Virgin Media Back on Track

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Virgin Media (VMED) had a tougher than expected 2011 as the crisis in Europe included the UK economy. In addition, competition picked up as all of the company’s cable, satellite, and telecom competitors responded aggressively to the macro weakness. This environment led VMED to increase capital spending amid discounting form some competitors while its own subscriber growth slowed. Investors worried this was the beginning of period of slower growth and profitless prosperity for VMED as the company would need greater capital and marketing investment merely to maintain the current business model.
I was patient with VMED even as the stock slid from the low $30s to the low $20s because the excellent management team realizes the company maintains a key competitive advantage: the best broadband network in the UK. Earlier in 2012, the company clarified its capital spending plans and the stock appeared to bottom. Coinciding with its earnings report yesterday, management provided a complete strategic update that further explained how the company would sustain growth in operational and financial measures. The plan is to invest in the network by upping broadband speeds and enhancing the cable TV experience with Tivo’s (TIVO) best in class user interface.
This is exactly what I have thought the company should do. It is following a similar approach to DirecTV DTV) by focusing on higher end customers. In addition, VMED is offering a clear upgrade path for its customers to entice them to buy more services and move to higher priced offerings. The focus on broadband is something that is beginning to occur in the US cable industry. Broadband internet is taking over from cable TV as the lead product. Investors do not appreciate this shift or cable’s clear leadership and competitive advantages in broadband.
VMED’s new strategy should produce better growth beginning this year while maintaining the high free cash flow generation that supports aggressive share buybacks. I think the stock can head back to the low to mid-$30s, especially if worries about Europe’s economy begin to recede.
Disclosure: VMED is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a long only registered investment advisor. VMED, DTV, and TIVO are net long positions in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, a long/short equity hedge fund focused on media, communications, and related technologies. Steve also owns a stake in Entermedia’s investment management company and has personal monies invested in the
Funds.

Small Cap Back in Favor

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For the first time in 13 months, Northlake’s Market Cap model has a new signal. Beginning February, 2012, the model favors small cap. As a result, Northlake client holdings dedicated to the model have sold the S&P 400 Mid Cap (MDY) and proceeds were reinvested into the Russell 2000 (IWM). There were no changes to the Style model, which continues to strongly favor growth. Positions in the Russell 1000 Growth (IWF) will be maintained for at least another month.
As is often the case when the model signal shifts, the new small cap reading is a weak one. Bear in mind that there is often volatility in the signals as they transition so a shift back to mid cap next month is possible. However, barring a significant market setback that impacts the technical indicators, I do not expect that to occur.
The shift to small cap is primarily the result of the same technical indicators. Several months of a strong market rally has been led by small caps. The expanding breadth of the rally generally portends more rally lies ahead and continued strength for small cap stocks. The model also reflects improving U.S. economic performance. Small caps generally do well in the early stages of economic expansions as investors look to be more aggressive and corporate profits improve.
The expired mid cap signal did not produce excess performance but did not meaningfully lag the market. Over the 13 months, MDY gained 3.7% against an increase of 4.4% for the S&P 500.
Looking just at January 2012, the mid cap signal performed well, with MDY up 6.6% against a gain of 4.5% for the S&P 500. The Style model is also off to a good start in 2012. Growth was up 6.1% last month against 3.9% for value. After struggling in 2011, it is good to see the models on track again.
Disclosure: IWM and IWF are widely held by clients of Northlake Capital Management, LLC. MDY is held in select Northlake client accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. IWM is a net short position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in the funds’ investment management company, and has personal monies invested in the Funds.