Virgin Media Inc. Rating: Buy

Transcription

1 SATELLITE, CABLE & BROADCASTING David B. Kestenbaum James Leahy Company Update / Estimates Change May 10, 2007 Key Metrics VMED - NASDAQ $23.53 Pricing Date 05/09/2007 Price Target $ Week Range $29.50-$19.99 Shares Outstanding (mm) Market Capitalization ($mm) $7, Mo Average Daily Volume 2,245,786 Institutional Ownership 75% Debt/Total Capital 66.3% ROE NM Book Value/Share $18.95 Price/Book 1.2x Dividend Yield NM LTM EBITDA Margin NM EPS($) FY: December Prior Curr. Prior Curr. 2006A 2007E 2007E 2008E 2008E 1Q-Mar (0.86) (0.69)E (0.73)A Q-Jun (1.24) (0.57)E (0.76)E Q-Sep (0.61) (0.54)E (0.58)E Q-Dec (0.52) -- (0.40)E FY (3.23) (2.21)E (2.46)E (1.39)E (1.51)E P/E NM NM NM Our revenue and EPS estimates represent the combined entity. Estimates are in US$ for First Call. See model for exchange rates. Revenue($mm) Prior Curr. Prior Curr. 2006A 2007E 2007E 2008E 2008E 1Q-Mar 1, ,021.3E 2,001.7A Q-Jun 1, ,011.4E 1,986.2E Q-Sep 1, ,020.3E 2,013.5E Q-Dec 2, ,111.2E 2,107.8E FY 6, ,164.2E 8,109.1E 8,319.1E 8,289.7E 1 Year Price History for VMED Q2 Q3 Q Created by BlueMatrix Company Description: Virgin Media Inc. ( is the largest cable television provider in the United Kingdom and one of the country's largest providers of broadband and communications services. The company provides residential broadband and dial-up Internet; telephony service, and cable television service and a suite of commercial voice services and Internet access, managed business communications networks, and communication transport services Virgin Media Inc. Rating: Buy Riding the Virgin Media Roller Coaster: You Always End up Where You Started Investment Highlights: Stock Back at $24; AGAIN is Very Compelling. Revenues and EBITDA were 1.022bn and 305.7mm vs. our 1.032bn and 301.9mm estimates. The company reported EPS of ( 0.37) vs. our ( 0.35) estimate. While the company continues to integrate its businesses and realize the synergies coming from its acquisitions, it is clearly struggling in the competitive UK market. However, we believe it is working to mitigate its disadvantages and we like the way it is overall positioned. We reiterate our Buy rating and $40.00 price target. Operating metrics highlighted by solid RGU numbers. Total RGU net additions of 29,600 were solid, despite customer losses of 46,900 during the quarter. Despite the relative strength in RGU net additions, the loss of BSkyB's (BSY - $ NYSE) basic channels at the end of February has yet to fully impact customer and RGU numbers due to a 30-day cancellation notice policy. The addition of 87,900 new broadband RGUs was the highlight in 1Q07 as Virgin's offering remains well-positioned competitively. ARPU (average revenue per user) fell to but RGUs per customer, triple-play penetration, and churn improved to 2.20, 42.9%, and 1.6%, respectively. Virgin Mobile revenue is light; customer losses to continue. Revenues were 141.0mm vs. our 151.5mm estimate as net customer losses continued (a total of 61,300 during the quarter). ARPU fell to as the company reduced pricing of its contracts under its new quadruple-play bundling and saw seasonally lower ARPUs from its prepaid customers. However, we believe the customer losses should stabilize later this year. Expect challenging environment to continue into 2Q07. Due primarily to the company's ongoing fight with BSkyB and the challenges it continues to face in its telephony business, we believe Virgin Media will experience negative customer, video, and telephony net additions during the quarter, which will more-than-offset any broadband net additions. Furthermore, we anticipate sustained declines in the company's Business segment and continued pressure in the Content segment on seasonal issues and the loss of subscription revenues from BSkyB. Trimming estimates for 2Q07 and annual outlook dims slightly. 2Q07E revenue and EBITDA move to 1.014bn and 304.2mm from 1.027bn and 323.5mm; EPS moves to ( 0.39) from ( 0.29). 2007E revenue and EBITDA move to from 4.168bn while EBITDA remains 1.311bn; EPS moves to ( 1.26) from ( 1.13). For 2008E, our revenue and EBITDA estimates move to 4.232bn and 1.580bn from 4.247bn and 1.600bn; EPS moves to ( 0.77) from ( 0.71). The Disclosure section may be found on pages 6-7 of this report. The Valuation section may be found on page 6 of this report.

