Reviewing Rogers Communications

I feel I have done a good job and a bad job with Northlake's investment in Rogers Communications (RCI). On the one hand, I initially purchased RCI for clients in December 2006 around $29. With the stock at $39, up 34%, I should have no complaints. However, in early November the stock was in the low $50s, and it ended 2007 at $25.25. Unlike a lot of my big winners, I didn’t trim my RCI position on the way up. It is a loser on more recent new money or new client purchases and it has hurt clients' absolute and relative performance meaningfully so far in 2008.

The company reported 4Q07 financial results on Friday. The numbers were pretty good but there was not that much suspense as the equally important year end subscriber statistics and 2008 guidance was issued in mid-January. The subscriber metrics and guidance were both disappointing, compounding the investment case for the shares following initial worries about the May spectrum auction which will bring new wireless competition to Canada. The official auction rules were viewed as more favorable to new entrants than expected and as the current market leader and sole GSM provider in Canada, investors worry that RCI has the most to lose.

With the 4Q07 results in the books, I thought it would be a good time to review the investment case for RCI. I plan to continue to hold the shares but don’t expect to make real good money until the second half of the year. Developments surrounding the May 27th spectrum auctions, including the announcement of bidders on March 4th, seem likely to weigh on investor sentiment especially with new worries about flat rate pricing pans in the US and the spillover effect of a US recession.

However, I expect the stock to do much better and head back to at least the mid-$40s by year end. There are five reasons for my optimism. First, the shares are cheap at 7.4 times 2007 estimated EBTIDA. Second, growth remains robust with guidance calling for EBITDA growth of around 13% this year. Third, management has a consistent record of beating guidance. Fourth, the 4Q07 results and the conference call commentary reinforce that guidance is conservative and that the company is well prepared with its eyes wide open as far as new wireless competition is concerned. Fifth, the shareholder friendly actions taken in January, including a doubling of the dividend and initiation of a share repurchase show that management is effectively balancing competing shareholder interests of return of free cash flow and reinvestment in the operating businesses.

Wireless is the key to the RCI investment story as it provides 70% of projected 2008 EBITDA. RCI is the industry leader with 40-50% of net adds in Canada. Wireless penetration in Canada is well below the US but on the same penetration curve. If Canada follows the US penetration for several more years, subscriber growth should remain robust, enough to provide RCI, current competitors BCE and Telus, and new entrants with double digit growth.

RCI has benefited from operating the only GSM network in Canada. This gives the company dominant share of highly profitable international roaming revenue and the cheapest and best selection of handsets. New entrants via the spectrum auction will cut into these competitive advantages but it will be years before they are able to build out their own networks. Until that point RCI will be paid for roaming and access to its towers by the new entrants....

....The bigger risk is that new entrants upset the pricing structure in Canada leading to falling voice ARPU. This risk was heightened when US carriers moved to flat rate pricing plans last week. 4Q gross and net adds in Canada for all the wireless carriers were below expectations further raising worries about new entrants. Is Canada falling off the US penetration curve? Some believe that is the case and that new entrants will re-accelerate sub growth by offering cheaper voice plans (voice is much more expensive in Canada than in the US). RCI management said on the 4Q conference call that they believe that sub growth is seeing shifting seasonality from the 4Q holiday season to the 3Q back to school season because many new subs are coming from the youth market. This is a reasonable explanation and the youth market was penetrated later in the US but there won’t be a clear answer on this until late in 2008.

RCI's 4Q07 financial and subscriber results suggest the company is well positioned to deal with whatever environment develops in Canada this year. Sub growth was light but management said it did not respond to competitive rate activity. This is evident in the fact that cost per gross add and ARPU were in line with expectations and wireless margin still grew by over 300 basis points. 4Q07 wireless revenue growth was 17% with EBITDA rising 26%. Management went further and stated that so far they are seeing no slowdown in subscriber growth due to economic or competitive factors but they are still focusing on cost savings in case growth does slow. This statement speaks to the high quality of RCI management which not only focuses on quarterly results but thinks ahead about costs and capital spending. As noted earlier, the company has laid out a financial plan that rewards shareholders by returning a significant portion of rapidly growing free cash flow (the stock has about a 10% free cash flow yield) with ongoing investments in the asset base and corporate infrastructure to support growth and protect against competition.

