Time Warner Cable Bonds: Where Yield And Risk Intersect (NASDAQ:CHTR) (2024)

Time Warner Cable (TWC) corporate bonds currently standout with impressive yields. Both TWC and Time Warner Inc. (TWX) are rated Baa2/BBB by Moody's and S&P. Investors should realize Charter Communications (NASDAQ:CHTR) is considering a bid for TWC, which is fairly unusual.

Time Warner Cable, which earlier this week indicated that it was open to a deal at the right price, has a market value of more than $34 billion, compared with Charter's market value of about $13 billion.

_{Reuters, November 1, 2013}

Don't forget, Charter Communications filed for, and emerged from bankruptcy in 2009.

Here are a few Time Warner Cable bonds, including Time Warner Entertainment L.P. bonds, on the secondary market:

Before considering TWC bonds, investors should read Moody's recent commentary:

Holders of Time Warner Cable's bonds should be wary, Moody's Investors Service says in a new report, "Time Warner Cable Likely to Lose Investment Grade Rating In a Charter Takeover.

Furthermore we should examine Time Warner Entertainment L.P.:

TWC was formed in March 2003 in connection with the restructuring of Time Warner Entertainment Company, L.P. by Time Warner and Comcast (the "TWE Restructuring"). TWC is the successor to the cable-related businesses previously conducted through TWE and TWI Cable Inc...

TWE is a Delaware limited partnership that was formed in 1992...

As of September 30, 2006, TWE had $3.2 billion in principal amount of outstanding debt securities with maturities ranging from 2008 to 2033 and fixed interest rates ranging from 7.25% to 10.15%...

TWC S-1/A 12/07/2006

Simply put, these bonds have higher yields for a reason. The cable companies are constantly merging, acquiring, spinning-off, changing and rechanging names. This is, perhaps, one reason Moody's points to a lack of change of control provisions in TWC's outstanding bonds. Additionally, note the Time Warner Entertainment bonds due in 2033 are listed as "Srsubdb," the company lists them as senior debt, and one brokerage states their collateral is, or was subordinate debt.

I called TWC's investor relations to inquire about the Time Warner Entertainment 2033 bonds. They put me through to TWC's treasury, and e-mailed the offering memorandum from 1993. They also e-mailed a schematic showing TWC's current structure, the offering memorandum shows the structure of Time Warner Inc. in 1993.

Here is the schematic from 1993:

(click to enlarge)

Here is the current schematic:

(click to enlarge)

The offering memorandum may help to clear up the "Srsubdb" classification:

Ranking... The Debentures will rank pari passu (equal-footing) with all other unsecured and unsubordinated obligations for money borrowed of the Company, including the Company's obligations under its credit agreement, dated as of June 23, 1992...

Additionally, the offering memorandum shows these bonds totaled "$1B aggregate principal amount of 8 3/8% Senior Debentures due 2033." So, now we know the bonds are senior, since the "Srsubdb" on the listing could cause confusion. Additionally the offering memorandum details use of proceeds:

To prepay a portion of the outstanding loans under the TWE Credit Agreement.

TWC bonds yield more, though they are rated the exact same as Time Warner Inc. TWC is the subject of a potential buyout, additionally the company has about $12.5B in bonds maturing by 2020:

Now, take a look at Time Warner Inc. bonds, keep in mind Time Warner is set to spin-off Time Inc., in the second quarter of 2014:

Notice the 10-year bonds only yield an unimpressive 3.6%, given these bonds are rated Baa2/BBB. To understand just how unimpressive, take a look at these much higher rated bonds:

Apple (AAPL) is rated Aa1/AA+, Howard Hughes Medical Institute is rated Aaa/AAA.

Is there some sort of incredible divergence, which would justify these equivalent yields?

(click to enlarge)

Source: U.S. Treasury

The 7-year and 10-year treasury rates have certainly made moves. However, I see nothing that would justify an equivalent yield between Baa2/BBB bonds with a 9-year maturity, and Aaa/AAA rated 10-year bonds.

TWC Relative To Time Warner Inc.

In 1978 Time Inc. bought American Television & Communications, in 1989 Time Inc. merged with Warner Cable, then in 1992 ATC and Warner Cable became Time Warner Cable. Time Warner Cable went public in 2007 and spun-off from Time Warner Inc. in 2009. TWC ranks second largest cable company behind Comcast (CMCSA).

Time Warner Inc. remains a larger company, with less overall long-term debt than TWC. Check out the two companies' stocks:

TWC data by YCharts

This chart is dramatic, and one of the first things I'm wondering about is the direction of shares outstanding. First let's look at TWC individually, then both companies:

TWC Shares Outstanding data by YCharts

It appears TWC has reduced shares outstanding by about 19.5% since late 2010.

TWC Shares Outstanding data by YCharts

Time Warner Inc. also appears to have made a concerted effort to reduce shares outstanding.

