20x multiple on C$710 Million is C$10.5-14.2 Billion – or C$45.90 – C$61.20 per share or US$35 to US$46 per share. Shaw is likely to trade at these levels in late 2005 as the market discounts 2006 and 2007 numbers. This yields a pretty healthy appreciation from its present US$14.11 price.

If one took more conservative numbers (just FCF) and assigned a 20x multiple to the 2006 FCF number, you still get an intrinsic value of US$27. Even if one takes the usual cable metric of market cap per customer, it is a paltry US$1370 per customer. US Cable companies are valued at north of US$3000/customer – and that was before all the big upside with internet broadband, next generation digital cable etc. Shaw’s revenue, for many households, is approaching US$100/month with the internet broadband, digital cable and premium channels.

Shaw is not over-leveraged. It has a very solid balance sheet. As of 9/30/03, it has total assets worth C$7.6 Billion. Total debt is under C$3 Billion. In addition the company has an unused C$1 Billion line of credit and is a net generator of significant cash flow. As cash flow grows from C$200 Million to C$400 Million you can see how rapidly that debt declines. There are no significant near-term maturities. C$275 Million is due in April 2005 and the rest is past 2007 through 2011. With an average interest rate of 7-8%, interest savings annually from debt pay down will add about C$30+ Million to the FCF every year.

Shaw is an extremely good executer with excellent management. They have excelled at getting internet service sold to existing cable customers. As an example over 41% of Shaw basic cable customers have also subscribed to their broadband internet service. It is the highest rate of penetration by any major cable company in Canada. Cox, for example, has a 26.7% penetration and Comcast is at 20.5%. Clearly shows they’ve trounced DSL and other alternatives.

Also, fully ¼ of their basic cable subscribers have been upgraded to the very profitable digital cable platform. They have also deployed a leading-edge video-on-demand service throughout their customer base that has a very large library and comes with VCR like features (forward, rewind, pause etc.). It allows up to 48 hours to see the movie.

The cable business is very good with the proven ability to raise prices ahead of inflation. In addition, they have a large base of customers to which profitable upgrades can be sold. And they’ll keep adding more customers over time. All three lead to a healthy revenue and cash-flow growth engine.

The stock is endorsed by none other than the Oracle of Omaha. Berkshire Hathaway owns 22 Million shares representing a hefty 9.4% of the shares outstanding. Bershire’s average cost is US$17.71/share. Longleaf owns 28 Million shares (12%) and Cheftain Capital has about 10.3 Million shares. Collectively, the three strong value players own over ¼ of Shaw. In addition the Shaw family recently bought back 700,000 shares and owns about 19 million shares. They intend to keep buying.

There is brief blurb on Shaw in the 12/31/02 issue of OID (Outstanding Investor Digest). It’s a reprint of Q&A with Buford, Cates and Hawkins of Longleaf by shareholders and advisors. In addition the interested reader can look at the Longleaf quarterly reports on their website (www.longleafpartners.com) and they usually have a paragraph or two on Shaw in their comments every so often. All very positive. Shaw has the added benefit of providing a natural hedge against the weakening US Dollar.

Shaw is a terrific value opportunity in this overheated and overvalued market. In addition with its $3 Billion+ market cap, one can build a decent position without running it up.

Catalyst

Great Management, Exceptional Monopoly Business, Bargain Price, Blue Chip Value Investors. Overtime the market will value the business appropriately as the cash gushes in.