Cogeco Investors Fret U.S. Deal After Portugal: Corporate Canada

Cogeco Cable Inc. Louis Audet
Chief Executive Officer Louis Audet now says buying Quincy, Massachusetts-based Atlantic Broadband, which operates cable systems in Pennsylvania, Florida, Maryland, Delaware and South Carolina will give it an entry into the recovering U.S. economy where there is still scope for cable consolidation. Photographer: Norm Betts/Bloomberg

Cogeco Cable Inc. shareholders are concerned its $1.36 billion purchase of U.S. cable operator Atlantic Broadband won’t be any more successful than its last international foray in Portugal.

The Montreal-based cable company fell for a second day on the Toronto Stock Exchange after the deal was announced yesterday morning. The decline yesterday was the biggest since June 2, 2006, the day it announced the purchase of Cabovisao-Televisao Por Cabo SA in Portgual. After six years of struggling to turn a consistent profit in Europe, Cogeco sold Cabovisao in February.

Chief Executive Officer Louis Audet now says buying Quincy, Massachusetts-based Atlantic Broadband, which operates cable systems in Pennsylvania, Florida, Maryland, Delaware and South Carolina, will give it an entry into the recovering U.S. economy where there is still scope for cable consolidation.

“You couldn’t be any closer to home than that,” Audet said yesterday on a conference call.

Canada’s fourth-biggest cable operator, which lost 26 percent this year before today, fell 4 percent to close at C$36.40, cutting its market value to C$1.78 billion ($1.77 billion).

“Negative sentiment regarding the previous acquisition of Cabovisao in Portugal remains fresh in investors’ minds,” said Maher Yaghi, an analyst at Desjardins Securities in Montreal.

Cogeco sold Cabovisao to Altice, a Luxembourg-based owner of communications companies, for 45 million euros ($55 million) after paying 465 million euros for it in 2006. The cash purchase of Atlantic Broadband is the biggest for Cogeco, more than double the size of its acquisition of Cabovisao.

“We would have preferred a smaller cable tuck-in or data center acquisition within Canada where cost synergies could be achieved,” Yaghi said.

Charter Origins

Atlantic Broadband was formed in 2003 after it purchased cable systems from St. Louis-based Charter Communications Inc. It currently ranks as the 14th-largest U.S. cable operator, according to the company’s website.

Atlantic Broadband serves about 252,000 basic video customers, and provides cable, phone and Internet to rural communities. That suits Cogeco’s experience of offering service in less-populated areas of Quebec and Ontario, Audet said. Cogeco has about 869,000 cable television customers.

“There is room as you can see for further U.S. growth, in contrast to Canada,” he said.

The purchase helps reduce Cogeco’s dependence on its market, where it competes with larger cable operators Rogers Communications Inc., BCE Inc., Telus Corp. and Shaw Communications Inc. Toronto-based Rogers is the largest shareholder of Cogeco, with a 32 percent stake. Rogers spokesmen didn’t immediately return requests for comments on the deal.

Deal Risks

RBC Capital Markets analyst Drew McReynolds said the deal carries risks as it’s Cogeco’s first attempt to enter the tough U.S. market and may distract it from competitors in Canada. He rates Cogeco the equivalent of a buy. Audet described the deal as “an attractive entry point into the United States,” which positions Cogeco to make further “tuck-in” acquisitions, he said.

Cogeco’s debt rating may be cut to junk on the Atlantic Broadband deal, Fitch Ratings said, putting it on “watch negative.” A downgrade may be limited to one level, Fitch said.

Cogeco was put under review with “negative implications” by DBRS Ltd., which cited concerns about the company’s ability to compete in a new markets with “characteristics that differ significantly” from its own regions. As part of the deal, Cogeco will take on an additional C$550 million in debt and assume C$660 million of debt at Atlantic, Toronto-based DBRS said in a statement yesterday.

Yields Rise

Cogeco bonds fell as their yields to government benchmarks rose by as much as 50 basis points, RBC Capital Markets analysts wrote in a note to clients today. The 4.925 percent bonds due in February 2022 are bid at 300 basis points compared with 251 basis points yesterday, Bloomberg composite price show.

“The spread widening was a fair reaction reflecting the higher risk profile: higher projected leverage, the surprise nature of the acquisition, and execution risk associated with Atlantic Broadband or further U.S. initiatives,” RBC analysts led by Andrew Calder wrote.

Cable consolidation allows companies to avoid paying duplicate programming fees while combining their sales forces and paring infrastructure costs. Smaller operators are under pressure to merge because those fees are climbing about 7 percent to 10 percent a year, eating into their profit margins.

Bloomberg reported in May that Atlantic was seeking a sale at a price of about $1.4 billion.

Cable Deals

The Cogeco transaction follows several strategic cable acquisitions, including Time Warner Cable Inc.’s $3 billion takeover of Insight Communications Co. in February and WideOpenWest LLC’s deal completed yesterday to buy Knology for about $1.5 billion including debt.

Also yesterday, BC Partners Ltd. and Canada Pension Plan Investment Board agreed to buy Suddenlink Communications, the seventh-largest U.S. cable operator, for $1.99 billion from investors including Goldman Sachs Group Inc. BC Partners and Canada Pension are making the purchase together with a management team led by Suddenlink Chief Executive Officer Jerry Kent. Including debt, the deal has an enterprise value of $6.6 billion.

Cogeco is paying 8.3 times Atlantic Broadband’s estimated annual earnings before interest, taxes, depreciation and amortization, the company said in the statement. Time Warner Cable paid 8.6 times Ebitda, while WOW paid 7.7 times, according to Bloomberg Industries.

Cogeco is paying about $5,400 per subscriber. That compares with $4,418 in the Time Warner deal, and $5,486 in the WOW transaction, the Bloomberg Industries data show.

“While valuation is in line with comparable transactions, Cogeco Cable is paying a significant premium over its trading multiple for the assets,” said Desjardins’ Yaghi, who rates Cogeco a hold.

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