Take a look at TWC and Time Warner Inc.'s debt to equity ratio:

TWX Debt to Equity Ratio (Quarterly) data by YCharts

Time Warner's debt to equity ratio has been consistent for the past 10 years. Time Warner Inc.'s total long-term debt decreased significantly when it spun-off TWC in 2009:

TWC Total Long Term Debt data by YCharts

Bond investors with greater risk tolerance may be considering TWC bonds, for their yield. Average investors might instead consider exposure to TWC debt through a mutual fund, given uncertainty and risk surrounding TWC. Still many investors may just not want to bother with the company, or this industry since the market has soared and the outlook is uncertain. Though the bonds are sure to get conservative investors' attention, there is a lot of information to contemplate.

Allocation / Income Example

Personally, I would consider an amount that I know can be absorbed by a previously existing bond ladder's income. However, I would be concerned about a buyout by Charter Communications, because it went through bankruptcy recently. For instance, if I know projected income is in the $5,000 range over the next 3 months I might consider anywhere from 3-7 of the Time Warner bonds, for their yield.

Just glancing at the chart at the beginning, if I had to pick one, I might go with this one:

They are under par, they mature sooner and their yield is over 5%. However, I would also consider the longer-term:

Though, I would allocate less to it than to the 2021 set. Whereas I might go with 5 of the former, I'd consider 3 of the latter. The Time Warner Entertainment bonds are listed as call protected (you should always double check call provisions with a broker, as listings are sometimes wrong.)

Three of the Time Warner Entertainment bonds should generate $251 in taxable income per annum, whereas 5 of the 2021 TWC bonds should generate $200. Five of the 2021 bonds would cost $4,639 and 3 of the 2033 bonds would cost $3,182. Keep in mind, the same amounts allocated to quality mutual funds would provide much more diversity.

The Ratings: Prospects of Merger or Buyout

On November 1st, 2013 Moody's issued a statement on Time Warner Cable:

• Time Warner Cable's subscriber loss trend will continue to put negative pressure on the ratings.

In July, Moody's also reported on the potential for a takeover by Charter Communications:

• Time Warner Cable could consider defensive acquisition to avoid leveraged takeover.

Liberty Media Corp. (LMCA) is said to be trying to merge Charter and TWC. Though, not only is TWC larger than Charter; TWC is larger than Charter and Liberty Media Corp combined.

• Time Warner Cable, market cap.: $34.13B
• Liberty Global plc. (LBTYA), market cap.: $32.07B
• Liberty Media Corp., market cap.: $17.07B
• Liberty Interactive Corp. (LINTA), market cap.: $14.27B
• Charter Communications, market cap.: $12.99B

You must first understand Liberty Interactive, used to be known as Liberty Media. The name change occurred in 2011, then Liberty CapStarz changed its name to Liberty Media Corp. In 2004 the company spun off Liberty Global.

Once the entire network of Liberty companies are considered, I begin to see where Liberty (Media, Global & Interactive) chairman, John C. Malone Ph.D, is coming from. Liberty Media has major stakes in Charter, Sirius XM (SIRI), and Live Nation (LYV).

The problem, as I see it, is Charter is run differently than Time Warner Cable. Charter Communications has a long history of quarterly and annual net losses, compared to gains made by Time Warner Cable.

TWC Net Income (Quarterly) data by YCharts

Though Charter's stock has done well, clearly there are two opposing management styles at work here. Charter has $41M in cash, $2.7B EBITDA and $14B in long-term debt, so it is not the obvious choice for them to try to takeover a company valued at $34B, with $25B in debt of its own. Especially just a few years after emerging from bankruptcy.

Take a look at the companies' revenue:

TWC Revenue (Quarterly) data by YCharts

If anything, I would think Time Warner Cable might consider buying Connecticut based Charter Communications (this may be the point of Liberty and Charter's actions, as echoed by Moody's.) It is ironic, because while John C. Malone is calling for larger cable companies, Liberty Media Corp. Liberty Interactive Corp. and Liberty Global all operate separately, with John C. Malone as their chairman.

So, there is something of a power struggle brewing; while the story is intriguing, a larger force than just Charter and Liberty Media Corp. would need to make a serious offer for TWC. Liberty Interactive's Venture unit already owns 2% of TWC. Investors should not completely dismiss the possibility of some sort of deal, given Malone's clout.

TWC: Can Old Tech Compete With New Tech

What the graphs do not show, which helps explain TWC's rebound, are multiple acquisitions. Just a few weeks ago the company announced plans for a $600M acquisition of North Carolina based DukeNet. TWC also acquired, or was involved in acquiring:

• Adelphia, 2006, $17B (in a complex transaction between Time Warner Inc. and Comcast)
• NaviSite, 2011, $230M
• Insight Communications, 2011, $3B

Whether DukeNet is a defensive play, designed to prevent a buyout is not certain.

A large private equity firm, Crestview Partners, had a large investment in Insight, and has a large investment in Charter Communications. One of Crestview's partners, Jeff Marcus, founded a cable company acquired by John C. Malone's Tele-Communications (Tele-Communications merged with Liberty Media in 1994.) There does not appear to be a relation between Jeff Marcus and Robert Marcus, who is slated to be TWC's new CEO (I asked Robert Marcus' office and they responded "not that I know of," further inquiries supported this.)