I believe RCI longs will be rewarded by investors later this year when sentiment improves following the wireless auction as RCI reports results and shows it is on track to at least meet its 2008 guidance. Modest expansion of the multiple to 8 times gets the stock back to $35, up 16%. 8 times is not a stiff price to pay for double digit growth in operating income and free cash flow, a superior and shareholder friendly management team, and a company that would be very valuable if regulatory trends toward loosening international ownership of Canadian companies continue.

Disappointing Guidance From Rogers

Before the open on Monday, Rogers Communications (RCI) announced 4Q07 subscriber growth below expectations, doubled its dividend, initiated its first ever share repurchase, and reported mixed 2008 guidance. In response, RCI shares fell 6.2%. I decided to hold off on writing up my thoughts until the smoke cleared and following a little defense by a couple of analysts, RCI shares bounce backed by 2.4% on Tuesday even as the market got drubbed in the afternoon.

RCI will be in the penalty box for awhile but despite the disappointing news I think the shares are cheap enough to hold especially given the facts that growth will still be excellent in 2008 on all key financial metrics and management is noted for its conservative guidance.

The problem at RCI is mostly with the 4Q07 wireless subscriber gain of 183,000 which fell 20,000 to 40,000 short of analyst estimates. Guidance for 2008 is a little under most analyst estimates pretty much across the board. RCI management tends to be conservative with guidance and might be more so this year given new entrants to Canadian wireless and stepped up promotional activity from Telus (TU). While the doubling of the dividend is excellent news, it was widely expected and the accompanying share repurchase is pretty small. I suspect management is keeping some powder dry in case it feels the need to respond more vigorously to the competitive wireless landscape in Canada....

....I think RCI shares will be slow to bounce back as they are lacking a positive catalyst. Furthermore, investors will be skeptical of the guidance given the 4Q subscriber shortfall. That said, support should exist in the upper $30s based on 2007 results and 2008 guidance. Growth in revenues, EBITDA, and free cash flow will be solid double digits in 2008 and the balance sheet remains very underleveraged. Support for the shares should also come from Canadian investors needing to reallocate funds from BCE about it goes private later this year. The new healthy dividend yield at RCI will certainly help in this regard.

The bottom line is that I think RCI longs should hold on, weather the storm and add on further weakness. That is what I am going to do at least until quarterly results are fully reported in mid-February.

Rogers Hit Hard

The spectrum auction and build out rules in Canada are more favorable than expected for new entrants. As a result, Rogers Communications are trading down by 10% today. I have already seen two downgrades of the shares. Even with more favorable provisions for new entrants into the Canadian wireless market, I suspect that any impact on Rogers financial performance will be minimal for at least 2008 and 2009. However, the sharply negative tone of analyst and press coverage is likely to weigh heavily on sentiment toward the shares. It is also possible that Rogers will play it safe with its free cash flow and balance in order to protect its financial capacity against new competition. This could lead to a modest disappointment when the company announces its shareholder value plans next month. Rogers may also issue more conservative than expected 2008 subscriber and financial guidance in early 2008. Finally, even though quarterly earnings are likely to continue strong, the analysis will be more skeptical so even a minor issue will hurt sentiment toward the shares.

After saying all that, I am not ready to sell the shares, which even after today's drubbing will be up 50% this year. I'll be visiting with Rogers next week when they present at the UBS Media conference in NY. I'd like to hear their reaction and the tone of the Q&A portion of their presentation. I think it makes sense to let the dust clear before making a final decision.....

....The specifics of the auction and buildout requirements provide a set aside of spectrum for new entrants only, mandated roaming for new entrants on incumbents networks at commercial rates, and sharing of incumbent towers with new entrants. The roaming and tower rules are more favorable to new entrants than expected.

As the only GSM carrier in Canada, Rogers may be most impacted as the new entrants will probably build GSM networks. This will erode one of Rogers' key competitive advantages and could cut into very profitable international roaming revenues where its GSM network presently gets the bulk of the minutes. Offsetting this to some extent is the fact that Rogers will earn almost all of the roaming minutes from subscribers to new entrants in the period prior to their completing their network buildout. Furthermore, any subscribers won by new entrants away from Rogers' competitors will be roaming on Rogers network until the new networks are built out (2010 or later?).

The bottom line is that reality of fear will overcome the reality of minimal near-term financial impact. This will keep pressure on the shares. As a result, bulls like me need to re-evaluate their position. My approach is to pause and think rather than act immediately when there is major new information on one of my holdings so I'll be completing further analysis and deciding how to proceed next week. I think you can tell from the tone of this post, however, that I am leaning toward taking my profit and moving on.

