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Time Warner Cable Acquired by Charter Communication

FE 820 Corporate Financial Management

December 3, 2016

Authored by: Michael Cruz, Seung Ryul Lee, Congyi Liu Abstract: "For most of you, who will be moving on to New Charter, the future is extremely bright. Tom Rutledge and the team he has assembled are seasoned, talented leaders with proven track records of success" said from TWC’s CEO Rob Marcus, who has been paid tens of millions of dollars on the way out the door, to his employees in the email. And he is the only one of the leaving top executives in the deal between Charter Communication and Time Warner Cable. This analysis includes: case background overview, comparable company multiples valuation, comparable acquisition multiples valuation, and discounted cash flow valuation. The final valuation analysis of TWC will be based on these three approaches in the summary with a glance of the real deal.

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Background Overview: May 18, 2016 – Charter Communications, Inc. (Nasdaq: CHTR) announced that it has closed its previously announced transactions whereby legacy Charter, the previous public company (“legacy Charter”), has combined with Time Warner Cable Inc. (“TWC”). The combination of Charter and TWC will create a leading broadband services and technology company, serving over 25 million customers in 41 states. Though TWC would call this deal “combination” or “merge” and claimed the customers wouldn’t feel any big change right away, but gradually, in the coming months, Charter will strip away Time Warner Cable and Bright House's names and introduce its own branding. This means the much-maligned Time Warner Cable (TWC) name -- a piece of cable television history -- is going away. The newly enlarged Charter is now one of the biggest television providers in the country, standing alongside Comcast (CMCSA), AT&T (T, Tech30) and Verizon(VZ, Tech30) . 1

The most obvious incentive for this giant acquisition is enhancing competitiveness. Though Charter has somewhat higher marks for customer service than Time Warner Cable, the industry as a whole is not very popular among customers. By purchasing TWC, Charter is hoping to win new fans in Time Warner Cable markets like L.A. and New York.With the “Spectrum”, which is a cool name of the new Charter’s cable TV and broadband services, Charter is convinced that their network and product investments combined with its consumer friendly operating strategy will lead to faster customer and financial growth, enhancing career development opportunities for its employees and driving value for shareholders. From TWC’s standpoint, this deal could give them a chance to flip over the terrible impression of customers. According to a new survey from the American Customer Satisfaction Index , the 2

cable and internet providers is at an all-time low. And the all-time-lowest of these lowly corporations is Time Warner Cable, with score of 51 out of 100. TWC would have a better chance to improve their HD picture quality and call center function by Charter’s technologies and customer services

1 Stelter, Brian. "Bye, Bye Time Warner Cable. Hello Charter." CNNMoney . CNNMoney, 18 May 2016. Web. 07 Dec. 2016. http://money.cnn.com/2016/05/18/media/time-warner-cable-charter/ 2 American Customer Satisfaction Index, “Benchmarks by Industry: Internet Service Providers””, ASCI , ASCI, Dec, 2016, http://www.theacsi.org/index.php?option=com_content&view=article&id=147&catid=&Itemid=212&i=Internet+Service+Providers

http://money.cnn.com/quote/quote.html?symb=CMCSA&source=story_quote_link

http://money.cnn.com/quote/quote.html?symb=T&source=story_quote_link

http://money.cnn.com/technology/tech30/index.html?iid=EL

http://money.cnn.com/quote/quote.html?symb=VZ&source=story_quote_link

http://money.cnn.com/technology/tech30/index.html?iid=EL

http://www.theacsi.org/index.php?option=com_content&view=article&id=150&Itemid=215