2 Decidedly mixed quarterly results for 1Q07; company hit by competitive pressures. Virgin Media reported revenues of 1.021bn vs. our 1.03bn estimate; EBITDA of 305.7mm compares to our 301.9mm estimate. The reported EBITDA benefited by a 7.9mm reversal of an accrual. During the quarter, the company reported Consumer revenues of 638.1mm vs. our 645.0mm estimates. Consumer revenues fell below our estimates largely due to a decline in ARPU during the quarter on the Telewest side of the business combined with continued customer losses which reduced the company's overall Consumer revenue base. Outside the core business, the company reported Business revenues of 163.1mm vs. our 156.0mm estimate and Content revenue of 86.5mm vs. our 79.4mm estimate. Business revenues were above our estimate but were impacted by the completion of a project for one of the company's wholesale wireless customers (this should help pressure Business revenues in 2Q07). Within Content, the company reported Virgin Media Television and sit-up revenues of 35.2mm and 51.3mm vs. our 26.5mm and 52.9mm estimates. Virgin Media Television saw advertising revenue increases that were more than offset by declines in subscription revenues from BSkyB while sit-up was largely impacted by seasonal factors following the very strong holiday shopping season in 4Q06. The Virgin Mobile segment generated 141.0mm of revenue vs. our 151.5mm estimate, with a reduction of ARPU, total customers, and lower equipment revenues. On the bottom line, the company reported a loss per share of 0.37 vs. our 0.35 loss per share estimate. While the company is clearly demonstrating that it is properly integrating the businesses and is on the road towards fully realizing the synergies of the transactions, there are some nagging concerns which give us pause. We believe the company has a lot of work to do to improve the performance of its telephony RGU base and we expect VMED to absorb significant near-term pain related to its competitive battle with BSkyB while dealing with ongoing issues in its Content and Business segments. These concerns are certainly significant issues heading into 2Q07 and may weigh on the company deeper into Despite this, we believe Virgin Media is taking the necessary steps to mitigate these concerns and we believe the company remains well positioned in the UK market. As a result, we reiterate our Buy rating and $40.00 price target. Operating metrics mirror results; overall RGU numbers healthy with some concerns elsewhere. Total RGU net additions remain solid, as the company continues its push of bundling and cross-selling activities. At the same time, the company's customer losses continue, thanks largely to continued telephony losses given that the company's telephony customers tend to completely churn away from the company if they churn off telephony. Virgin Media lost a total of 46,900 customers vs. our 43,300 customer loss estimate though much of the impact from the loss of BSkyB's basic channels on Virgin Media's platform has not hit yet due to the 30-day notice period needed under the company's customer contracts. Despite the customer losses, the company grew RGUs by 29,600 given the continued health in the company's broadband business. Within the overall RGU numbers, the company added 87,900 net broadband RGUs (vs. our 65,000 estimate) and lost 63,400 total telephony RGUs vs. our 60,000 loss estimate. Broadband RGUs continue to remain solid thanks to the company's industry-leading broadband service offering, which includes top speeds of 20.0Mbps (this is an increase from the previous high-end speed of 10.0Mbps) and unlimited downloads across the service portfolio. We believe the company's trial of 50.0Mbps service will ultimately lead to a highly differentiated product that no other operator in the UK will be able to immediately match. Despite the strength in broadband, telephony remains highly challenged. Given that the company's broadband and television dual offering has been one of its most popular packages, telephony has been largely de-emphasized. Furthermore, the cannibalization of fixed-line telephony by mobile telephony has been more pronounced than many industry observers have predicted. On the video side, the company added 36,100 RGUs vs. our 5,000 addition estimate, including 75,200 net new digital video RGUs and the loss of 39,100 net analog video RGUs. The company's push to market its VOD (video on demand) and DVR (digital video recorder) services has had a positive impact of digital video RGUs, given that VOD in particular is only available on Virgin Media's platform. VOD is offered to over 3.1mm subscribers and is today used by about 43.0% of them on a monthly basis. Content today includes over 500 movies, thousands of hours of content, and the Virgin Central portal which 2 MORGAN JOSEPH & CO. INC.

