The current wholesale sell-off in global stock markets is leading to many a baby being thrown out with the bathwater! Inevitably there are some stocks which are being sold off which are sound businesses. There are certainly far more exciting investment opportunities out there than there have been at for a good four years. No doubt the forthcoming economic recession will have an impact on all industries, and most companies will see a significant reduction in revenue, profits and cash flow. Many however are currently being priced as if they will go bankrupt, or head into a long painful terminal decline. Some of these very undervalued companies might even manage to grow earnings in the forthcoming recession.
Cable & Wireless: business segments and spin-off discussions
One example is Cable & Wireless in the UK. Cable & Wireless essentially has two distinct businesses. The growing internet and broadband division for corporate customers in Europe, Asia and the US, and the International division which includes the legacy cash generative telecoms businesses in the Caribbean, Panama, Macau and Monaco. For years shareholders have argued that the combination of these two divisions is not strategically compelling and that a demerger would be the best way to realise value.
Earlier this year management announced that they were considering strategic options including a demerger and returning cash to shareholders. In the following months, the share price rose 20%, dramatically outperforming the sector, but in the last few weeks it has fallen over 30%. Part of the reason for the recent stock price sell off is that management have suggested, quite sensibly in my view, that the current market turmoil is hardly the time to be realising value via a demerger and spin-off. This does not signify a change in strategic thinking but rather a delay until more rational markets prevail.
Cable & Wireless’s acquisition of Thus
C&W has also recently completed a takeover of its smaller UK rival, Thus. Even after paying £361 million for Thus, the company will still be significantly underleveraged with a net debt position of £184 million, less than 10% of equity. The purchase of Thus, following on from the acquisition of Energis in 2005 gives C&W increased market share and helps them consolidate their position as a clear number two to BT in the provision of internet services to corporate customers in the UK.
Cable & Wireless: guidance and valuation
In the June 2008 interim statement, management said it was on track to achieve its guidance of a 20% increase in operating profits for this year. Let’s be conservative and assume that current economic circumstances mean C&W will not achieve any improvement in the underlying going concern this year or next. At the current price, this would put the business at a very reasonable 6.6X cash flow. The dividend should be secure too; giving a current yield of 6%. Throw in likely cost savings from the Thus acquisition, and a potential special dividend from the eventual separation of the two key businesses, and it seems to me that Cable & Wireless is a bargain.
Disclaimer: Note the author may hold investments in any of the companies mentioned in this article. Any new investment should only be considered in the context of the risks in your existing portfolio.
Posted under individual stocks
This post was written by ex-fund-manager on October 31, 2008