You must realize cable and entertainment companies are complex; Time Warner Inc. and TWC's stocks have done well in recent years. Today movies are easily streamed via Netflix (NFLX), Microsoft's (MSFT) Xbox Video and Amazon (AMZN) Instant Video, cable companies have taken a hit, but have managed to stay afloat.

Some reasons for this may be:

• live sporting events
• morning and evening talk shows
• current news

Though, Cable television is one of the first things to be cut, when a family or individual's budget is tight. Inventions like Google's (GOOG) Chromecast ($35), for instance, act as a conduit, so videos on a computer can be streamed to a television.

Amazon Prime, costs $79 a year, the service provides free shipping on a wide selection of merchandise and several free movies and TV shows. However, regular viewing of paid videos on Amazon can add up.

Cable television finds itself in a crowded niche, similar to landline telephone service in the age of cell phones. Advertisers are a major component of the entertainment and cable industries, and they are attracted to the largest audiences. While Time Warner Inc. and TWC have strong leaders on their boards, the two companies' combined market cap. is about $95.6B compared to Google's $339B, or Amazon's $160B.

While Execs Tangle, Customers Find Alternatives

Television networks buy the rights to film and broadcast certain events; like the Olympics, or the Super Bowl. However, many prominent events are controlled by ABC (DIS), NBC (Comcast), CBS (CBS) and Fox (FOXA), channels available without cable, in many regions.

People upgrade to cable to access more channels than the very few available for free. The channels try to attract viewers with compelling productions, that are either entertaining, educational or both. Take a look at the current top cable TV shows, versus top non-cable TV shows:

1. Walking Dead AMC
2. NFL Regular Season Seattle / St. Louis ESPN
3. Thursday Night Football (Cincinnati / Miami) NFLN
4. NBA Basketball (Chicago / Miami) TNT
5. WWE Entertainment (WWE RAW) USA
6. Sons of Anarchy FX
7. NASCAR Sprint Cup ESPN

The top cable television shows pull in far less viewers than competing prime broadcast network programming. The current top show on regular TV, which varies from month to month, is NCIS. You may recall CBS and TWC struggled to agree to terms, leading to a month-long blackout of the channel, and a drop in TWC customers:

1. NCIS CBS
2. Fox World Series Game 6 FOX
3. NBC Sunday Night Football NBC
4. 60 Minutes CBS
5. NCIS: Los Angeles CBS
6. Fox World Series Game 5 FOX
7. Dancing With The Stars ABC

Customers realize if they do not have cable, they might not be able to watch the popular television show of the day; however, the biggest limitation is whether they can afford the monthly cost. Additionally, customers will change their service provider, if their favorite shows are caught up in a disagreement between executives.

Internet service, provided by cable companies, on the other hand, seems to be a strong product for the future. Though TWC limits users to a certain amount of internet time per month, while many service providers allow unlimited internet usage.

Take a look at an EBITDA, trailing twelve months, comparison between TWC, Comcast, Cablevision (CVC) and Time Warner Inc.:

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TWC EBITDA (TTM) data by YCharts

Clearly Comcast has demonstrated stronger earnings, though TWC's $7.8B is sizeable.

A Look At The Competition

To get a sense for how TWC compares to other cable providers, take a look at Comcast bonds, rated A3/A-:

Now, let's look at Cablevision bonds, rated junk B1/B+:

Again, the 10-year Comcast bonds yield less than the Howard Hughes Medical Institute bonds mentioned earlier. Cablevision bonds yield more, though are rated below investment grade.

TWC has rewarded stock investors recently, and depending on when bond investors entered, they may have gains or losses. More cautious investors may wait to see how the potential Charter Communications deal works out. If the current trends in TWC's revenue and earnings continue, the next few years of debt repayment should not be a problem (unless a takeover, or major acquisition greatly reduces the quality of existing debt, and the ability to take on more debt.)

I would like to think these executives, on both sides, wouldn't risk a default. However, Charter Communications (during a significant economic downturn) couldn't avoid bankruptcy. Even if TWC bought Charter, the additional long-term debt and EBITDA, carried by Charter, could create a strain. I believe Charter Communications needs to demonstrate the ability to perform, and handle debt responsibly, post bankruptcy.

TWC has $8.75B in bonds maturing between 2017 and 2020, and investors must determine whether business will thrive 5 years from now. Given the wheeling and dealing that seems prevalent in cable companies, the path to maturity is not necessarily a simple straight line.

If you have any thoughts on TWC bonds, please leave a comment below.

Disclosure: I am long AAPL, DIS, CVC, MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long Apple and HHMI corporate bonds. I am considering a small position in TWC bonds, though may wait until clear direction on the possible buyout. Please consult a financial adviser to determine proper allocation, if any, to corporate bonds (especially during a period of potential change of control.) Keep in mind longer term bonds can be affected by shifts in technology.

Charles Margolis