3 drew 3.0mm episode views in its first month. Further, the company now has over 150,000 V+ DVR subscribers and continues to expand availability of its HDTV (high definition television) programming. The company's other operating metrics also project a mixed picture in 1Q07. ARPU fell during the quarter to from the recorded in the prior quarter but we note that legacy NTL ARPU actually rose by 0.30 during the quarter, reflecting the continual improvement of the legacy NTL systems and the full rollout of the advanced services across that footprint. At the same time, RGUs per customer hit 2.20 vs in the prior quarter and triple-play penetration hit a solid 42.9%, up nicely from 40.6% a quarter ago. The company has improved its bundling strategies and its new package offerings are clearly getting customer attention. We note that the company today has over 126,000 quadruple-play customers, with cross-selling of mobile telephony into its cable base generating increasing success. Churn reached 1.6%, down from 1.7% a quarter ago as credit policies and shifts towards direct and retail sales improved the company's ability to retain customers. However, we believe the fight with BSkyB over Sky 1 and Sky 2 carriage will hit churn significantly in 2Q07 as customers have begun to churn away from Virgin Media in April. Unlike in prior quarters, the company did not break out the performance of its legacy NTL and legacy Telewest businesses but did mention that the difference between the two legacy businesses continues to narrow. Additionally, the company provided less in the way of a look at its customer service metrics. However, it did mention that call center performance took a hit late in 1Q07 thanks to increased call volumes from customers looking to clear up the BSkyB channel loss or to churn away due to the channel loss. Virgin Mobile contract business beginning to regain momentum; prepaid losses should continue as company shifts focus to contract customers. The Mobile segment disappointed in the quarter as it generated 141.0mm in revenues (including 136.0mm in service revenues and 5.0mm in equipment revenues) compared to 151.7mm in 4Q06. Net customer losses continued during the quarter as the company continued to reduce its base of low-arpu prepaid customers and market its new contract service offerings on cross-sales channels (47,000 new customers were added through cross-sales into existing cable customers). Total customer losses in the quarter were 61,300, including a loss of 115,500 total prepaid customers and additions of a solid 54,200 contract customers. ARPU fell to during the quarter from in the prior quarter due to a reduction of contract ARPUs in connection with the company's 4 for 40 quadruple-play bundled service offerings which include a discounted mobile contract and seasonally lower ARPUs from prepaid customers. The company continues to expect losses of prepaid customers to more than offset gains of contract customers into 2Q07 as current market trends continue. However, Virgin Media does plan to reinvigorate its value-based marketing messages while it focuses on growing the contract business and improving its retail distribution. We believe this should help stabilize the Virgin Mobile business late in Content business is a real question mark in the quarter; competitive fight with BSkyB brings lower revenues. The company's Content business, with Virgin Media Television and sit-up, has been the eye of the storm between Virgin Media and BSkyB, even in the face of other competitive issues between the two companies. On February 28 and March 1, BSkyB pulled its Sky 1 and Sky 2 channels from Virgin Media's network after Virgin Media refused BSkyB's demand for a 100% increase in the rights fees that Virgin Media pays to carry the channels. At the same time, Virgin Media signed a new two-year carriage contract with BSkyB for BSkyB's carriage of Virgin Media Television and sit-up which will result in a reduction of subscription revenue by 30.0mm in At the same time, the company is involved in a legal suit with BSkyB and has, in concert with other providers in the UK, gotten Ofcom to explore the competitive environment in the UK, given BSkyB's content dominance in the market and its ownership stake in ITV (ITV.L LSE). 3 MORGAN JOSEPH & CO. INC.