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Valuations

1. Discounted Cash Flow Analysis The following assumptions are used for the DCF valuation approach. The details of weighted average cost of capital and projections of future cash flow and be found in the exhibits. While it may be easy to project revenue as a singular entity, this is not a reasonable thing to do for Time Warner as the outlook for each market is different. Projections for revenue are broken down into 4 revenue streams: residential, business, advertising, and other. We then projected each revenue stream using prior 3-years growth averages, and lastly, adjusted each projection based on upcoming market outlooks. Three year growth was chosen because the industry landscape has changed rapidly prior to that. Residential revenue has been relatively flat over the last 3 years. The number of subscribers has stagnated, and the number of “cord cutters” (people that unsubscribe from cable TV) has increased. However, Time Warner Cable has been successful in upgrading internet service speeds and adding additional voice subscribers for their retained customers . As such, projected 3

revenue growth for their residential customers is projected at 2.15%. On the other hand, business revenues have grown immensely in the last 3 years with most of the contribution coming from new high speed data accounts and new voice accounts. They’ve also been successful in selling voice services to their previous business customers. While we realize that the projected 18.4% business revenue growth is aggressive, we believe it is sustainable for another year or two, but taper off before the 5 year projection period and terminal growth takes over. We believe advertising revenue will stay constant at 2.5% as it has been historically. Lastly, we believe other revenue will increase at a high rate for the next 5 years due to a new partnership with the Los Angeles Lakers. All these factors together lead to a CAGR of 4.45% for the years of the projection period. Capital expenditure will scale with growth as additional infrastructure for residences, commercial buildings and cell towers will need to be installed to support new and existing

3 Time Warner Cable, “Time Warner Cable Reports 2016 First-Quarter Results.” Time Warner Cable Investor Relations , April, 28, 2016, http://ir.timewarnercable.com/investor-relations/investor-news/financial-release-details/2016/Time-Warner-Cable-Reports-2016-First-Quarter-Results/default.aspx

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subscribers. Lastly, SG&A is expected to grow at a slightly increased rate beyond revenue due to increased training and salaries improve customer experience . 4

Long term debt maturity dates were pulled directly from their “Trending Schedules, Reconciliations and Other Financial Information” 5

Weighted Average Cost of Capital:

● The debt to equity ratio is calculated by the market value of TWC’s equity, which is equal to the price per share $209.56 on May 17, 2016 multiple the 284.6M outstanding shares, and the book value of TWC’s debt, which is 22,492M.

● The risk free rate and market risk premium are as of May 2016. ● The average unlevered beta of the cable TV industry is 0.89 (Total Betas for sector,

Stern, NYU, 2016). ● The pretax cost of debt is quoted by TWC’s average cost of all the debentures⁵. ● Terminal growth rate is 2.6%, which is the projected nominal GDP growth rate to 2022

from the Bureau of Labor Statistics (Overview of projections to 2022). Based on the assumptions above, the weighted average cost of capital could be gained as the discount rate. The average unlevered beta of cable TV industry could be re-levered to TWC’s levered beta by considering the effective tax rate and the debt to equity ratio of TWC. And the capital asset pricing model is applied for the cost of equity. And after weighting the cost of equity with the after-tax cost of debt, the weighted average cost of capital turns out to be 6.80%. Projected Cash Flow: To calculate free cash flow, we started with Operating Income Before Depreciation and Amortization (OIBDA). We believe this is a better metric to use for Time Warner Cable because it does not include the restructuring costs associated with the merger with AOL in 2001. Yearly expenses incurred are still hovering around $150 million per year. We do not believe that this is reasonable to include as they are not recurring charges and are non-operating expenses unrelated to the core business.

4 Time Warner Cable, “Time Warner Cable Annual Report 2014,” Time Warner Cable , May 2015, http://s1.q4cdn.com/730563363/files/doc_financials/Annual%20Reports/2014/TWC-2014-Annual-Report.pdf 5 Time Warner Cable, “2016 Trending Schedules, Reconciliations and Other Financial Information”, Time Warner Cable , April, 28, 2016, http://s1.q4cdn.com/730563363/files/2016NewFolder/TWC-Trending-Schedules-Q1-2016-FINAL.pd f

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A sensitivity analysis for firm value and share price can be found in Exhibit 2 which details varying growth assumptions.

2. Comparable Companies Approach: In both evaluations using comparables, we used median as representative multiple, from our consideration that only small number of samples are used for the evaluation while couple of samples shows outlying figures from range of other samples. Lastly, we averaged three median multiples representing EV/revenue, EV/EBITDA, and EV/EBIT. For the evaluation we adopted trailing valuation approach. Industry Comparable: Ten of public companies in media industry are screened for comparables. They are qualified to have similar market cap, ranging from $10 billion to $ 75 billion, as the Time Warner Cable has market cap of $70 billion. All ratios come from financial data as of Dec 2015, given by Thompson. Media industry shows the average of three evaluations as 71,703 million dollars.