Rogers Communications Reports Another Good Quarter

Rogers Communications reported another excellent quarter with revenues, EBITDA, EPS, and free cash flow rising 13%, 26%, 61%, and 91%, respectively. These figures were at the high end of analyst estimates with the Cable and Media segments providing material upside to EBITDA. EBITDA and profit margins at wireless were a little lower than expected but that was caused almost entirely by much better than expected subscriber growth. I'll gladly trade a few million dollars in EBITDA for an extra 50,000 subscribers relative to estimates of 150,000 subscriber additions. The results helped RCI shares hold up reasonably well as the market got slaughtered on Thursday. By mid-day Friday, the shares were rallying against a still weak market, up almost $2 and hitting a new all-time high. I think the positive reaction is a correct interpretation of the results and more upside remains.

With three quarters under their belts and having just completed a better than expected quarter, RCI management stated that they have a "generally positive bias toward exceeding the higher ends of certain guidance." Specifically noted were EBITDA at Wireless, Cable, and on a consolidated basis, net subscribers at Wireless, and consolidated free cash flow. It is quite clear that RCI is sustaining momentum in its wireless and cable businesses at the current very high level. This bodes well for 2008 guidance which will begin to be provided in January when subscriber growth goals are announced.

Also on the agenda for sometime in the December through February time frame is an update on how the company plans to use its suddenly flowing free cash flow. On the earnings conference call, Ted Rogers ruled out large acquisitions. I expect some combination of higher annual dividends, special dividends, share buybacks and additional investments in its businesses. One thing I like about RCI is that they always talk about how much more work they have to do to prepare their businesses for competition. There is plenty of free cash flow to go around and the eventual announcement should be a positive for the shares....

....RCI's Wireless business seems to be weathering the introduction of wireless number portability (WNP) in Canada earlier this year. Retention spending is up but it is paying off in record low churn levels and net subscriber additions. Rogers operates the only GSM network in Canada which gives it a significant competitive advantage as it battles Bell Canada and Telus for subscribers. WNP remains a risk but it appears to be diminishing.

The other major risk is the possibility of new entrants into Canada's wireless market via upcoming spectrum auctions. Without government subsidies, the buildout of new networks is uneconomical. There have been rumblings of large subsidies but nothing definitive. The new spectrum represents headline risk but is unlikely to have a financial impact for several years.

I am sticking with my long position on RCI. The shares are up 78% this year. A few more dollars and they will hit the level at which my position control discipline tells me it is time to trim. Plenty of upside remains however, with increases to 2008 estimates likely, several more years of very visible double digit growth, and a reasonable valuation of under 9 times current 2008 EBITDA estimates. I think the shares have a good shot of heading north of $60 next year and I find the stock a very attractive core holding through at least mid-2008.

Good Quarter, Bad Reaction For Rogers Communications

Rogers Communications (RCI) reported 2Q07 earnings on July 31st. The results were at the upper end of expectations and management raised the high end of the guidance range for many key metrics. Nevertheless, the shares traded off as much as 4% initially, cut the loss in half as the conference call was occurring, and closed down 5% succumbing to the last hour sell-off in the market..

I think the negative reaction to a solid earnings report occurred for five reasons. First, expectations were too high given that Rogers' shares had risen over 30% since the last quarterly report due to heightened takeover activity in Canadian telecom and recognition of the growth and profitability of the company's #1 position in Canadian wireless telephony. Second, this quarter was not the blowout positive surprise that the company had usually provided over the past six quarters. Again, the expectations game worked against the shares. Third, the guidance increases were widely expected and the new ranges did not exceed current analyst estimates. Fourth, margins at Rogers Cable retreated for the second consecutive quarter. Finally, the company was quiet on further uses of the growing free cash flow to enhance shareholder value. Additional dividend increases, tuck-in acquisitions, and capital spending to "bullet proof" the company's network and customer service infrastructure for the cable and wireless businesses were mentioned. Major acquisitions and share repurchases were ruled out. I believe that some investors were looking for a more aggressive stance including a major share buyback.

Despite the reaction of the shares, I came away from the quarter more positive on Rogers. Plugging fresh numbers at the high end of the upwardly revised guidance raises my target for the shares to $54. Two major factors are at work. Wireless is booming and free cash flow in 2008 looks even better than I had thought....

In Wireless, Rogers beat consensus again with 13% service revenue growth and 21% EBITDA growth on margins of 51.7%. Postpaid net adds were 133,000, about 20,000 ahead of consensus, and postpaid churn fell to just 1.15%. These figures give me confidence that 2008 will see mid-teens EBITDA growth on the back of further top line growth and sustainable margins over 50%. Wireless is by far the most important driver of Rogers stock price so this is good news indeed.

