When I think of the Virgin brand of companies, I immediately conjure up a picture of Richard Branson, the U.K. billionaire who founded his sprawling empire at the tender age of 16.
However, Branson’s Virgin Group has very little to do with Virgin Media (NASDAQ:VMED), the U.K. cable company operates under license from Virgin and has delivered outstanding performance in 2012. It’s up 72% year-to-date through Dec. 27, better than all U.S.-listed cable companies.
Can it keep it up? You better believe. Here’s why.
Barron‘s interviewed successful money manager Chris Mittleman in November, and one of the five stocks he mentioned was none other than Virgin Media. Mittleman, whose firm manages $115 million in assets, has a track record few can equal. Accounts managed by Mittleman Brothers Investment Management are up 20.6% on an annualized basis since 2002, more than double the return of the S&P 500.
Mittleman’s success comes from a focus on EBITDA and free cash flow, two valuation metrics favored by private equity firms. In November, when VMED was trading at $32, Mittleman valued it at $40, or 7.5 times EBITDA and 13.6 times free cash flow. In the 32 trading days since Mittleman’s recommendation, the stock is up 14.7% compared to 3.3% for the SPDR S&P 500 (NYSE:SPY).
According to Mittleman, CEO Neil Berkett has done a masterful job since taking the helm in 2008. Bundling its four services: TV, phone, Internet and mobile, Virgin Media has been able to build some customer loyalty — not to mention free cash flow.
In four years as CEO, Burkett has increased its free cash flow from £180 million at the end of 2008 to a projected £455 million at the end of 2012. That’s a compound annual growth rate of 20.4%. With the additional free cash flow, Virgin Media bought back 20% of its outstanding shares at an average price of $25.
Especially gratifying for shareholders is that it bought those shares within 20% of their two-year low. Not many companies are able to pull that off.
The one chink in Virgin Media’s armor is its debt, which is $9.5 billion, if you include the current portion. That’s 3.6 times EBITDA. In comparison, Comcast (NASDAQ:CMCSA), the biggest cable company in the U.S., has $38.6 billion in total debt, or slightly less than two times EBITDA. Time Warner Cable (NYSE:TWC), the second-biggest cable company in the U.S., has a debt multiple identical to Virgin Media’s.
The question most investors have when it comes to cable companies: When are they going to get off the spending carousel? It seems I’m constantly receiving letters from my cable company reminding me how much it has spent in the past year to update its infrastructure. Anything, I suppose, to justify that 5% hike in my monthly service fee.
Long-term this will become a problem as the industry transforms itself. But for now, Virgin Media should be able to raise free cash flow sufficiently well to keep the bankers at bay. And more important — to keep its stock price moving higher.
For those of you who agree with Mittleman’s argument but worry about the debt, two equal-weighted ETFs will get you Virgin Media without the additional risk.
The first option is the First Trust NASDAQ 100 Ex-Technology Sector Index Fund (NASDAQ:QQXT), which invests on an equal-weighted basis in the 57 non-technology stocks in the NASDAQ 100. It’s annual expense ratio is 0.60%, which isn’t bad for a fund that’s rebalanced every three months. Virgin Media’s weighting, like all the other stocks, is 1.8%. Long term, this has been an excellent performer.
The second ETF option is the Direxion NASDAQ-100 Equal Weighted Index Shares (NYSE:QQQE), which invests an equal-weight of 1% in all 100 stocks. Charging 0.35%, it’s a cheaper alternative to the First Trust fund. However, the QQXT avoids info-tech stocks completely, while the QQQE has an IT weighting of 49%, 16.75% less than the NASDAQ-100 index itself. It’s a good compromise.
Nonetheless, if it were my money on the line, I’d go with QQXT, but I’m a wimp when it comes to technology.
Looking into 2013, Virgin Media probably won’t deliver a 71% return like it did this past year. However, a solid 20% return, which is nothing to sneeze at, is likely in the cards.
As of this writing, Will Ashworth didn’t own any securities mentioned here.