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Is $138 to $141 a Fair Buyout Price for Charter Communications?

Jon C. Ogg

Charter Communications Inc. (CHTR) went from warm to hot late last week on word that the buyout interest was heating up. This is one of those situations where 24/7 Wall St. has questioned whether this is becoming too much of a forced situation in the land of mergers and acquisitions. Now we have the stock options indicating not so much of a premium left in this once-troubled cable TV provider.

What is happening is that Team Malone and Maffei at Liberty Media Corp. (LMCA) are pressing for a merger to consolidate the cable industry. This is not really surprising when you consider that they own a large stake in the company. News broke last week that Cox Communications was interested now in bidding against Time Warner Cable Inc. (TWC), which brought interest back into Charter but put real pressure on Time Warner.

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We have maintained that Charter’s expected profitability is perhaps a valuation concern because Charter trades at literally more than 50 times its expected 2014 earnings estimates. Time Warner Cable trades at close to 16 times expected 2014 earnings. Quite simply, buying Charter Communications could be highly dilutive to earnings for 2014, 2015 and perhaps even 2016.

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Now on Monday, Fox Business News noted that Cox is not really in discussions, although we would still warn readers that when a merger comes up any rival might take an interest, even if they try to refute being interested. Now, back to those options ...

Stock options are signaling what is not a very big premium for Charter Communications. Liberty may want a deal, but Time Warner Cable and Cox might both be thinking that a price tag is already too high, if you just look at the stock options. We are going out one month to September to allow enough time for a merger to come about.

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Charter shares rose handily last week, from $125 to $134, but shares are down 1.7% at $131.74, based on the headlines about Cox. The speculative September call options are priced as follows: $135 at $5 bid and $6.20 ask, so $6 for rounding, generating a buyout premium of $141 for a breakeven. The $130 September calls were speculative before Friday, and their $7.70 bid and $8.70 ask generate a median rounding point of $8 or $138 for a breakeven.

Trading at 50 times a year-out earnings is high by any stretch, particularly when you consider that Charter had to go into bankruptcy protection and reorganization to dump its high debt load in recent years. The stock has almost doubled off its 52-week low as well, indicating that a large portion of any premium already has been worked into the current price.

By our take, the stock options are generating an implied buyout price of $138 to $141 by Friday, September 21, 2013. Speculators have probably already made their big money here, or at least the new speculators getting in now are taking all the risk, compared to the speculators who got in when Liberty started pressing for more mergers and consolidation in the cable TV sector.

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