Irrational exuberance of the market has no limits indeed, from LinkedIn (LNKD) trading at over 1000 P/E and Saleforce (NYSE:CRM) trading at 650 P/E to little known PRXI (NASDAQ:PRXI) trading at 36% of its book value. While LinkedIn and Saleforce are not ideal candidates for shorting after careful consideration, there are some companies that fit the all the criteria perfectly. It seems that very few read the financial reports these days. Analysts somehow producing target prices that make little sense and stamp BUY ratings on companies which deserve NEVER BUY ratings while beating out great companies like RIM to death.
I'm not talking about all analysts of course. But here is one example. In February this year I made a prediction about Yellow Media (TSX:YLO). My opinion was radically different from analysts' consensus opinion. To me it was clear that Yellow Media is literally bankrupt and the stock is essentially worthless. My friend, investment adviser from Desjardin Securities, didn't agree. He never reads the reports cause he claims to have no time. I've spent three days reading the entire report to the last letter, because to me its the only way to get clear picture. Yellow Media shares plummeted from $5.75 to 20 cents since February. Unfortunately I did not short the stock; I just advised few of my friends which were holding it to get rid of it as soon as possible. None of them listened.
It wasn't long before my friend discovered Cablevision (NYSE:CVC) in Google's stock screener. Cablevision is one of the largest cable operators in the United States based on the number of basic video subscribers, it also has ownership interest in national and international programming networks and through its subsidiary Newsday LLC operates newspaper publishing business. Additionally, Cablevision owns a motion theater business and cable television advertising sales business. Sounds like a great business to be in. Indeed, Cablevision has annual revenue of $7.2 billion and market cap of 4.9 billion (down 50% from recent $10 billion). Its net profit margin is 4.9% based on Dec. 31, 2010.
The problem with this company is its enormous amount of debt presently standing at $10.6 billion and total liabilities of $12.4 billion (at June 30, 2011). Its debt/market cap ratio is 213% and cash flow/debt ratio is 0.14. Generally when analyzing companies, we talk about cash flow to equity. In case of Cablevision it seems more like cash flow from equity. Is there any equity? No, there is none; even the financial report is using the term "shareholder deficiency" instead of "shareholder equity." Shareholder deficiency or negative equity in other words stands at -$5.5 billion or -$19 dollars per share. Shares currently trade around $17. How could this be?
The company has $5.2 billion in total of 7.5%-8% senior notes and debentures rated B- and 11 credit facilities with $4.9 billion outstanding. For the last six months ended on June 30, net income was $138 million. Cash flows from financing activities are truly fascinating and look like this:
|Cash flows from financing activities:|
|Proceeds from credit facility debt||605,000|
|Repayment of credit facility debt||(128,726)|
|Proceeds from issuance of senior notes||-|
|Repurchase of senior notes and debentures, including tender premiums and fees||-|
|Repayment of senior notes||(325,796)|
|Proceeds from collateralized indebtedness||191,688|
|Repayment of collateralized indebtedness||(163,686)|
|Proceeds from stock option exercises||5,893|
|Dividend distributions to common stockholders||(79,507)|
|Principal payments on capital lease obligations||(714)|
|Deemed repurchases of restricted stock||(32,761)|
|Purchase of shares of CNYG Class A common stock, pursuant to a share repurchase program, held as treasury shares||(394,540)|
|Additions to deferred financing costs||(149)|
|Distributions to noncontrolling interests||(133)|
|Net cash provided by (used in) financing activities||(323,431)|
Many people are very familiar with taking the money from a credit card to make the minimum payment on the same credit card. Lets take a deeper look though.
During just one last quarter total liabilities of Cablevision decreased from $15.4 billion to $12.4 billion. How on earth did they managed to achieve that? The name of the trick is leveraged spin-off. In this deal each of the cable company Class A and Class B shareholders got a quarter of a comparable share of AMC Networks which used to be wholly owned subsidiary of CVC. As part of this distribution CSC (Cablevision Systems Group) caused AMC to incur an aggregate of $2.425 billion in debt. Note eight of the recent report details this transaction.
|Satisfaction and discharge of debt with AMC Networks debt||1,250,000|
|Distribution of AMC Networks (Cablevision)||1,101,616|
|Distribution of AMC Networks (CSC Holdings)||1,169,564|
By the way, Daniel Loeb (on GuruFocus' list of gurus) bought CableVision shares one day before spin-off. He was hoping to capitalize on it. But Cablevision shares dropped by about $10 on spin-off day. These $10 represented the exact value every shareholder would have received if he sold AMC shares on the day of spin-off. Unfortunately, AMC shares also dropped very quickly.
The company is planning to do same thing with its other subsidiary, Rainbow Media Holdings. Will these "brilliant" moves help Cablevision? In the short term yes; in the longer term definitely no. In fact the management says it clearly in the latest report. After mentioning that in the next 12 months CVC will be able to repay its scheduled debt maturities, the report states "In the longer term, we do not expect to be able to generate sufficient cash flows from operations to fund anticipated capital expenditures, meet all existing future contractual payment obligations and repay our debt at maturity. As a result we will be dependent upon our ability to access the capital and credit markets"
Cablevision didn't get here overnight. They have been growing long-term debt and negative equity year after year for many years. Today it is in the situation of negative compounding which is generally an irreversible trend. Over the last 10 years the company experienced average sales growth of 8%. There is no point in talking about net income growth because net income has been negative for 6 last years out of last 10. But what was the average compounded growth of long-term debt and negative equity? The following table summarizes it:
|Long Term Debt||Growth||Equity||Growth|
|[b]2003-2010 Average Compounded Growth||5%||19%|
If sales grow at 8% rate, while negative equity grows at 19% compounded on average the outcome is pretty predictable. In other words bankruptcy is imminent.
