Cable & Wireless has a robust balance sheet and is generating a profit, but the valuation is too high.
If there's one thing that has characterised telecommunications companies over the last few years, it has been their very weak balance sheets with high levels of debt and large numbers of intangibles. Both these characteristics are hangovers from the heady party days of the 1990s.
Cable & Wireless
(LSE: CW.)
is one of the companies that partied long and hard. It had the hangover and checked itself into a rigorous rehab programme and has a healthy balance sheet as a result. Rehab is also bearing fruits in other ways.
In today's results, operating profit leaped from £189m to £221m. This is on revenue of £ 3.35bn up from £3.23bn. EBITDA increased by 20% to £492 million. The dividend has been increased by 30%. Cable & Wireless is not indebted and has net cash of £332 million.
So these results look pretty good. Are the shares worth buying?
Firstly, seeing that Cable and Wireless, like most telecommunications companies, concentrates on EBITDA, let's look at EV/EBITDA. If we calculate the enterprise value (EV) by taking off the net cash from the market capitalisation, we get an EV/EBITDA ratio of 8.4. Whilst this is not value territory, it isn't overly expensive.
EBITDA, though is a dangerous measure. It excludes depreciation on capital equipment and may therefore make results look more attractive than perhaps they should. This may especially be the case for telecommunications companies who have to buy a lot of equipment. Depreciation is, after all, a useful way of estimating its usable life.
In the case of Cable & Wireless, depreciation was £256m in this most recent year as opposed to £263m in the previous one. If the equipment that this depreciation represents was still in good order, Cable & Wireless might not need to buy any more. But, in reality, the company is still buying. It spent £388m on new kit last year and £ 412m in the one before. So, if anything, the depreciation figure is perhaps slightly understated.
Another thing worth mentioning is tax. The company says: "the current tax rate for Europe, Asia & US will be effectively nil for the foreseeable future as a result of unclaimed capital allowances." This is a good thing, of course, but it means that our financial ratios are going to be skewed -- most companies pay around 30% tax.
So, for the sake of comparison, let's use the pre-tax profit figure of £196m and take off a notional 30% tax. This leaves £137m. However, much of this profit is attributable to "minority interests" rather than the shareholders. Based on the results, these minority interests have a right to about 39%. This leaves £84 million for the shareholders, putting the company on a notional price-earnings ratio of 53.
Perhaps, this is too much analysis. However, I find these sorts of calculations invaluable to check and double check whether value is screaming at us from all angles.
In this case, it clearly isn't.
Cable & Wireless is emerging from the dot.com crash with a robust balance sheet and generating profit. The valuation though means I'll stick it firmly in the "think-about-it-later" basket.
