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CARS REVIEW - Carlyle Courts Virgin Media


Heavily indebted, hemorrhaging customers, and in dire need of some managerial TLC, British cable company Virgin Media (VMED) may have found the solution to its problems in a $23 billion takeover bid from Washington (D.C.) private equity giant The Carlyle Group. The offer for Virgin Media, which has appointed Goldman Sachs (GS) to assess its options, could spark a bidding war with other private equity players such as Providence Equity Partners and potentially even rival media and telecom companies waiting in the wings.

Virgin Media confirmed on July 2 that it had received a "proposal" from an undisclosed company to take full control of the Nasdaq-listed company, sending its shares up nearly 18%. The stock was up another 1% on July 3, to $29. Virgin Media and Carlyle declined to comment on the offer, but sources familiar with the deal say Carlyle first approached Virgin Media Chairman Jim Mooney several weeks ago.

If successful, the deal could rank as the largest private equity buyout in British history (topping Kohlberg Kravis Roberts & Co's $22.4 billion takeover of pharmacy chain Alliance Boots, which was sealed on June 26) and would earn British serial entrepreneur Richard Branson and Virgin Media's other shareholders a tidy windfall. The estimated offer price of $30 to $35 per share would value the company at up to $11.3 billion, but any buyer also would have to take on Virgin Media's estimated $12 billion in debt.

A Better Offer?

Analysts expect Branson will maintain some stake in the new venture in order to protect the Virgin brand. Yet cashing out might prove tempting, as Branson's 10.1% stake could be worth as much as $1.1 billion, a hefty premium to the $27 per share he spent.

It's also the second time in a year that buyout shops have stalked Virgin Media. An offer last summer from a consortium of firms led by Providence Equity Partners failed when its bid—said to have totaled $20 billion including debt—was deemed too low. This time around, Virgin has more reason to accept. Formed last July from the merger of Virgin Mobile and British cable company NTL-Telewest, Virgin Media became Britain's first "quadruple play" telecom group, offering cable TV, broadband Internet, and fixed-line and mobile phone services in one package (see BusinessWeek.com, 12/06/05, "Why NTL Likes Virgin").

Its aim was to challenge what Branson deemed the "dominance" of Rupert Murdoch's British Sky Broadcasting's (NWS) satellite platform. The company spent $50 million on an ambitious rebranding campaign starring Uma Thurman, and a further $20 million to improve customer service.

Getting Along With Others

But all that hasn't been enough to stave off one setback after another in recent months. Squeezed by intense competition from BSkyB and numerous broadband providers, Virgin Media has struggled to add new subscribers. Its reputation took a bruising last December when it tried to buy British broadcaster ITV, only to be rebuffed when BSkyB bought a 17.9% stake in the terrestrial broadcaster.

Relations with BSkyB further deteriorated in March after Virgin refused to pay higher rates to carry Sky's popular news and sports channels over its cable network. BSkyB responded by pulling the channels from Virgin, helping spark a loss of 47,000 subscribers in the first quarter (see BusinessWeek.com, 04/12/07, "The Battle of Britain").

"Bringing together three disparate entities [Virgin, NTL, and Telewest] into one was always going to be a long and difficult task," says analyst Mike Cansfield of London-based telecom researcher Ovum. Little wonder Virgin Media's management is more open to takeover the second time around.

A Welcome Change

The deal also is expected to face less institutional resistance than before. A year ago, Bill Huff, chief investment officer of W.R. Huff Asset Management, opposed the Providence-led approach as inadequate. But he has since reduced his stake in the company to less than 5% and his influence on Virgin Media's board has declined proportionately.

Another activist investor, New Jersey's Franklin Mutual Advisers, also might welcome a change in ownership at the right price. After Virgin Media warned in April of continued subscriber losses, Franklin, which holds 9.4% of the company, demanded discussions about its "strategic direction, corporate governance, and management."

So what does Carlyle see in a struggling, heavily indebted cable company? For starters, Virgin Media offers a steady flow of cash from its more than 10 million customers. Private equity investors also apparently think they can make a better go of quadruple-play than a public company could. Away from the glare of impatient shareholders, they'll be able to make the heavy investments still required to upgrade Virgin Media's customer service and improve its content.

Big Tax Benefits

More importantly, spared from the quarterly earnings pressure of the public markets, they can better weather likely losses. (see BusinessWeek.com, 07/03/07, "Up Next for Buyouts: Cable TV"). In a recent note to investors, JP Morgan (JPM) speculated that a Virgin Media buyout priced at $30 a share could offer a return of up to 20% over a five-year holding period.

But some analysts reckon that Virgin Media's real value is in its massive tax losses, accumulated from years of spending heavily to dig up roads and lay cables with no immediate return. Virgin Media has more than $24.1 billion of unclaimed capital allowances, which could be used to offset the profits from another British company that is part of the same group. J.P. Morgan estimates that at least $3 billion of tax benefits from a Virgin buyout could be applied almost immediately after any takeover.

Still, any buyer must beware: Cable in Britain is an entirely different business from elsewhere. In the U.S. and some parts of Europe, it's the most popular form of pay TV. But in Britain, cable has been slow to catch on, thanks to the continued dominance of terrestrial broadcast TV—buttressed by the recent successful rollout of over-the-air digital TV—and a strong satellite play.

Cable take-up in Britain hit its highest level in almost five years in March, according to Ofcom, the communications watchdog, reaching 13.4% of all homes. But that number still pales in comparison to the 30% market share enjoyed by satellite broadcaster BSkyB. It makes you wonder whether Virgin's worth $23 billion.

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