Cable has been one of the most hated industries out there, and that's made it one of the cheapest. But whether it's the excitement surrounding Voice over Internet Protocol (VoIP) or the increased demand for services like Video on Demand, there is sure to be a headline somewhere talking about the reach of cable and its impact on home entertainment.
We've wanted to find the best way to gain exposure to this sector. The problem is that the stocks can't seem to get out of their own way. The group is over-owned by the investing public and, on the aggregate, scores horribly in the Alpha factor of our proprietary rating system.
However, our search did unearth a stock that we feel provides a solid entree to the cable business: Knology (KNOL) , which bundles video, voice and data service mainly in the Southeastern U.S., and we are going to initiate a 500-share position in this Inflection Point play today.
It is more speculative than some of the larger, better-known cable and data players out there, but investing in Knology here gives the portfolio a deleveraging play that boasts the highest revenue per subscriber in its industry. The company has been through Chapter 11 reorganization, which it completed in September 2002 at very favorable terms. (The company issued $39 million in Class C stock and secured two credit facilities for a total of $55.5 million.)
The company seems to have stayed on solid footing since, as it had $51 million in free cash at the end of the second quarter, which was basically unchanged from the end of 2003. And just this week, the company reached a deal to push out amortization start dates on its credit facilities that will save about $25 million in principal payments over the next few years, removing most of the doubt surrounding liquidity. The company has managed to stay operating cash flow positive despite posting losses since the fourth quarter of 2003.
The company recently doubled its network reach when it acquired Verizon Media Venture's assets in California and Florida for $15 million. Almost simultaneously, management brought in $14.8 million by selling off its California assets, which means management essentially brought in the Florida subs for $200,000 while stabilizing cash flow going forward.
After coming public at $9 a share last December, the stock has steadily sold off to its current price of $4.03, which puts it at about a 30% discount to its peers on an EBITDA basis. Of course, there are risks. Knology is having a rougher-than-anticipated time signing up customers in its Florida market and the violent hurricane season will put a dent in the current quarter. Its competitors -- AT&T (T) and Brightpoint -- also pose some risk, but we believe that its industry-high voice and data penetration will be front and center now that its finances are in order, and that should yield a higher stock price.
We believe the stock can trade back to its IPO price of $9 a share in the next year now that it has pushed out interest payments on some of its loans and continues to deliver subscriber growth.
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