Time's Parting Gift: Debt

Pity the folks at Time Warner Cable Inc. They've been looking forward to being free of their lumbering parent Time Warner Inc. They just didn't realize they'd have to pay a king's ransom to win that freedom. As Time Warner unveiled details of how it will carve off its big cable arm, analysts and investors were shocked to see that Time Warner Cable will have to borrow $10.9 billion to fund a special one-time dividend of $10.27 a share. The dividend will be payable just before the cable company is cut loose from Time Warner Inc. While some investors will share in the loot, 84% of the money -- or $9.25 billion -- will go into the coffers of Time Warner, for it to spend as it pleases. Investors had expected some kind of dividend to be paid ahead of the spinoff. But by being so generous to itself, Time Warner will leave its cable business weighed down with $24 billion in debt. That's equivalent of leverage -- the ratio of its debt to the past 12 month's earnings before interest, taxes deprecation and amortization, or Ebitda -- of 3.75. Time Warner Cable's internal target is 3.25. It's also higher than most of Time Warner Cable's main peers and rivals. Comcast Corp., the No. 1 cable operator by subscribers, has a ratio of 2.3, while Verizon Communications Inc. has 0.8 and AT&T Inc. is at 1.3, says John Hodulik, an analyst at UBS. Satellite-TV operator DirecTV Group Inc. has even lower leverage of 0.65, although the company is levering up to buy back stock. At the other end of the spectrum is Cablevision Systems Corp., the Dolan family-controlled cable operator that has a leverage ratio of about six, estimates Mr. Hodulik. But few on Wall Street see Cablevision as a model for financial engineering. Few worry that the company can make the payments on its debt load, because cable companies have been cash-flow machines. Time Warner Cable believes it can get its leverage ratio down to 3.25 by the end of 2009. But the debt will limit its ability to do deals or roll out new services. And growing competition from Verizon and AT&T -- which are rolling out high-speed fiber-optic networks -- might cause an exodus of customers, hurting the company's cash flow. That's the reason Comcast is deliberately keeping leverage low, despite grumbling from shareholders who want a big stock buyback.