On free cash flow, the company raised the top end of guidance by 15% to $1 billion and did not deny analyst questions that they would meet or exceed the top end. This gives me confidence to flow through most of next year's 15-17% EBITDA increase to free cash flow, benefiting the stock price by an incremental $1-2 per share.

Besides an unexpected slowdown or margin contraction in wireless the areas of risk to Rogers are capital spending and cable. Management may raise capital spending more than expected to "bullet proof" the company, cutting into my free cash flow projections. In cable, Rogers has suffered some margin contraction this year and margins trail peers by 500 basis points. Rogers chalks up the margin shortfall to a focus on rapid subscriber growth and the transition of circuit switched telephony to VOIP. If margins don’t begin to expand, there could be multiple compression on the cable business which is implicitly valued above Comcast in a sum of the parts valuation model.

My bottom line is that Rogers remains a great idea for fresh money given strong growth characteristics, rapidly growing free cash flow, and possibility that someday Ted Rogers may decide to listen to an offer from a financial or strategic buyer.

Barron's Discovers Rogers Communications

Barron's Online gave Rogers Communications (RCI) a nice write-up yesterday, succinctly outlining the bull case. Barron's noted the positive dynamics of the Canadian wireless market which has just 60% penetration and therefore promises several more years of well above average growth (unless Canadians end up being a lot less fond of mobile phones than the rest of the world). Remember wireless service was launched in Canada about three years after the US and if you overlay the penetration curves from the launch date they look remarkably similar. The US saw double digit growth throughout the period that Canada is entering. RCI also benefits because Canada presently has just three national wireless operators vs. six in the US. As a result, the market is less competitive and supports higher margins. Last quarter, RCI and Telus (TU) each had margins over 50%. In the US, only Verizon enjoys a similar level of profitability....

Speaking of TU, yesterday the company announced that as part of the ongoing strategic review by BCE Inc. (BCE), formerly Bell Canada, TU and BCE were exploring a merger. BCE is also considering overtures from two different private equity groups. BCE is the other national wireless company in Canada, while TU and BCE each also offer wireline services. I think a combination of BCE and TU would be bullish for RCI as the merger integration would likely create an opportunity for RCI to gain subscribers while the BCE and TU brands were being consolidated.

Canadian regulators will give any TU-BCE combination a tough review given the wireless market would have just two national companies. TU and BCE are probably assuming that regulators may let them slide because a fourth national license is on the drawing boards. Additionally, they are playing the patriotism card as the sale of BCE to private equity led buyout groups would reduce Canadian ownership of the telecom infrastructure.

RCI makes a great takeover candidate itself for private equity or a major US cable company but there is no indication that family patriarch Ted Rogers has any interest in selling. The family's massive investment and patience with RCI is finally paying off – the shares have more than tripled since the end of 2004 including a double in the last year and a gain of about 50% this year. With fundamentals very solid for the next year or two, it seems unlikely the Rogers family would sell but one never knows.

Another Great Quarter For Rogers

Rogers Communications (RG) reported another very strong quarter, continuing a string of positive news that has led to a double in the stock over the past year. EPS in US dollars looks like 23 cents vs. expectations for 18 cents. Revenues appear to be inline at $2 billion. I am hesitant about those numbers due to the fact the company reports in Canadian dollars.

Getting down to the segment level, it seems clear that the results are quite good. Wireless revenues were at the high end of expectations with dramatically higher margins than expected. Service revenue margin rose by 700 basis points well ahead of estimates that were looking for a still substantial 400 basis point expansion. Margin expansion likely emanates from a big jump in data revenue that led to much higher ARPU than expected. Minutes of use also grew rapidly and cost per gross add was stable. RG may have also benefited from a slight shortfall in net adds which came in at 86,000 vs. some analysts looking for 90,000 to 110,000. Fewer new customers typically helps EBITDA. Net adds were still up dramatically vs. a year ago indicating that growth in the Canadian wireless market continues. It is probable that RG focused on customer retention this quarter since wireless number portability just arrived in Canada. On the call, management said portability was not having any negative impact so far.

In Cable, RG performed very well with revenues rising 14.2% and EBITDA rising 14.9%. Subscriber additions were up vs. a year ago in all products. Telephony subs fell sequentially as RG focused on data and internet in the quarter. Management indicated that RG would refocus on telephony this quarter. Cable growth closely matched street expectations....