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Table 1. Reference companies in Media industry

Name EV/ Sales EV/ EBITDA EV/ EBIT

CBS CORPORATION 2.42 11.71 12.8

CHARTER COMMUNICATIONS, INC. 6.88 20.6 68.39

DISH NETWORK CORPORATION 2.54 11.3 15.69

LIBERTY GLOBAL PLC 3.92 9.02 31.8

LIBERTY INTERACTIVE CORPORATION 1.87 10.05 18.19

SFR Group 2.61 8.22 32.1

SKY PLC 1.67 10.23 20.2

TIME WARNER INC. 3.26 11.27 12.28

VIACOM INC. 2.15 9.81 10.67

Vivendi 1.93 9.77 13.45

Mean 2.96 11.36 24.68

Median 2.48 10.14 16.94

Evaluation from industry comparable multiple ($, million)

Revenue EBITDA EBIT

$ 23,697 $ 8,085 $ 4,389

EV/Revenue 2.5x 58,769

EV/EBITDA 10.1x 81,982

EV/EBIT 16.9x 74,360

Avg 71,703

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3. Comparable Acquisitions

Four companies are taken on our list, because they are acquired in Q1 2016, recent deals right before TWC deal at May 2016. We searched media industry but reached out to digital media as well, in order to avoid too small size of sample, despite of using median. We also rationalized that both industries has common traits in that publishing and distributing contents via media. In fact, no big difference from media industry, despite of big gap in deal price. All ratios come from Solganic’s deal report. Comparison with prior acquisitions shows the average of three evaluations as 72,742 million dollars. Table 2. Reference companies acquired at Q1 2016 ( Media/Digital Media industry)

Direct TV Webzen inc

Gameloft Inc

Activision Blizzard

Median

EV/Revenue 1.9x 2.5x 2.4x 5.9x 2.4x

EV/EBITDA 8.0x 7.7x 80.3x 19.2x 13.6x

EV/EBIT 11.7x NA NA NA 11.7x

Evaluation from acquisition comparable multiple ($, million)

Revenue EBITDA EBIT

23,697 8,085 4,389

EV/Revenue 2.4x 57,228

EV/EBITDA 13.6x 109,760

EV/EBIT 11.7x 51,236

Average 72,742

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Summary For the final value, we weighed the DCF, multiple acquisition approach and multiple common company approach with 70%, 15% and 15%, respectively. We believe that this is a very large industry with a very few number of giant companies. While there are companies that compete in the same digital media distribution, high speed internet, and voice communication industry, their size (Verizon with revenues of $131.6 billion in 2015 vs. Time Warner Cable’s $23 billion) or operations (Comcast, with 38% of their $74 billion revenue streams coming from NBCUniversal) varies too much to make a similar comparison.

For the low estimate, we believe that the DCF forecasted growth has potential to be high. Time Warner business revenues may not grow as planned so total revenue growth may only grow at 3.66%.

For the high estimate, current net neutrality laws may get passed and Time Warner Cable will be able to throttle other digital media distribution websites such as Netflix, thus massively driving “cord cutters” back into subscriptions for Time Warner Cable’s video service.

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For the real deal, Charter acquired TWC for $195.71 per share with $100 in cash and $95.71 in New Charter stock, equivalent to 0.5409 Charter shares. This offer equates to TWC enterprise value of $78.7 billion, which are $56.7 billion equity valuation plus $22.7 billion net debt, less $0.7 billion equity investments. For the multiples been used, the enterprise value over TWC’s estimated EBITDA in 2015 is 8.3. While after being adjusted for synergies and tax benefits, 9.1 was utilized for the final multiples. And the deal was closed in 55.1 billion.

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Appendix Exhibit 1a. Income Statement with 5 Year Forecast

Exhibit 1b. Cash Flow with 5 Year Forecast

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Exhibit 1c. Balance Sheet with 5 Year Forecast

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Exhibit 2

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