Time Warner Cable: Time to Tune In?

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Commercial Market Opportunities

While principally focused on residential customers, TWC and several other major cable operators have recently begun to deploy more financial and human capital to the commercial market. These efforts are aimed at what we see as an undertapped but potentially sizable market for small, midsize, and large enterprises across their cable footprints. We view the commercial business as a potentially viable longer-term growth platform for the entire cable industry.

OPERATING OUTLOOK

We expect consolidated revenues to rise about 9% in each of the next two years, reaching about $19 billion in 2009, with full contributions from the acquired systems. A completed deployment of digital phone should drive penetration of bundled data and video services. Even with relatively modest basic subscriber losses, we see video revenues aided by annual rate increases, and higher average revenue per user (ARPU) on a continued penetration of advanced offerings. We also anticipate increasing (if relatively small) contributions from commercial customers (data and phone), as well as further gains in advertising revenues.

While 2008 margins may be constrained by higher marketing spending, we anticipate an improvement in 2009, helped by greater upside from the acquired systems, as well as further scale-related savings in programming costs, outweighing increased competitive pressures in legacy and acquired systems alike. We project consolidated EBITDA advancing about 9% and 11.5% in the respective years, to nearly $6.3 billion and $7.0 billion. It is noteworthy that TWC expects 2008 revenue growth of 9% (off a base of $15.955 billion), and EBITDA growth of 9% to 11% ($5.742 billion).

FINANCIAL CONDITION

Despite near-term concerns with higher financial leverage on the pending separation, we view TWC's financial condition as generally sound. The company had long-term debt of about $13.3 billion (net of $226 million cash and equivalents) as of Mar. 31, 2008, and $4 billion of available borrowing capacity under a $6 billion unsecured five-year revolving credit facility. For 2008, TWC expects free cash flow to grow at least 40% (vs. $1.06 billion in 2007), benefiting from reduced cash taxes resulting from the economic stimulus package.

Pursuant to the separation, the company plans to finance its one-time dividend through a $9 billion bridge loan, plus a $1.9 billion drawdown of its revolving facility. In the unlikely event that TWC cannot fully refinance its bridge loan within two years, we note that Time Warner, its parent company, has also provided a supplemental loan commitment of up to $3.5 billion for a period of two years after separation. S&P Credit Market Services (an entity operating separately from S&P Equity Research) has placed the company's BBB+ credit rating on negative watch.

RELATIVE VALUATION

We believe TWC deserves a relative valuation premium to publicly traded peers, and to recent private market transactions, based on what we view as demographically attractive locations for the company's cable systems, an industry-leading penetration of its triple-play offering, a continued strong penetration of its advanced and interactive services, possible further upside from a successful integration of recently acquired cable systems, and a longer-term opportunity from the commercial market.