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Ascent Media (ASCMA) – Monitronics acquisition update

December 22, 2010

I know it’s too early to do any real analysis on the Monitronics purchase (Yes, for those of you not following the fine print about Ascent Media, they are not only in the process of selling all their operations, but also of purchasing Monitronics International, a large home security firm, from the private equity firm ABRY), but I’m going to provide my 2 cents anyway.

I have to say the first thing I thought when I saw that Ascent was buying Monitronics from ABRY was ”Gee, I thought they were sophisticated investors. You know,  John Malone and all. What are they doing buying something outside their core competence, and from a private equity firm to boot?  They’re probably getting reamed on the deal!” But then I thought, or perhaps it was just hope interjecting itself into a dark situation, “Maybe appearance isn’t everything. Let’s take a closer look”.

Ascent is buying this company, Monitronics, that had net income of $252 thousand in fiscal 2010 (ending in June) for $1.2 billion, with about $300 million in cash coming from their pocket, $100 million coming from borrowings on a new credit line and the assumption of what I calculate to be $800 million in Monitronics debt (structured finance as the press release calls it).  First, I am hoping that the line of credit is just to tide Ascent over until the sale of the Content Services group is finalized in the first quarter of 2011. Otherwise why would they need the loan? After the sale of their operating businesses Ascent should have over $550 million in cash and marketable securities, plenty for the Monitronics price tag of $413 million with $100+ million left over. The second thought was “Are they really selling their money losing operations to buy a breakeven business, albeit one growing at 20%+ per year?” A little closer consultation of the press release reveals the answer; while there was only $252 thousand in income for 2010, there was $187 million in EBITDA. So where is the big difference? Amortization, my friend, amortization! I’m assuming this is amortization of goodwill, amortization that will not be dispersed with the acquisition. Now, a company with little reported income (and low tax payments) but with significant cash flow, that’s beginning to look more like a Malone investment.

 As you know, if you have read any of my analyses, I prefer the simple to the complex. If a quick and dirty, back-of-the-envelope analysis doesn’t yield something attractive, I basically go no further and stay away. So let’s review the Monitronics acquisition through my quick-and-dirty glasses. Looking at last year’s income statement, we have $187 million in EBITDA. Next I assume the same interest expense on the inherited structured finance (assuming they pay off the ‘bridge loan’), rounded up slightly, to $60 million, and capex at about 20% greater than depreciation just to be safe, and we get to cash flow (CF) before taxes of about $120 million. My guess is that Ascent will find a way to pay little if anything in taxes, but I have made a ‘best case’ at 4% and a ‘worse case’ at 35% just to be on the safe side.  Using these assumptions we calculate cash flow per Ascent share in the range of $5.50 to $8.00. Not bad at the current share price of about $35.

Ascent/Monitronics Cash Flow estimate (in millions)

 

 

Worst case

Best Case

EBITDA

$187

$187

  Interest expense

$60

$60

  Capex

$7

$7

Est. pre-tax CF

$120

$120

  Tax

($42)

($5)

Est. annual CF $78

$115

     
CF per share

$5.46

$8.05

 So what does this do to our valuation of Ascent Media shares? Without looking up comparative CF multiples for security firms (Brinks for example?) I might estimate that a similar company could be worth 6-8x cash flow. Assuming a 20% growth from last year’s Monitronics figures we might be looking at cash flow per share of $6.60 to $9.50 per share this year, and, using the above cash flow multiple, we might get to a range of values for Ascent’s Monitronics business of $40 to $75 per share. And that’s before the $10 per share in cash that Ascent should be left with after the acquisition.

 Mr. Market has responded less than enthusiastically to the Monitronics acquisition announcement, but I think this is because the details of the deal were rather sparse and the economics rather opaque (just as they should be for a Malone deal). I would guess that over the next 6 months or so Mr. Market might begin to see the above details emerge and begin to price ASCMA somewhere in the $40s. After that, and it could take a year or more of operating results to raise awareness, the price might rise into the $50 to $70 range. Originally, I was looking at a price target on ASCMA of between $40 and $45 per share.  I may begin to lighten up around $45 per share under my initial investment hypothesis, but would, at least at this point, continue to hold onto most of my position looking for a  share price of $60 or more. That, of course, if my above hypothesis is proved out in later filings.

But, don’t take of these ramblings as advice for what you should do. More than likely I’m way off the mark. Always remember: Do your own due diligence.

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2 Comments
  1. Alex permalink

    The Amortization is of subscriber acquisition costs. Their business model is to buy subscriber accounts from the dealers who originate those accounts. Therefore, these costs are really more like growth capex. A typical contract lasts for 3-5 years, it is amortized for 10 years. If you look carefully, operating cash flows are swamped by the investing cash flows once you factor in the subscriber acquisition costs.

    Most people in the industry value using Monthly Recurring Revenue as the metric of choice. On this metric, they well-overpaid at 50 months versus more recent transactions at 30-35 months.

  2. Thanks for the insight Alex. I haven’t been able to review the Monitronics financials nor do I know alot about the industry so I’m still shooting from the hip. If what you say is true and ASCMA overpaid for Monitronics, my above thesis is Kaput; they’ll need all that cash flow to keep growing the business, so its not really ‘free’ cash flow after all. My question is, what if they slow down subscriber acquisitions and grow the cash flow instead? It seems to me that the key to cash flow generation is a combination of subscriber acquistion (growth) and subscriber retention, and I’d like to see how Monitronics compares to other companies in the business. We’ll need some metrics (hopefully available in the ASCMA 2010 annual report since the acquisition was completed prior to year end) to figure this out.

    Overall, given what you report, maybe I shouldn’t have been so optimistic in my original post. Only time will tell.

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