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December 15, 2006

Rogers Communication: New Buy Targeting 25% Upside

I have spent this week completing my follow-up work on Rogers Communications (RG), my second favorite presentation from last week's UBS Media and Communications conference (more on my favorite presentation, NII Holdings (NIHD) coming soon). I liked what I learned and pulled the trigger on an initial purchase of RG for Northlake client accounts, including my own. The stock is off its recent highs and the combination of valuation and operating momentum leaves me comfortable buying the shares as I think they will hold up well if this market ever rolls over (something I have incorrectly expected for several months).

RG is the largest wireless carrier and the largest cable company in Canada, with 6.5 million wireless subs and 2.3 million cable subs. The company also owns 51 radio stations, a home shopping channel, four regional sports networks, more than 70 magazine titles, and the Toronto Blue Jays and Rogers Centre. All of these media assets serve the Canadian market.

In the last twelve months, RG earned 51% of its revenue and 63% of its EBITDA from wireless. An additional 35% of revenue and 32% of EBITDA are from cable. Total revenues for the trailing twelve months were CDN$8.9 billion. Trailing twelve month EBITDA is CDN$2.3 billion. To translate to US dollars, you can shave about 15% off those figures at current exchange rates. Market Cap is $18.9 billion. In other words, RG may exclusively serve the Canadian market but it is a sizable company. Average daily volume for the past three months has been 166,000 shares for the NYSE listed shares. RG has a good balance sheet for a wireless and cable company with debt of about $6 billion, or 3 times EBITDA.

RG has been growing rapidly with revenues and EBITDA up 15% and 33% in the most recent quarter. Rising subscriber counts, new products, steady to higher ARPU, and operating leverage are driving the growth. Year to date revenues have risen 14% and EBITDA is up 25%. 2006 guidance was recently raised with the top end of revenue and EBTIDA growth matching year to date growth. Given current operating momentum, it seems that the possibility of the company exceeding guidance is high....

The same trends driving 2006 growth are projected to remain in place in 2007 leading to another year of strong growth. Revenues should rise in the low double digits with additional margin expansion pushing EBITDA to a gain of at least 20%.

Growth in wireless is driven by continued significant gains in wireless penetration in Canada. Canada is several years behind the US but tracking US growth almost perfectly. This suggests that the next few years should see gains similar to the better than expected growth seen in the US in the last few years. RG also benefits by being the only GSM operator in Canada with a very strong spectrum portfolio. According to RG, Canada is the 7th most visited country in the world and 80% of the global market uses GSM. This helps drive roaming revenue which is asymmetrically balanced versus Canadians traveling abroad. Also as in the US, data revenues are growing rapidly, reaching over 10% of ARPU in 3Q06. Canada and the US lag the world in data revenue as a % of ARPU leaving plenty of upside. Put it all together and RG's recent wireless growth of 30-40% should not slow too much in the next few years.

The story in cable is also good. RG is benefiting from rollout of the triple play just as are Comcast, Time Warner and the rest of the US operators. Cable penetration for TV is higher in Canada than the US, potentially setting up a longer tail of growth in digital cable, high speed internet, and VOIP Telephony. Furthermore, Rogers is just getting started in VOIP Telephony, tracking the lagging entry of Comcast into the US market. Just as VOIP Telephony has accelerated Comcast's growth (and Time Warner's and Cablevision's before that), it will also drive accelerating growth at RG over the next few years. Finally, just as US cable operators are starting to target the large opportunity in small and mid size businesses, RG is also aggressively pursuing business customers. In the most recent quarter, RG received over 6% of revenue from its business division.

RG's strong performance in 2006 and equally strong outlook for 2007 has not gone unnoticed. The shares are up 40% this year. Comcast has risen even more but a comparison of the 2005 charts for each stock show that RG rose by about 30% in the second half of 2005 while Comcast shares languished and closed 2005 at close to their annual low.

Despite the strong performance, RG shares don’t look expensive on 2007 estimates especially considering the 20% growth rate in EBITDA and possibility of further upside surprises. RG shares trade at 10.3 and 8.6 times 2006 and 2007 estimated EBITDA respectively. Assuming RG meets 2007 estimates, I think the shares can trade at 10 times 2007 estimates one year from today leading to 22% upside to $72. This target ignores (1) transfer of value from debtholders to shareholders as debt levels are further reduced in 2007, (2) the possibility of continued upside surprises, and (3) the Toronto Blue Jays which operate at an EBITDA loss. Replacing the losses with the theoretical value of the franchise suggests over $2 per share in hidden value.

Despite the attractive fundamentals I have outlined, risks do exist. Any setback to the positive sentiment surrounding US cable and wireless stocks would translate to RG. Also, RG is family controlled. The Rogers family has a 23% economic interest and 95% voting control. The family has done very well for itself and its public shareholders the past few years but there is no guarantee that public shareholder and family interests will always be aligned.

In summary, with 20% growth and the possibility of continued upside surprises in 2007, RG shares are reasonably valued. Given the multiyear growth profile for the company's wireless and cable assets, I'd argue the shares are cheap. I'd also argue that the visibility of the growth protects downside in the shares. I expect RG shares to earn a 25% return by the end of 2007.

Posted by Steve Birenberg at December 15, 2006 09:12 AM in RG