(By Mani) Shares of Cogeco Cable Inc.
(TSX:CCA) has fallen 22 percent after it agreed to acquire all the shares of U.S. cable-based operator Atlantic Broadband for US$1.36 billion to fuel overseas growth.
Cogeco intends to finance the transaction through $150 million of cash on hand, a US$550 million drawdown on its existing revolving term facility and $660 million of borrowings under committed nonrecourse debt financing at Atlantic Broadband.
Atlantic has grown to become the fourteenth largest cable provider in the U.S. and has seen modest growth in its subscriber base but has decent runway for further uptake of each of its services, given penetration rates that lag peers.
With investments in infrastructure in place at Atlantic, Cogeco is counting on the U.S. operation to play catch-up in subscriber penetration rates as the Canadian cableco continues to look to foreign markets to fuel growth.
However, investors seem to have disappointed with the company's move as the deal is expensive with no synergies to offset the premium paid. The acquisition multiple for the deal is about 8.3 times next year's EBITDA. Given Cogeco Cable was trading at 5.0 times 2013E EBITDA prior to the acquisition, this is an expensive deal for the company.
"Even on a comparative basis relative to recent U.S. transactions, which averaged multiples closer to 7.8 times, the premium paid by Cogeco for Atlantic appears somewhat rich," CIBC analyst Robert Bek wrote in a note to clients.
While an additional premium could be justified in acquisitions with operational synergies, none are expected to materialize at the combined Cogeco/Atlantic entity. In addition, there are no geographical advantages given noncontiguous operating regions, nor are there any programming synergies.
"In fact, there is likely programming risk as we are seeing a continuing battle between satellite/cable providers and content owners," Bek said.
With several retransmissions and content lawsuits already taking place in the U.S, Cogeco's role as a small regional player puts it at a further disadvantage in controlling these costs, with its position in Canada doing nothing to mitigate this either.
Moreover, DBRS has placed Cogeco's debt rating on review after the acquisition, with "negative implications", given concerns over Cogeco's ability to execute and compete effectively in an operating region, which is very different from its own.
Fitch has followed suit also placing Cogeco's credit rating on watch, with the need to assess the long-term parent/subsidiary relationship.
"We wait on the sidelines for confirmation from the rating agencies to determine if CCA's investment grade rating is in jeopardy," the analyst added.
Above all, investors were wary of the company's ability to execute on the purchase of a foreign asset, after the failure at Portugal. In 2006, Cogeco Cable acquired Cabovisao for about US$660 million, marking its first major foray into Europe.
Economic conditions in the country quickly deteriorated after the acquisition, while competitive intensity amplified resulting in customer losses across most product categories. With subscriptions on the decline and no sign of a turnaround, Cogeco began to realize impairment charges on the asset, ultimately writing it off in the third quarter of 2011.
At last, the Portugal story ended in February 2012 when Cogeco sold Cabovisao for 45 million euros (or about C$59.3 million), representing a massive discount to what it paid for the unit.
Fresh off this failed attempt to grow outside of Canada, Cogeco is once again looking abroad to acquire cable assets – this time in North America. After the failure at Portugal, investors should consider the potential for further acquisition risk especially since the company has indicated it may not be done looking for growth opportunities in the U.S.
"We believe this stock will remain in the penalty box for an extended period of time as future acquisition risk, and fear of execution weight on shares," Bek noted.