Time Warner Cable: Improving but Not the Target we are Looking For

For a pdf of this report, follow this link: Time Warner Telecom: Improving but Not the Target We are Looking For.

At first glance, it seems that Time Warner Cable Inc. could be an interesting focus for activist investors like Pershing Square Capital Management LP.  Just like Target Corp., which Pershing found attractive back in the summer of 2007, Time Warner Cable shows very good relative value and a track record of recent operating momentum, but analyst revisions and key fundamental characteristics lag other companies in the Consumer Discretionary sector. No other company fits Target's 2007 profile at the moment.

However, a closer look at TWC beyond the rankings shows that while working capital management could be improved a bit, it seems unlikely that anything simple could be done to change its trend of high capital spending and low returns on capital, which reflects the very nature of the capital-intensive telecom services and cable industries.  Time Warner Cable deserves to be noticed, but it is simply not the Target we are looking for.

In a subsequent report, we will look for attractive opportunities similar to Pershing Square's recent investments in Corrections Corporation of America (CXW) and Kraft Foods Inc. (KFT).

  

What Pershing Square looks for
According to Pershing's founder and CEO, William Ackman in a June 1, 2009 letter to the New York Times, Pershing invests in "...great businesses preferably with great management teams because time is the friend of such businesses, they are more resilient in tough times, and it makes our job a lot easier. We have done so successfully in companies like McDonald's, Wendy's, Ceridian, Longs Drugs and others. In each case, the companies and their shareholders are better off by virtue of our intervention. We devote enormous energy, analysis, and insight [in our efforts]."

Background on Pershing Square's Target Corp. investment
In July 2007, Pershing Square acquired a 5% stake in Target Corporation (TGT). Shortly thereafter it proposed that Target transfer its credit card risks to a partnering financial institution, and that it spin off its real estate assets. The credit card business was significantly impacting its profitability due in part to net write-offs and bad debt expenses that were rising and well above the credit card industry average. In addition, it seemed as if Target's 2009E EV/EBITDA multiple was less than half the average of real estate companies and private ground lease valuations. Probably due to his analysis of the sub prime real estate markets, and more specifically, MBIA and Ambac, William Ackman saw Target as near the edge of an economic precipice though having clear and compelling alternatives that could unlock value. Unfortunately for him the majority of shareholders did not see it that way. But that's a different story.

Target Corp. probably did benefit from activist intervention
Below is a table showing Target Corp.'s rankings in the summer of 2007 and how they evolved to the present.  Several things catch our attention here.
 

We see that Target was ranked fairly well for value and operating momentum, but that fundamental quality was poor and analyst revisions were relatively poor. It seems to support the idea that Ackman may have seen good value but hard times ahead for Target. 

That Target was already ranked well for value may have indicated to Ackman that this was potentially a slam dunk idea. It is easy to see why he may have been surprised and frustrated that the Target board did not see things the same way. To Ackman's credit, recent history seems to support the idea that his intervention improved the fundamental qualities of the company. That, or just random happenstance, that is.

Time Warner Cable:  Looks promising, but never-ending capital spending story gives us pause
From the same table, we can see that the closest stock that fits Target's summer 2007 profile today is Time Warner Cable, Inc. (TWC). Like Target, it shows very good value relative to some key fundamental characteristics as well as solid operating momentum, but is currently ranked poorly for analyst revisions and fundamental quality. TWC looks very similar to Target -- even better, actually. If management or an outside investor can make some changes that will improve its overall fundamental quality, this TWC may be able to do very well. 

TWC is down 59% from 6/30/2007 but is up 17% for the year to date. Incidentally, what may be interesting is that famed activist investor Carl Icahn's playbook purchased a 2.7% stake in TWC during the three months ended December 2007, thought he sold his position a year later.

Unfortunately however, a quick glance at the models below do not indicate any obvious way to improve the quality of TimeWarner Telecom's operations. Working capital management is being managed well though there is some room for improvement, but it does not seem like much can be done for reducing the required capital to run this business.