Is Virgin Media vulnerable to takeover?

The face of Virgin Media's 2007 numbers, however much make-up is slapped on, isn't looking its best. In a year that's seen the company lurch from an expensive rebranding, to a public bust-up with the Murdochs and Sky, right through to an on-off potential sale, the stark truth is that Virgin Media's customer base is smaller than it was back in January, and profits have been severely hit.

In the first quarter of 2007, Virgin Media posted a loss of £15.3m. Things then got better on the balance sheet, with the Q2 numbers ending with a £3m operating profit, but even that was less than half last year's equivalent point (although it broke a period of seven continued quarters of loss). Worryingly, in that same quarter, the company shed over 70,000 customers, putting 40,000 of those down to its public spat with Sky which resulted in the removal of the likes of Sky One from the Virgin Media cable channel line-up.

A further liberal dose of salt has then been applied, as it seems the majority of customers who have migrated elsewhere were those who were taking three of the company's services, and that's brought the average amount that Virgin Media earns from each of its customers down from £42.75 to £42.16. Widely reported problems with customer service are believed to be one of the contributory factors.

Ready for sale?

Yet it's been little secret that Virgin Media is a goose being fattened up for sale. Itself effectively born out of a collection of merged companies, including NTL, Telewest and Virgin Mobile, Virgin Media was approached in June by the Carlyle Group, a Washington-based private equity business.

As was extensively reported at the time, the Carlyle Group was interested in a takeover bid valued around the $10-11bn range. Furthermore, that enquiry sparked other potential buyers into action, and a queue quietly formed of potential businesses that liked the idea of a communications giant on the asset register. Most agree that the likes of broadband and mobile phone communications will be a cash cow for many, many years to come, and the sale of Virgin Media offers a rare opportunity for latecomers to the bandwagon to jump firmly on board, with a company that's potentially far from its ceiling.

Thus, an auction was the likely next result, with Goldman Sachs and UBS brought in to evaluate the offers and options open to Virgin Media. It soon became a case of just how high could that price tag potentially go.

Problems

After the Q2 results came in, Virgin Media's stock price valued it at closer to $7.5bn. The likes of Moody's Investors Services then moved its view of Virgin Media's credit rating from stable to negative, arguing that since the Virgin Media group was put together, it had failed to live up to financial expectations. The company's biggest shareholder, Richard Branson, is believed to agree.

External forces then took a role of the dice, too. The significant rumbles in the stock market over the summer, having already hampered more than one potential major deal (Cadbury-Schweppes and the re-financing of Manchester United's takeover debt, for instance), look set to claim Virgin Media's sale as a casualty too. With uncertainty surrounding the future of the debt markets, it's proven not to be the right time to mount a multi-billion dollar sale. Certainly it's believed to have thrown private equity firms off the scent, with the volatility of the markets loosening their ability to raise the necessary monies needed to procure the Virgin Media business. The fact that Virgin Media has over £5bn of debt on its books is also a major contributory factor.

As a result, Virgin Media has subsequently announced that a strategic review - or, in this case, code for putting the business firmly in the shop window - was being delayed. It seems Virgin Media has little choice but to ride out the storm, at least for the time being, and this was confirmed when it confirmed that the planned deadline for the first round of bids for the business - due in August - had been pushed back, with no definite new date on the horizon.

Turnaround?

There's at least one school of thought though that argues this could very much play in Virgin Media's favour. Believe the rhetoric coming from Steve Burch at the start of August, and the then-chief executive was certainly beating the right drum. Talking in The Telegraph of "encouraging mobile and broadband growth", he concluded that "further merger benefits mean the cash outlook for the rest of the year and beyond remains strong".

And you could see the point. The Sky rumpus, while not without public relations benefits, had proven costly, but its impact was always going to be finite. Likewise, the real benefits of a four-pronged communications offering weren't going to instantly deliver overnight, not least with the infrastructure of large companies needing to be bolted together in a coherent way.

It's worth remembering too that Virgin Media is in the process of suing BSkyB over claims of abusing its position in the market (and that's before the small matter of BSkyB's investment in ITV is dealt with, that all but scuppered Virgin Media's plan to bid for the terrestrial broadcaster), and if rulings come down in Virgin's favour, that's not going to do the share price any harm at all.

So Burch's arguments certainly had credence to them, even accepting the need to paint a smile on the sternest of faces. And then, on Tuesday 21 August, Burch suddenly and abruptly quit, citing "family and personal reasons". Company denials that Burch's move was related to the sale process failed to pour water on the inevitable flames. He had been in post for just 19 months.

In his place steps Neil Berkett, formerly Virgin Media chief operating officer, and now interim chief executive. His job is clear - to jolt the sale process back into life, and get Virgin Media back on track. Again, he's making the right noises, talking about his desire to earn the job full time, but it appears he has quite a job.

Vulnerable?

And so we come back to the question we started with: is Virgin Media vulnerable to takeover?

Obviously, to a degree it's a moot point, given that Virgin Media has been fairly obviously courting offers for its business. Perhaps the real question should be is Virgin Media desperate to be taken over? Because if the strategy for the last six months has been to put the business in a sellable state, then that's going to have some form of repercussion if said strategy then needs to be adapted to hold out for the right price to be attracted.

While amalgamation of reportedly still-disparate component parts is clearly on the Virgin Media agenda, rarely does a business up for sale invest heavily in itself, and one school of thought is that that's what Virgin Media needs to do. That said, recently reported plans to roll the brand out across Europe offer much-needed positive noises.

So let's adapt the question further. As the deadline for first bids has been moved to an undecided future date, which many speculate will not be soon, how long realistically can Virgin Media keep itself in a sellable position? Or, more succinctly, how long before the market turns again in its favour?

The predictions are reasonably gloomy, with a good number of pundits expecting choppy times in the debt markets for some time yet to come. What's perhaps most damaging to Virgin Media is the sheer uncertainty; a stable market, even if borrowing isn't quite as cheap as it has been, would at least give the private equity firms who are circling Virgin Media the leveller playing field that they need to stack up the required funding.

And it's private equity firms who are the prime candidates for Virgin Media. The Carlyle Group, as was widely reported, triggered the current sale process, and subsequently names such as Providence Equity Partners, Liberty Media, Permira, Apax, Kohlberg Kravis Roberts & Co, Cinven and the Blackstone Group have been linked with a potential bid. The majority, if not all, of these names have, unsurprisingly, been hit by aforementioned issues with the market.

Sale or no sale?

This has, ultimately, led to a deep-seated suspicion among some shareholders of Virgin Media that their suitably fattened goose - and a $10bn+ potential asking price, as was the case just a month or two ago, is some goose - may not be sold off after all. Much though many investors chase communications stocks, the stability in the marketplace for such a big deal is most certainly lacking, and even those still inclined to pursue a transaction simply don't have the resources in the locker to close one, nor the ability to attract what they need to do so.

So this is a story that, thus far, has an uncertain end. The current scenario sees Virgin Media in a little bit of a limbo, with an interim boss, a rapidly cooling sale and an increasing tough marketplace.

There's little doubt that Virgin Media will ride out the latter, but the chances are it may come out in less impressive shape. And that $10bn price tag may just be a pipe dream as a result. The next few months could very well be crucial.

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