Table below demonstrates cash deficit the company had during 2003-2010 and had to borrow. It's like a cash flow statement but it excludes any proceeds from credit lines or from issuing new debt.
|Cash From Operating Activities||Cash From Investing Acitivities||Dividend||Payment of Bank Debt||Repayment repurchase of senior notes||Repayment of Collateralized Indebtness||All Other Debt and Lease Payments||Cash Deficit(Net Change In Cash)|
|2003||$ 430,623||$ (666,488)||$ -||$ (2,056,908)||$ -||$ -||$ (266,745)||$ (2,559,518)|
|2004||$ 611,976||$ (877,131)||$ -||$ (3,209,247)||$ (350,000)||$ (121,239)||$ (1,710,867)||$ (5,656,508)|
|2005||$ 943,859||$ (683,426)||$ -||$ (1,192,614)||$ -||$ (222,623)||$ (11,956)||$ (1,166,760)|
|2006||$ 1,040,491||$ (868,706)||$ (2,840,780)||$ (2,322,000)||$ (263,125)||$ (548,867)||$ (8,739)||$ (5,811,726)|
|2007||$ 981,972||$ (222,419)||$ (67,319)||$ (176,750)||$ (693,158)||$ -||$ (76,310)||$ (253,984)|
|2008||$ 1,441,347||$ (1,691,226)||$ (64,854)||$ (161,000)||$ (500,000)||$ (579,134)||$ (8,660)||$ (1,563,527)|
|2009||$ 1,598,881||$ (808,762)||$ (123,499)||$ (510,000)||$ (2,398,740)||$ (161,358)||$ (20,564)||$ (2,424,042)|
|2010||$ 1,700,829||$ (2,195,006)||$ (140,734)||$ (619,638)||$ (1,078,212)||$ (148,174)||$ (217,999)||$ (2,698,934)|
On average the company had a deficit of $2.7 billion which it needed to borrow to meet its obligations.
For how many more years this can go on? At which point will the banks stop extending credit facilities? Currently CVC senior notes are rated B-. Let's quote its definition from Fitch's website:
'B' National IFS Ratings denote two possible outcomes. If policyholder obligations are still being met on a timely basis, the rating implies a significantly weak capacity to continue to meet policyholder obligations relative to all other issues or issuers in the same country, across all industries and obligation types. A limited margin of safety remains and capacity for continued payments is contingent upon a sustained, favorable business and economic environment. Alternatively, a 'B' National IFS Rating is assigned to obligations that have experienced ceased or interrupted payments, but with the potential for extremely high recoveries.
Below B- ratings are only C(xxx) ratings which clearly state that it is a real possibility that an issuer can't meet his obligation. Lets see if we can predict when the company will seek new debt and its chances of getting it. As a result of AMC spin off, Cablevision revenue will decrease by about $1 billion a year and our estimate is that cash from operating activities will decrease by $266 million, bringing it to $1.434 billion. Based on the recent quarter report only $1.4 billion remain undrawn on credit facilities. All credit facilities have minimum repayment requirements.
Based on a recent second-quarter report we estimate that the company is facing minimum annual repayments of $500 million in 2012 and $688 million in 2013. The interest portion on top of it is massive $754 million charged against income. So only to support its debt the company needs $1.18 billion in 2012 and $1.3 billion in 2013. That represents 41% and 49% respectively of the total cash from operating activities for the coming years. Additionally, a stock repurchase for the remaining $324 million has been authorized. After the stock repurchase program is completed there will be left only about $1.1 billion on the credit line.
Assuming the company will not make any acquisitions in the next coming years, here is what simplified cash flow will look like for 2012 and 2013, assuming no new debt will be issued and no ambitious leveraged acquisitions will be attempted:
|Cash from Operating Activities||$1400 mil||$1400 mil|
|Capital Expenditures||$820 mil||$820 mil|
|Cash Dividend||$140 mil||$140 mil|
|Retirement of Debt||$580 mil||$688 mil|
|Change in Cash||-$140 mil||-$490|
So by the end of 2013 there will be only about $400 million of available credit left on the credit lines. The company can carry its debt by making minimal repayments during 2012-2014. In 2015 it will be hit with $754 million Bresnan cable credit facility expiration. In 2016 they are facing $2.8 billion of term B2 and B3 extended credit facilities expiration. By that point all existing credit lines will be maxed out unless the Rainbow spin-off will be completed. Those spin-offs may be a temporary solution, though the revenue will be decreasing as well. Then finally in 2018-2020, $5.2 billion of 7.5%-8% senior notes and debentures will mature. It may be very difficult to sell another issue of notes then. We can apply another methodology to determine when the credit line will be maxed out. We could use a historical long-term debt average compounded growth rate from the table above. If it's 5%, it should take only two years for all existing credit lines to be maxed out.
Many people on Wall Street still seem to be focused on the earnings per share, ignoring the cash flow completely and therefore not seeing the ugly reality for some companies. Even respected (or not so much anymore) Standard and Poor's in its report on the company determined fair value for CVC shares to be $12. It says they use proprietary methodology. But what about just using common sense?