QUALIPORT
Cable & Wireless: A Qualiport Asset Play?

By Maynard Paton (TMFMayn)
August 9, 2001

Rochester, Kent –  Cable & Wireless (LSE: CW.) is an intriguing investment proposition. Following some canny sell-offs, C&W's resultant cash mountain significantly differentiates the group from its debt-laden telecom counterparts. In fact, having plenty of cash should give C&W the upper hand for some time to come. Although C&W's new telecom services are presently at a fledgling stage, the group's balance sheet could give the company that all-important sustainable competitive advantage.

In terms of making a C&W investment decision, the key points involve the group's asset base and the likely demand for its new telecom services. In today's article, I'll concentrate on C&W's assets. On Monday, I'll continue the C&W coverage by looking at the company's growth potential. I'll also be revealing whether C&W shares are suitable for the Qualiport!

The business

In recent years, C&W has undergone a significant transformation. The group used to own a diverse array of telecom-related operations alongside various joint ventures and minority stakes. However, with the appointment of Graham Wallace as Chief Executive in 1999, the group embarked on a dramatic disposal programme. Amongst many other ventures, out went C&W's cable television business, mobile telephone stakes, Hong Kong Telecom operation and marine cable laying company.

The disposal proceeds are currently being used to fund C&W's global Internet protocol (IP) network. In short, IP technology allows voice, video, data and images to be carried in a far more efficient manner than conventional telephone lines. The first move into IP came in 1998 when C&W purchased the Internet "backbone" business of MCI for $1.75b. Since then, C&W has focused on the worldwide corporate market and has established further network "nodes" throughout the US, Europe and Japan.

As well as the global business ("C&W Global"), which alongside IP also provides pure voice and data services, C&W still owns a handful of small, local telecom businesses ("C&W Regional"). C&W is presently in the final stages of disposing of its Australian Optus business, although the deal has yet to be officially cleared by the regulators.

The financials

It's at this point during a Qualiport company review that a five-year profit history is presented. But given the transition from telecom conglomerate to focused global IP player, such a table (and the resulting analysis) is academic. As we'll see, it's the balance sheet that takes precedence at the moment.

In terms of assets, you can effectively divide C&W into three parts: the cash pile, C&W Regional and C&W Global. In fact, at the current 335p share price, the Global business looks to be "in for free". That being the case, investors don't have to make any in-depth judgements over C&W's standing in the IP stakes. Instead, investors could simply be buying £1 coins (or a rough equivalent) for 50p!

At C&W's latest year-end, cash and cash equivalents less debt totalled £4.6b. Taking into account changes in the value of listed investments, and making the following assumptions and adjustments...

* The Optus deal goes through, with C&W effectively receiving £3.9b cash;
* Cash capital expenditure since the March year-end totals £700m, and;
* The recent £280m purchase of Digital Island.

...C&W's cash and cash equivalents should currently total £7.6b, or 272p per share (a full rundown of the calculation can be seen here).

Free of charge

Placing a value on C&W Regional is a little more straightforward. The division generated earnings of around £220m in its latest full year. Place that figure on an undemanding price to earnings (P/E) ratio of 12.5 and we get a rough valuation of £2.8b (100p per share).

So, with the present 335p C&W share price, investors can pick up the 272p per share cash pile, the 100p per share C&W Regional business and effectively get back 37p per share in change! And the C&W Global business gets thrown for free too!

But what is the value of C&W Global business? On a "book value" basis, it operates with anything between £2b and £4b (71p and 143p per share) of tangible assets, depending on how you apportion C&W's goodwill between the group's operating divisions. 

But the difficulty with an asset investing approach to C&W is simple -- you need somebody who's interested in buying a part-completed IP network to "out the value". Importantly, we're not talking of reasonably liquid assets (e.g. land or property) here.

Given that most telecom companies are busy managing their debts, I suspect a third party realising the C&W asset value is remote. What's more, if there were somebody who was interested in buying C&W for its assets, they'd also have to think the assets were roughly worth what the accounts state.

By just taking the book value view (and assuming my calculations are accurate), there's a maximum investment upside of 50%. But as time goes by, the cash pile will diminish and the amount of network assets and goodwill (through acquisitions) will increase. Obviously, as the reliable cash pile shrinks, so will the chances of a C&W asset predator striking.

At the end of the day, operating assets are only worth the discounted future cash flows they generate. With C&W Global presently a loss-maker, plus long-term profitability reliant on large cash expenditure over the short-term (around £2b-£3b this year alone), any judgment on the market value of the division's assets is quite speculative.

While the accounts may say so, I'm not entirely convinced that "asset value" C&W investors are clearly getting a bargain at the moment. Indeed, such a short-term investing approach is not the Qualiport's style. That said, on Monday, I'll continue with C&W. Specifically, I'll be taking a long-term valuation view on C&W by judging the future potential of its telecom businesses.

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