Among RG's other businesses the only item of note is the operating loss at Rogers Business Solution which is the company's large business telephone offering. Management has guided a barely above breakeven year for this segment. The 1Q loss does not appear to put the guidance at risk.

On guidance as a whole management said that "we have a generally positive bias toward meeting or exceeding certain full year guidance metrics" but that they preferred to wait until the 2Q report to officially revise guidance. I'd call that good news.

There was limited commentary on the call regarding the BCE Inc. (BCE) situation and whether it might make RG reconsider its own capital structure. For now, RG is using its free cash flow to paydown debt. The company recently received investment grade ratings. Pressure is building on management to do something with its riches and a midyear announcement still seems likely. The added pressure of the major private equity players being all over Canadian telecom should keep the "BCE premium" that has recently boosted RG shares intact.

Looking much further ahead, RG's base earnings power seems to have grown considerably. On the call management indicated that wireless margins have settled into a 45-50% range that should prove sustainable. They do not intend to let margins get much higher and will reinvest to maintain its industry leading competitive position. With the possibility of a subsidized fourth facilities based provider in Canada, RG is making a smart move to focus on its competitive position.

2008 and beyond wireless margins in analyst spreadsheets look too low. This represents the higher earnings power I alluded to above. At the same time, margin expansion built in beyond 2008 no longer seems likely. Fortunately, the Canadian wireless remains several years behind the US in terms of penetration so RG's long-term growth will continue off a higher base.

The bottom line is that RG remains an excellent story of the short and long-term. Any weakness should the BCE premium dwindle would be an excellent buying opportunity. I don’t expect that opportunity to present itself, however, as operations support the move to higher prices over the last month. I suspect my price targets of $38 in 2007 and $45 in 2008 are going higher.

Rogers Communcations 1Q07 Earnings Preview

Rogers Communications is expected to report 1Q07 EPS of 18 cents on revenues of $2.03 billion. Those figures appear to be in US dollars but the company will report in Canadian dollars so look for about 15% more on both in the press release.

RG has been growing very rapidly over the past year thanks to its wireless business with cable providing an added bump. I expect 1Q07 to show a continuation of these trends. This should be good news for the stock but the likely privatization of BCE Inc. (BCE), Canada's largest telecom company, has taken precedence in recent stock price action for RG. RG shares have risen by 20% since late March. I think projected 2007 results support the current price but without the BCE news bringing the prospect of private equity taking a run at other Canadian telecoms, I don't think the shares would be this high already....

I have always though RG was a takeover candidate but timing is contingent on family patriarch Ted Rogers, who may never sell. The logical acquirer is Comcast, but private equity may represent a good alternative if, and that is a very big if, Ted Rogers decides he is willing to sell or have a partner. I think the possibility is real enough that RG shares are unlikely to give back more than 10% of their recent gains if the takeover speculation subsides. 2007 estimates support a $38 stock price and 2008 estimates can justify at mid-$40s price. As a result, barring an unexpected shortfall in RG's operating fundamentals I am comfortable holding the shares and buying on weakness.

In 1Q07, RG should report revenue growth of 12% and EBITDA growth of 26%. Growth will be driven by the wireless business, which is the #1 provider in Canada. Wireless revenues are projected to grow 14% with service margins expanding by 400 basis points to over 46%.

Cable will also continue to contribute to RG's strong growth with revenue and EBITDA growth growing 15%. RG's growth is closely tracking that of US cable operators, driven by the triple play offering of TV, high speed data, and telephony.

A couple of other things to look for in the conference call Q&A include updates on guidance, capital spending, and use of the company's growing free cash flow and balance sheet strength. I think it is too early in the year for RG to update guidance but 1Q results will probably suggest the high end of range is within reach. Capital spending discussion will be focused on the rollout of RG's high speed wireless network. Regarding free cash flow, management has promised a mid-year update. May 1st may be too soon but RG shareholders should be rewarded soon with a significant use of cash flow and capital structure to enhance shareholder value.

Private Equity Comes To Canada - Officially

It is now official that private equity has arrived in Canada. BCE Inc. (BCE), formerly Bell Canada, has announced that is negotiations with a group of Canadian pension funds being backed by Kohlberg, Kravis, and Roberts. KKR was the in the original stories about a possible private equity-financed takeover of BCE but the stories which broke last week indicated that Providence Equity would be the lead private equity firm working with a Canadian pension fund that is not included in the newly formed KKR group. For a more complete and Canadian perspective on the BCE story, here is an article from the Globe and Mail.