4 Additional details about off-net; Beyond Cable has a chance to be a big boost for Virgin Media. The company announced a renewed off-net strategy on its prior earnings call but provided few details about the business. What Virgin Media did highlight, however, was that it would sign a wholesale unbundling agreement that would give it access to the 4.3mm homes it does not pass and would give it the ability to deliver IPTV (Internet protocol television) in 2008 as the centerpiece of a full quadruple-play service offering. In addition, the agreement would allow the company to deliver VOD and DVR services that would more closely equate to its current cable offerings and be a significant upgrade to its current Freeview-based off-net service offering. We believe the agreement with a wholesale provider will be signed by the end of 2Q07 and believe such an agreement will allow the company to greatly improve its ability to market in the UK. In terms of the company's initial rollout of its new off-net strategy, Virgin Media added 10,000 net new broadband subscribers to reach a total of 271,000 while it added 21,000 net new telephony subscribers to reach a total base of 65,000. We believe the company's off-net strategy will be an important component of its long-term growth given that it will greatly expand Virgin Media's footprint and reach in the UK, and will help to mitigate the loss of customers who move away. 4 MORGAN JOSEPH & CO. INC.

5 Virgin Media, Inc. - Quarterly and Annual Income Statements E (in millions) 1Q06A 1Q06PFA 2Q06 3Q06 4Q Q07 2Q07E 3Q07E 4Q07E 2007E 2008E Consumer , , ,556.5 Business Revenue Content Revenue Virgin Revenue sit-up Revenue Total Revenues , , , , , , , , ,232.2 Exchange Rate ($/ ) $ $ $ $ $ $ $ $ $ $ $ $ Total Revenues ($) $1,071.5 $1,557.6 $1,615.2 $1,921.5 $2,072.1 $6,680.2 $2,001.7 $1,986.2 $2,013.5 $2,107.8 $8,109.1 $8,289.7 Yr/Yr Change in Revenue 22.8% NE 83.3% 112.3% 122.6% 2.1% 15.0% 14.7% 0.3% -0.5% 14.9% 2.2% Qtr/Qtr Change in Revenue 25.9% NE 44.6% 15.9% 5.5% NA -5.5% -0.8% 1.4% 4.7% NA NA Yr/Yr Change in Revenue ($) 14.0% NE 86.7% 122.9% 142.3% 1.7% 28.5% 23.0% 4.8% 1.7% 21.4% 2.2% Qtr/Qtr Change in Revenue ($) 25.3% NE 50.7% 19.0% 7.8% NA -3.4% -0.8% 1.4% 4.7% NA NA Cost of Revenue Total Operating Expenses , , ,715.5 Opex % of revenue 41.7% 41.5% 41.6% 42.9% 47.2% 43.7% 44.0% 44.0% 41.9% 41.0% 42.7% 40.5% Exchange Rate ($/ ) Total Operating Expenses ($) $446.7 $646.7 $671.2 $824.9 $977.8 $2,920.7 $880.0 $873.9 $843.1 $864.2 $3,461.2 $3,360.2 Selling, general and administrative exp , Exchange Rate ($/ ) Operating Costs $1,950.0 $2,000.0 $2,050.0 Selling, general and administrative exp. $277.1 $425.5 $408.2 $500.8 $494.6 $1,680.7 $522.8 $516.4 $513.4 $526.9 $2,079.6 $1,835.1 SGA as % of revenue (in US$) 25.0% 27.3% 25.3% 26.1% 23.9% 25.2% 26.1% 26.0% 25.5% 25.0% 25.6% 22.1% Other Exchange Rate ($/ ) Other Total Costs , , ,652.4 EBITDA , , ,579.8 EBITDA ($) $333.0 $469.9 $535.7 $595.7 $569.7 $2,034.2 $598.8 $595.9 $657.0 $716.6 $2,568.4 $3,094.4 % of Revenues 31.1% 30.2% 33.2% 31.0% 27.5% 30.5% 29.9% 30.0% 32.6% 34.0% 31.7% 37.3% EBITDA Growth 11.3% 64.0% 79.4% 92.6% 77.9% 64.8% 14.0% 3.7% 5.6% 23.0% 19.4% 20.5% EBITDA Growth ($) 3.3% 60.3% 82.8% 102.2% 93.6% 68.9% 27.5% 11.2% 10.3% 25.8% 26.3% 20.5% Depreciation ,075.9 Amortization Other Charges/Asset Impairments Operating Income (expense) Operating Income (expense) $ $6.8 ($1.6) $11.5 ($18.1) $17.6 $17.9 ($29.9) ($13.3) $45.9 $105.5 $108.2 $399.4 Operating Margin 0.6% -0.1% 0.7% -0.9% 0.8% 0.3% -1.5% -0.7% 2.3% 5.0% 1.3% 4.8% Interest Expense Interest Income Other Income (expense) (49.0) (43.2) (85.3) (107.9) 10.0 (2.5) (2.5) (2.5) 2.5 (10.0) Minority Interest (0.7) (1.0) (1.0) (1.0) (3.0) (4.0) Pretax Income (119.9) (147.4) (205.7) (105.1) (89.1) (519.8) (116.8) (121.3) (91.1) (60.6) (389.8) (231.5) Pretax Income ($) ($210.1) ($258.3) ($375.7) ($197.1) ($170.7) ($953.7) ($228.7) ($237.6) ($178.4) ($118.8) ($763.4) ($453.5) Pretax Income Margin NM NM NM NM NM NM NM NM NM NM NM NM Income Tax Income Tax ($) (6.9) (9.8) (9.8) (9.8) (36.2) (39.2) Net Income Net Income ($) ($210.1) ($258.3) ($357.6) ($195.4) ($168.8) ($932.0) ($235.6) ($247.4) ($188.2) ($128.5) ($799.6) ($492.7) EPS (Weighted average) EPS (weighted average $) ($0.86) ($1.05) ($1.24) ($0.61) ($0.52) ($3.23) ($0.73) ($0.76) ($0.58) ($0.40) ($2.46) ($1.51) EPS Growth NA NA NA NA NA NA NA NA NA NA NA NA Shares (weighted average) Source: Company reports and Morgan Joseph & Co. Inc. estimates 5 MORGAN JOSEPH & CO. INC.

