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If John Malone Doesn’t Buy Time Warner Cable, Someone Else Will

If TWC wants to survive, it needs to get bigger

Stick a fork in Time Warner Cable (TWC). The second-largest cable company is done.

The company picked a fight — noble that it might have been — with CBS (CBS) over retransmission fees that it couldn’t win. So if media tycoon John Malone shows up with an offer, TWC should take it and head for the exits.

Time Warner Cable Getting Bigger, One Way or Another

Rumors that Malone will make a bid for Time Warner Cable by the end of the year caused shares of the New York-based company to jump about 3% in trading last Friday. It also rose briefly Monday after Deutsche Bank analyst Brian Russo raised his rating on the stock to a “buy,” saying a merger with Charter Communications (CHTR) is “more likely than not.” Time Warner has so far rebuffed Malone’s overtures, according to media reports.

Odds are that Russo’s prediction will come to pass.

As the Los Angeles Times and others noted, combining Charter and Time Warner Cable would create the second-largest cable company, serving 17 million customers. A larger company might be better able to stand up to content companies as they continue to try to pass on their rising costs for programming, especially for sports. By joining forces, the two companies also might be able to counter the rising power of new entrants in the media sector such as Amazon (AMZN) and Netflix (NFLX). Considering all the challenges facing the industry, every little bit would help.

Of course, even if a merger with Charter falls through, Time Warner Cable — which has a big foothold in major cities such as Los Angeles — might attract a private equity buyer or perhaps a media conglomerate. That’s because even a weakened cable company earns quit a bit of money. Free cash flow — a key metric for these buyers — rose 4% to $440 million in the latest quarter. TWC expects to generate $2.5 billion in cash this year, which isn’t too shabby.

Why TWC Should Buy … or Sell

Otherwise, Time Warner Cable’s options for growth are severely limited.

Its doubtful that federal antitrust regulators would ever allow Comcast (CMCSA) to buy the company because some might argue it would restrict competition. The company might be able to acquire Cablevision (CVC) if the Dolan family, which controls the smaller cable company, would sell. But that seems unlikely.

Average 52-week price targets on the stock are only a couple dollars ahead of current prices. Nonetheless, some analysts think Time Warner Cable stock has more room to run. Deutsche Bank’s Russo, for instance, recently raised his price target to $141 — a 14% upside to current prices. I also think TWC presents a buying opportunity, considering its weakened state.

For one thing, the company’s latest earnings weren’t great. Net income at the New York-based c0mpany sank 34% year-over-year to $532 million, or $1.84 per share. Excluding one-time items, profits were $1.69 per share, beating the $1.64 analysts had expected. Revenue rose 3% to $5.52 billion, lagging the $5.54 billion analysts had expected.

Meanwhile, Time Warner Cable stock’s run of 26% is beating the broader markets by a few percentage points, though it’s slightly behind CMCSA shares, and Charter is blowing the field away with 80% year-to-date returns.

The dust-up with CBS, which lasted two weeks, was far more damaging to Time Warner Cable than analysts had feared. The company lost an astounding 304,000 video customers, which was almost double what analysts expected. That far exceeded the 129,000 video customers Comcast lost in the same time period. Comcast, though, managed to gain 287,000 high-speed Internet customers and 123,000 voice customers.

Time Warner Cable wasn’t so lucky. The firm lost 24,000 residential Internet subscribers, indicating that many of these angry clients “cut the cord” with Time Warner Cable entirely. Analysts were expecting Time Warner Cable to add 46,100 customers.

Those figures are shocking. Consumers didn’t pay any attention to Time Warner Cable’s arguments that CBS’s fee increases were unreasonable. Consumers seem to be undeterred by the fact that they would eventually see these fee hikes in their cable bills. And this is a bad sign for the pay TV industry.

Cable and satellite providers are getting pounded by retransmission fees. Market researcher SNL Kagan estimates that they may reach $6.05 billion by 2018, more than double their $2.36 billion in 2012. Of course, these increases are not sustainable. Let’s not forget that the content companies bundle their popular channels with their less popular ones. Earlier this year, Cablevision filed suit an antitrust suit against Viacom (VIAB) over this issue. CVC has claimed that Viacom wanted a penalty of more than $1 billion in exchange for allowing it to choose what networks it wanted to show. Viacom, of course, rejects this notion.

Cracks are starting to appear in the decade-old framework of the television industry. DirecTV (DTV), Verizon (VZ), AT&T (T) and Dish Network (DISH) have all refused to carry Comcast’s regional sports network in Houston, arguing steep fees Comcast was charging couldn’t be justified by the viewership. Having the Houston Astros, one of the worst teams in baseball, as part of the channel’s programming lineup doesn’t help matters either. These spats will become more commonplace.

Bottom Line

Battle lines are being drawn between content makers and distributors. For Time Warner Cable to stand a chance in these battles, it needs to get bigger, or become part of something bigger.

Investors should buy shares now. If Malone doesn’t buy TWC, someone else will.

As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities. Follow him at Berr’s World.

Article printed from InvestorPlace Media,

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