When we last checked in with Cogeco Cable, in May of 2011, we noted the shares were suffering from an unpopular acquisition, and investors would likely profit if the company could just post results that were reflective of its core Canadian business.
So much has changed for Cogeco since then. And yet so little.
At the time, the problem was Cogeco Cable's cash-hemorrhaging Portuguese cable company, purchased for $658-million in 2006. Cogeco ultimately disposed of Cabovisao last year for $59-million, less than one-tenth its purchase price. (Canaccord Genuity analyst Dvai Ghose, in a striking example of polite Canadian commentary, refers to this as "less than successful." May I suggest "not quite apocalyptic"?)
Investors who thought Cogeco would settle in to selling new services to its small-town Canadian customers and continue to boost its dividend had a rude remainder of 2012. The company paid $1.36-billion for Atlantic Broadband, a collection of small-town U.S. cable systems that had been shucked off from the larger Charter Communications in 2004. Then, just before Christmas, it said it paid more than $600-million for Peer 1 Networks, a U.S. provider of data services, primarily for business.
The market's reaction has been to send Cogeco's shares to 2010's Portuguese-distressed levels, namely the mid-$30 range. It's a tremendous buying opportunity if you think Cogeco management has been unfairly placed in the penalty box for these deals. But if you think the risk outweighs the reward in the next couple of years, you're likely right.
To be fair, neither acquisition, in isolation, was terribly expensive or inconsistent with Cogeco Cable's business plans.
The deal for Atlantic Broadband valued it at 8.3 times its estimated 2013 EBITDA, or earnings before interest, taxes, depreciation and amortization, Mr. Ghose figures. That price was below the 10-year average multiple for North American cable systems transactions and less than the 9.4 EBITDA multiple in a deal announced the same day by the Canada Pension Plan Investment Board and B.C. Partners Ltd. for U.S. cable operator Suddenlink. The price for Peer 1 Networks was 11.2 times EBITDA, Mr. Ghose said, also in line with previous transactions.
The problem, however, is that Cogeco spent much of the year before the deals trading at just five times its forward EBITDA. The market views the deals as Cogeco using cheap stock to pay for more-expensive companies.
Cogeco will use some cash on hand and take on a lot of debt for the two deals. Net debt was 1.6 times EBITDA before the Atlantic Broadband deal, Mr. Ghose says; it will be close to four times after the Peer 1 deal closes. The major credit ratings agencies have all put Cogeco Cable on some form of watch for possible downgrades given the rapid expansion of debt.
This leveraging, in turn, will likely mute Cogeco's dividend growth, which had been significant over the last several years despite the Portuguese problems. "For us," says Mr. Ghose, who has a "hold" rating and $41 target price, "the real issue is that Canadian cable shareholders want dividend growth from this increasingly mature sector."
Shareholders might also have preferred some buybacks, with the share price at five times EBITDA. Taking shares off the market at that price may have driven value far better than borrowing nearly $2-billion and possibly having to issue more shares to pay the debt down.
Now, there are some good things to be said for these deals: Atlantic Broadband's customers take fewer of the phone and Internet services that Cogeco Cable has successfully sold to its legacy customers; CEO Louis Audet argues there are "sizable opportunities" for growth in this area.
Macquarie Capital Markets Canada analyst Greg MacDonald, who has an "outperform" rating and $47 price target on Cogeco Cable. says Peer 1, particularly, "boosts organic growth [and] further diversifies away from the current cable business by focusing on business customers."
The bulls will argue that Cogeco Cable sells at a discount to its peers. This was true two years ago, is true today, and, I think, will continue to be true for the foreseeable future. Management, one supposes, should get some credit for not standing still as its industry matures and declines. It won't get full credit, however, until it offers a little more evidence that it's found a better path for its shareholders.