The latest news continues to drive shares of Rogers Communications meaningfully higher. RG made another all-time high yesterday, rising over 3%. The shares are now up 25% this year and 14% this month. RG is Canada's second largest telecommunications company behind BCE with whom it competes in wireless telephony and high speed internet access. RG is Canada's largest wireless company and offers the triple play as the nation's largest cable company.

My spreadsheet on RG calculates a target of $38.58 based on 10.5 times 2007 estimated EBITDA. The estimates are within RG's 2007 guidance that was announced in January. The multiple is consistent with trading levels for RG over the past year on forward estimates. Looking ahead to 2008 and assuming multiples hold and EBITDA grows 12%, my target is $45.54. It is worth noting that RG has consistently beat earnings estimates over the past year....

Investors are clearly suggesting that if BCE can be taken private so can RG. In fact, some articles have stated that RG is a better target due its much better growth profile and the recent emergence of significant free cash flow. However, unlike BCE, RG is a family controlled company. There is no way of knowing whether family patriarch Ted Rogers would be willing to sell but most observers believe he is not a seller. At least not yet.

Then again, with Providence Equity apparently shut out of the BCE deal, there is another willing entrant into the Canadian telecom industry that might look for a new deal. I've always thought the end game for RG was a sale to Comcast which has similar family ownership and would benefit from RG's wireless expertise as it will probably offer wireless services to its US customers in the next three to five years.

While I do not expect a deal for RG anytime soon, I do think the arrival of major private equity players with experience in media and telecom on our northern frontier means that RG shares have moved to a new higher multiple range. As a result, I don't think a major amount of the recent gains are likely to be given up. Should RG track at or above its 2007 guidance, I think investors will be willing to quickly look ahead to 2008 earnings and my 2008 target will be accelerated. That may take a few months but independent of a buyout, I think RG is worth holding despite reaching my 2007 target. I'd be a buyer on a pullback toward $35 or about half of his month's gains.

RG is not the only Canadian telecommunications enjoying a spurt from the BCE news. Shaw Communications (SJR) has risen over 10% this month amid speculation that it could be a seller to either private equity, or more likely private equity in partnership with RG. For some great background on SJR, here is another article from the Globe and mail discussing recent takeover speculation. The article also mentions Corus Entertainment (CJR), another company controlled by the Shaw family. CJR shares are up 12% in April.

Another potential takeout in Canada is Telus (TU). TU is a major wireless and wireline company. There has been some speculation that BCE might take a run at TU. TU would also be attractive to private equity for its fast growing wireless business. Not surprisingly, TU shares are also up 12% this month.

There is lots of activity up north beyond the Stanley Cup playoffs (Let's Go Sabres!) and traders and investors should look to RG, BCE, CJR, SJR, and TU for possible buy ideas. The telecommunications landscape in Canada is viewed favorably relative to the US due to a less fierce competitive environment. Additionally, wireless penetration in Canada is only in the upper 50% ragne, well behind the United States. Wireless started a few years later in Canada and if you plot the penetration curves of both countries based on start date, Canada is right on track with the U.S. That means that the next several years could witness the same superior growth witnessed in the U.S. in the last few years. So if you head north to speculate on the next private equity deal, you can travel knowing that the fundamental landscape is as pretty as the Canadian natural environment.

Private Equity Comes To Canada - Good News For Rogers

Private equity speculation comes to Canada. More rumors about a takeout of BCE Inc (BCE), formerly Bell Canada, emerged yesterday with speculation about a buyout led by the Ontario Teachers Pension Plan with the help of Providence Equity. BCE shares closed up more than 6% but remain well below a rumored bid from this group near $35 (C$40).

This news along with prior speculation of KKR financed bid have pushed the shares of Rogers Communications (RG) to a new all-time high. RG has been gaining wireless and cable telephony subscribers at the expense of BCE and is leading the healthy Canadian telecommunications industry with strong double digit operating income growth.

I got long RG back in December under $30 on the basis of the superb results coming from the company’s wireless and cable businesses. I established a $38 target based upon RG trading at 10.5 times 2007 EBITDA in 2H2007, a level consistent with where it has traded on forward estimates in the past year.

Since that time...

RG reported better than expected 4Q06 results and issued favorable 2007 guidance. Additionally, the company indicated it is looking at how shareholders could benefit from the company's transition to a significant generator of free cash flow. These two facts reinforce my $38 target.