6 Required Disclosures Rating and Price Target History for: Virgin Media Inc. (VMED) as of /14/05 I:Buy:$105 03/13/06 Buy:$42 10/12/06 Buy:$ Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix Price Target Our price target is $ Valuation Methodology We rate Virgin Media a Buy, with a 12-month $40.00 price target. Our price target is based on a 10.0% FCF yield on the combined entity, and we currently estimate the company trades at about a 16.4% yield on 2008E FCF. At our price target, the stock would trade at a 7.7x multiple of our 2008E TEV/EBITDA, below the levels where other leading cable and telecom operators in the US and Europe trade. We also used our DCF model to test the reasonableness of our comp analysis. Risk Factors The integration of two large businesses always carries extra risk. In addition, the move to create new marketing strategies may cause additional integration risk. The company's acquisition of Virgin Mobile could add to the integration risk. Virgin Media operates in a very competitive market for each of its three major services. Mobile services are beginning to take a bite out of fixed services. The combined entity will have a significant, but in our opinion manageable, debt burden. Currency fluctuations remain a risk. I, David Kestenbaum, the author of this research report, certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the specific recommendations or views contained in this research report. I, James Leahy, the author of this research report, certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the specific recommendations or views contained in this research report. Research analyst compensation is dependent, in part, upon investment banking revenues received by Morgan Joseph & Co. Inc. Morgan Joseph & Co. Inc. intends to seek or expects to receive compensation for investment banking services from the subject company within the next three months. 6 MORGAN JOSEPH & CO. INC.

7 Investment Banking Services/Past 12 Mos. Rating Percent Percent BUY [B] HOLD [H] SELL [S] Meaning of Ratings A) Buy means reasonable outperformance relative to the market over months. B) Hold means market-type risk adjusted performance; potential source of funds. C) Sell means expected to underperform the market. Other Disclosures The information contained herein is based upon sources believed to be reliable but is not guaranteed by us and is not considered to be all inclusive. It is not to be construed as an offer or the solicitation of an offer to sell or buy the securities mentioned herein. Morgan Joseph & Co. Inc., its affiliates, shareholders, officers, staff, and/or members of their families, may have a position in the securities mentioned herein, and, before or after your receipt of this report, may make or recommend purchases and/or sales for their own accounts or for the accounts of other customers of the Firm from time to time in the open market or otherwise. Opinions expressed are our present opinions only and are subject to change without notice. Morgan Joseph & Co. Inc. is under no obligation to provide updates to the opinions or information provided herein. Additional information is available upon request. Copyright 2007 by Morgan Joseph & Co. Inc. Morgan Joseph & Co. Inc. 600 Fifth Avenue, 19th Fl New York, NY Tel Fax Sales and Trading New York Tel Fax Pittsford Tel Fax MORGAN JOSEPH & CO. INC.