Laura Martin: Real Options and the Cable Industry

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Laura Martin: Real Options and the Cable Industry

Introduction

Laura Martin, an equity research analyst for cable stocks, believes that the best way to value cable stocks is through creative methods such as real options and not through more traditional or typical valuation methods such as EBITDA multiples, ROIC analysis and DCF analysis. In 1999 she presented at the Credit Suisse First Boston Broadband conference, where she wanted to portray the message that real options is a superior valuation technique for cable stocks. She also wanted to have the opportunity to demonstrate her knowledge of the drivers of value in the cable industry.

The main reason why Laura Martin argues that real options is the correct method for valuing cable stocks is mainly driven by the evolution that this industry was experimenting. In this time period, cable companies were upgrading their cable infrastructure to have 750 MHz of bandwidth capacity, which left unused bandwidth capacity that could be used for other interactive services or services that didn’t exist at the moment. Laura Martin felt, and with reason, that the EBITDA multiplier and the DCF analysis did not account for this possible revenue stream which she named “Stealth Tier”. Her analyses led to a higher stock value using the real options method and lower values using the traditional methods aforementioned.

EBITDA, ROIC, DCF analysis

Studies demonstrate a correlation between value and returns on invested capital – which is stated in the case at 70%. This implies that future ROICs are predictive of value. ROIC is calculated by dividing net operating profit after taxes by the average invested capital for the period (sum of fixed assets and net working capital). The relationship between the ROIC and the valuation of cable and entertainment companies is defined by the ratio of enterprise value to average invested capital. By predicting the ROIC for the year, a regression line is used to estimate the target

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