Although it was not central to my initial buy recommendation, I think that RG is an excellent acquisition candidate in its own right. The company is controlled by the Rogers family, whose patriarch, Ted Rogers, will be 74 in May. Ted is going strong and has to be enjoying the fantastic returns produced by RG over the past few years (the stock was under $3 in October 2002) but eventually estate planning considerations have to enter his thinking and make him consider the possible sale of the company.

Any deal that would privatize BCE would focus potential acquirers on RG. A BCE deal with a significant foreign ownership component would further increase speculation toward RG. Canada has a conservative government, which according to the Globe and Mail, showed a willingness to be flexible on foreign ownership when Inco was sold last year to a Brazilian mining company.

Any private equity firm is a logical acquirer of RG. Not only does RG have good fundamentals, significant and growing free cash flow, and a reasonably leveraged balance sheet, but there are significant assets that could be sold such as the Toronto Blue Jays and their stadium, the Rogers Centre, and publishing and broadcasting assets.

I also think that RG would be a very logical acquisition for Comcast (CMCSA/CMCSK) or Time Warner Cable (TWC). Both of these companies are likely heading toward a quadruple play that includes wireless. As a leading wireless player in Canada, RG would bring expertise along with synergies in the cable business. RG may also view Comcast as a satisfactory acquirer given the shared legacy of family ownership and control.

The bottom line is that RG remains an attractive investment on its own fundamentals. Reaching the upper $30s on 2007 estimates and low to mid $40s as another double digit growth year in 2008 comes into focus. If privatization and takeover speculation continues to swirl around BCE, RG's own attractiveness as a takeover candidate just reinforces my upside targets and provides downside support for the shares.

Good Results From Rogers Communications

Rogers Communications (RG) reported very strong 4Q06 results. Wireless was the star performer with margin expansion exceeding analyst estimates. The Cable and Media divisions also performed well with modest beats on both revenues and EBITDA. EPS look to be way ahead of expectations at 28 cents vs. an estimate of 11 cents but RG trades off revenue and EBITDA and based solely on 4Q results it should trade higher.

This is also the time of the year when RG provides full year guidance. I find the guidance to be good but not great relative to expectations. I don’t think that analysts will have any major issues but since it is not a blowout the guidance could dampen the positive impact of the great 4Q numbers. Net-net, I think the quarter and guidance are a winner and RG will continue to trend higher after closing at an all-time high just prior to the earnings report....

RG released 4Q06 wireless subscriber results in January which suggested that margins in wireless could surprise to the upside. Slightly below par gross additions and lower than expected churn implies a focus on the best and most profitable part of the customer base. This turned out to be accurate and margins significantly exceed estimates based on service revenues and profits. Analysts were very impressed on the conference call.

There really wasn't much discussion about cable results in 4Q on the call as revenue and EBITDA growth both came in just slight ahead of expectations at about 11% growth.

Guidance for 2007 calls for consolidated revenue growth of 10-13% for revenues and 12-18% for operating profit. It looks to me like analysts estimates call for 12% and 14% growth so the guidance brackets the estimates. Given revenue and EBITDA growth of 20% and 34% in 2006, I think there was some hope for even higher guidance. This is the only area of concern for the stock coming out of the call but I don’t think it is a big deal. I suspect one year from today RG's 2007 results will be at or above the high end of guidance. In other words, as management noted the guidance is "respectable and achievable." I read that comment as all but saying "conservative."

Breaking down the guidance, wireless is expected to show 15% growth in revenue and EBITDA. The lack of margin expansion was source of questions following about 900 basis points of expansion in 2005. Management noted that it would not get anymore benefits from past merger integration and that they are planning conservatively given the coming launch of wireless number portability in Canada. Analysts seemed satisfied but their models might get tweaked. The big beat in 4Q and 2006 wireless results means that tweaking margins down won’t mean absolute estimates will come down.

On the cable side, 2006 revenue and EBITDA growth is fore cast at 12% and 11% respectively. Management noted that basic cable TV is the most profitable product so the slight margin contraction implied by the guidance is merely mix related as VOIP, high speed internet and digital TV continue to grow. I suspect that as VOIP matures margins will expand again. This guidance should not be an issue with analysts.

One area where guidance looks poor is in the company's business focused telecom operations. I either missed it or it didn't come up on the call but the company is calling for a $40 million decline in EBITDA in 2007 to just $10 million. It is not a big deal since total EBITDA is at $3.4 billion.

