Charter to acquire Bright House for $10.4 billion, will de-lever to 3.9 times debt ratio

By Paul Deckelman

New York, March 31 – Charter Communications Inc. announced plans Tuesday to acquire Bright House Networks LLC in a $10.4-billion mostly stock-funded transaction – a deal that Charter said will help its chop its leverage ratio of net debt as a multiple of adjusted EBITDA by at least half a turn from where it stood at the end of 2014.

“Our pro-forma net debt will be just under $23 billion, with a leverage ratio of 3.9 times” based on year-end 2014 pro-forma EBITDA, Charter’s chief financial officer and executive vice president, Christopher L. Winfrey, told analysts on a conference call outlining the Bright House transaction.

“Obviously, that leverage should come down a bit by the time we close the Bright House transactions,” he added.

Leverage up, then down

Stamford, Conn.-based Charter is slated to become the second-biggest provider of cable TV, internet and phone service in the United States in terms of total subscribers serviced once the industry’s top dog, Comcast Corp., completes its pending acquisition of the current runner-up, Time Warner Cable Enterprises Inc. – which Charter had tried unsuccessfully to acquire last year.

As part of that acquisition, the combined Comcast/Time Warner entity will divest itself of about 3.9 million customers in order to meet potential antitrust concerns, with systems serving 1.4 million of them sold directly to Charter and the other 2.9 million spun off into a new company that Charter will hold a 33% stake in, with an option to later buy the remaining two-thirds of the spin-off. Charter and Comcast/Time Warner also agreed to swap systems each serving another roughly 1.6 million of their own customers to better rationalize each company’s geographic footprint.

In the deal announced Tuesday, Charter will acquire another 2 million subscribers in Florida and several other states currently served by Bright House, which itself had been spun off from Time Warner back in the early 2000s.

According to slides prepared for use during the conference call presentations by Winfrey and Charter’s chief executive officer and president, Thomas M. Rutledge, Charter’s net debt before the Comcast transaction stood at about $14.2 billion, and the company’s 2014 year-end leverage ratio was at 4.4 times EBITDA.

It took on another $7.2 billion of debt to fund the Comcast/Time Warner-related transactions, including $3.5 billion of new seven-year term loan G debt at the company’s CCO Safari, LLC subsidiary that it entered into last July, plus $3.5 billion of new junk bond debt that came to market in two tranches: $1.5 billion of eight-year senior notes and $2 billion of 10-year senior notes, which both priced last October via another subsidiary, CCOH Safari, LLC.

That brought the company’s pro forma net debt up to about $21.3 billion, with pro forma leverage raising to 4.8 times the 2014 EBITDA figure.

Charter will take on another $2 billion of debt to fund the cash component of the Bright House acquisition – but figuring in a new $700 million investment in Charter by its largest single shareholder, 25% owner Liberty Broadband Corp., pro forma net debt following the closing of both the Comcast and the Bright House transactions should be around $22.7 billion, with a leverage ratio of 3.9 times, based on the rise in pro forma adjusted EBITDA to $5.8 billion versus $3.19 billion last year.

Besides that cash payment, Charter will give Bright House owner Advance/Newhouse Partnership 34.3 million common Charter partnership units, which are worth $5.9 billion and are convertible into Charter stock on a 1-for-1 basis.

It will also give Advance/Newhouse 10.3 million preferred Charter partnership units worth $2.5 billion, which are convertible into the common units and thus are exchangeable for Charter shares.

More strategic flexibility

Besides Charter’s expected growth in scope, footprint, revenues and earnings from the increased subscriber base it will have once the Comcast and Bright House transactions have been completed, Winfrey said that “one of the other key benefits of this transaction is the significant balance sheet flexibility at closing, enabling further strategic use of that capacity, whether it is for M&A, buybacks or further investment in the business.”

“And even at 3.9 times on last year’s EBITDA, it implies $6 billion of excess debt capacity when you consider the top of our target leverage range – and that target remains unchanged.”

During the question-and-answer portion of the conference call following the formal presentations by Rutledge and Winfrey, as well as Bright House’s CEO, Steven Miron, an analyst asked Winfrey about the projected leverage target.

Winfrey reiterated that “our target leverage has [been] and remains for the time being 4.0 to 4.5 times, plus or minus a half-turn. We always said that was the case; I think this was a good example of that. Almost a year ago, we announced a transaction [i.e., the acquisition of the divested Comcast/Time Warner cable assets] at the time that would push us up to 5 times... Here’s a transaction we’re going to announce that at closing is going to put us more than minus a half turn at the time of the closing, so that’s enabling a strategic opportunity. But our target leverage range would be in that 4.0 to 4.5 times [range], plus or minus for these opportunities.”

The CFO explained that among the factors the company considered when setting its leverage target and considering possible changes over time was the short-term financing needs connected to its portfolio of communications towers, as well as interest rates, “so you know that if you have a higher interest-rate market, more financing needs to take place in the short term.”

However, he said, “Your biggest factor is your confidence around your growth rate – you can de-lever through EBITDA growth naturally, and Charter has been very good at doing that; we’ve been de-leveraging over time.”

And yet another factor is the quality and extent of the company’s tax assets. Charter has an extensive portfolio of net operating losses from years past that it can carry forward to offset future earnings, so that “a dollar of EBITDA at Charter is not the same as a dollar in EBITDA at another company. Another way of saying that is if you think about your interest-coverage ratio being EBITDA over interest, we don’t have cash taxes, so in essence, our real cash [interest] coverage ratio is much higher than the traditional coverage ratio would imply,” the CFO said.

With all of those factors in play, Winfrey said, the company’s cost of capital is about 5.6%, and “you have good growth and you have large tax assets – we’re very comfortable in that range, 4.0 to 4.5 times. If those factors start to change, then you re-evaluate. Right now, that’s the most efficient place to be for us in terms of cost of capital.”

The analyst also asked whether the company had decided on how to finance the $2 billion cash component of the Bright House acquisition, but the CFO said “I think it’s early for that,” since the purchase is contingent upon Comcast and Time Warner completing their merger, which is now in the hands of the federal courts and regulatory authorities.

When the time comes to make that decision, “we’ll go with what the market gives us – where we get the best rates, where we’re going to go. We’ve been very flexible about bank debt versus high yield.”

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