One interesting line of questioning concerned RG's sudden emergence as a significant free cash flow generator. 2006 marked the first time RG even had meaning free cash flow at $543 million. Guidance calls for $800 million to $1 billion in 2007 although management made mention that $1 billion was very realistic. RG is fast becoming underleveraged with $7 billion in debt and $3.4 billion in 2007 projected EBITDA. Management promised to provide an explicit plan for using free cash flow by mid-year. This should be good news for shareholders as acquisitions and significantly more debt reduction were more or less ruled out.

All the numbers in this summary so far are Canadian dollars.

In US dollars, RG is trading at a little under 9 times 2007 EBITDA guidance without adjusting for $1 billion Canadian in free cash flow. I think the stock can hold the current 10.5 multiple on 2006 reported results which equates to a target of $39. That leaves close to 20% upside on what I suspect will turn out to be conservative guidance. Not surprisingly I am staying long.

Rogers Communication 4Q06 Earnings Preview

Rogers Communications (RG) preannounced solid subscriber results that should be supportive of a good quarter when the company reports full EPS after the close on Thursday. There aren’t many estimates on RG and there could be some confusion relating to U.S vs. Canadian dollar numbers but with those caveats look for EPS of 9-11 cents on an 11% increase in revenues to $2.4 billion. EBITDA should be near $680 million, rising 33% vs. 2005, a similar growth rate to 3Q06.

Wireless telephony will represent a little over half of revenue. RG already announced subscriber results that showed slightly below par net adds but lower than expected churn. These results are similar to what has been reported by other leading wireless players in Canada and could be indicative of an environment that is favorable for margins. Wireless number portability is coming soon to Canada and it appears that operators are looking to lock down quality customers and focus on ARPU at the expense of subscriber counts. I think this is a good strategy, especially considering that at around 57%, wireless penetration in Canada trails pretty much every other major industrialized market. Penetration is closely tracking these other markets but just a few years behind so giving up a few subs now should not prove costly. For the quarter, RG should see wireless service revenues rise around 17% with sharply margin expansion that has been evident all year continuing and driving EBITDA up by 55%. Other wireless issues to keep on eye on are trends in data and roaming. RG is the only GSM in Canada which gives the company a competitive advantage on roaming minutes and for obtaining the best selection of handsets.

2007 guidance for wireless will be an important part of the RG earnings report....

I only have limited access to analyst models but I would hope for revenue growth of at least 13% and EBITDA growth of at least 18% implying continued margin expansion. Prepaid net adds should grow by around 500,000, down from almost 600,000 in 2006 but still driving solid double digit growth. Churn may tick up slightly due to number portability but given actions on the part of RG and its competitors in 2006, a big increase should not be expected.

RG's other big business, representing about 30% of revenue is cable. Cable trends in Canada closely mirror those in the United States. RG should report double digit growth in revenue and EBITDA as the triple play continues to drive the business. These trends should continue in 2007. One thing that will surely be addressed is the 2007 outlook for capital spending. Comcast has spooked investors with its increase in capital spending plans and it is possible that RG could announce capital spending plans in excess of street estimates. As long as subscriber growth is also better than expected, as it was at Comcast, I don’t see any problems for RG even it does boost its capital spending guidance.

Overall, I expect a strong quarter and good guidance from RG. Canadian wireless remains an excellent investment theme and RG is the best way to play it. Having a secondary business like cable with solid digit growth prospect further supports the story. If RG hits current 2007 analyst estimates, the shares should continue to work higher toward my target of $36.

RG has handily beaten estimates in 2006. This creates lots of extra upside if the trend continues in 2007 but has also raised the bar a bit if the company begins to merely meet estimates. I expect them to beat.

Rogers Splits and Reports Subscriber Statistics

Rogers Communications (RG) shares began trading on a 2 for 1 split adjusted basis yesterday when the company also announced preliminary 4Q06 subscriber statistics for their wireless and cable operations. Wireless subscriber growth was in line with Street estimates with a surprisingly low churn rate. Low churn ahead of the pending roll out of number portable in Canada is a good thing as it might indicate that RG is locking up its subscribers. Low churn and in line subscriber additions might also be good for 4Q06 wireless EBITDA. In cable, subscriber metrics were also largely in line with estimates. VOIP Telephony, the current growth driver, saw better than expected subscriber additions while basic and digital subscriber additions were each slightly short of estimates. RG reports its full results later this month. Based on the preliminary subscriber report I see no reason to alter my buy recommendation or target price of $36.

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.