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Shaw Communications Inc. (SJR.b, Toronto SJR, New York)
RESEARCH SUMMARY
Report Author(s):	InvestorsFriend Inc. Analyst(s)
Author(s)' disclosure of share ownership:	Author(s) do hold shares
Based on financials from:	Aug. '06 Y.E.
Last updated:	27-Oct-06
Share Price At Date of Last Update:	$34.90
Currency:	$ Canadian
Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice):	Speculative Buy rated at $34.90
DESCRIPTION OF BUSINESS: For 2005, 72% of revenues are from cable TV division (Cable and high speed internet over cable and telephone over internet), concentrated in Western Canada. About 28% of revenue is from satellite TV. subscriptions and related services. In satellite, its Starchoice brand competes with the other large national provider in Canada, Bell-Express VU. (Updated Q4 2006) Shaw has 2.19 million cable customers, 1.31 million internet customers and 0.669 million digital cable customers. 0.869 million satellite customers. Cable penetration is 66.3% of homes passed, internet penetration is extremely high at 60% of basic cable. 31% of cable customers take digital cable. Has 8200 employees
RATING: The graph shows that sales have increased strongly over the years but earnings have had negative years. The value ratios do not seem attractive but this may be due to conservative accounting rules. It has the type of assets that could potentially generate substantial free cash flows and growth going forward. Insider trading / holding signal is positive. Also profits, which had been low, have been rising very sharply. Buffett tenets are only marginal. In operations and marketing it appears to be doing very well. Has strong competitive advantage in cable and also internet customers will tend to be sticky. The company has bought back a very large amount of its shares and sharply increased the dividend and this is a positive indication. Revenues and subscriber counts are growing rapidly. We have some concern about arguably excessive executive compensation, which makes us wonder if we can trust management. Placing significant weight on subscriber growth, the insider buying and the existing cash flow and probable future increase in cash flow, we rate this a (Speculative) Buy. The chief danger would be intense competition with Telus but we note that competition appears to be relatively disciplined so far. Barring a severe price war there is probably little downside risk in this stock if held for at least two years. There is also the possibility of a take-over or a conversion to an Income Trust. It is speculative because it requires strong growth to justify its price.
RISKS: The company indicates that risks include competition, technology changes, regulatory changes. To their list of risks we would add the risk that management will make bad investments, pay excessive executive compensation and that it could treat the subordinate voting shareholders poorly. The biggest risk is probably of intensified competition with Telus. See annual report for a full discussion of risks.
INSIDER TRADING / INSIDER HOLDING: Insiders have bought heavily in the past 18 months or more. Surprisingly JR Shaw has increased from 12.8 million shares to 16.45 million from 2004 to 2005 (JR does not appear to have purchased above $24). Ron Joyce increased from 5.9 million to 7.1 million shares (most recent purchase 200,000 in February 2006 at $31). Jeff Royer has 550,000. This is a very positive signal. Bill Yuill has about 2.9 million. It appears that Bradley Shaw and CEO Jim Shaw reduced holdings in the past year. For other executives , checking from January 1, 2006 to October 27, 2006, there were only a few trades "in the market". We noted five insiders selling at about $29 to $33 only Ron Joyce had bought shares in that period, in the public market. A large number of insiders were holding positions and not selling in this period. Overall, a positive insider ownership and trading signal.
WARREN BUFFETT's TENETS: (See Robert Hagstrom's book - The Warren Buffett Way) - Should be relatively simple to understand but seems to have very complex accounting (marginal pass), acceptable recent net profit history after many years of low GAAP earnings (marginal pass), prospects for above average returns due to incumbent position, high growth and eventual realization on capital spending (pass), Management seems highly competent but we are bothered by past mistakes and the arguably excessive executive compensation (marginal pass), historically low ROE but recently acceptable (marginal pass), high gross profits on sales (pass) , not a low debt ratio (fail), probably little chance of permanent loss of capital (pass) theoretically a low level of maintenance type capital spending required to maintain existing operations excluding growth - but this is not yet fully demonstrated (marginal pass) and not clearly selling at a discount to intrinsic value (no opinion).
MOST RECENT EARNINGS AND SALES TREND: After three years of large losses the company was profitable in the latest three completed fiscal years. Earnings are trending up very sharply but from a low level.
VALUE AND GROWTH RATIOS: Normally we focus on earnings or adjusted earnings to calculate value ratios. In this case the accounting seems too conservative and we include measures based on free cash flow. The price to book ratio is relatively high (unattractive) at 4.15, although book value may be grossly understated due to the accounting. The dividend yield is now attractive at 2.9% after recent sharp increases. In this case net income included substantial unusual gains and so we focus on the much lower adjusted net income. The adjusted P/E is very high at about 36 - but has been reducing as earnings improved sharply . The price to free cash flow ratio seems high at 29, however free cash flow deducts growth oriented capital spending and therefore is under-stated. The adjusted Return on equity in 2006 improved to an acceptable level of 12.4% and has been increasing rapidly. Most of these ratios would indicate a sell rather than Buy rating, however accounting issues may be distorting these ratios in an unfavorable way.
SUPPORTING RESEARCH AND ANALYSIS
Symbol and Exchange:	SJR.b, Toronto SJR, New York
Currency:	Canadian $
Category:	Growth
Contact:	0
Web-site:	www.shaw.ca
INCOME AND PRICE / EARNINGS RATIO ANALYSIS
Latest four quarters annual sales $ millions:	$2,459.3
Latest four quarters annual earnings $ millions:	$458.2
P/E ratio based on latest four quarters earnings:	16.6
Latest four quarters annual earnings, adjusted, $ millions:	$211.8
BASIS OR SOURCE OF ADJUSTED EARNINGS: Although net earnings may not be very relevant due to accounting issues, for most periods we have no basis on which to calculate an adjusted earnings. Also we note that more recently the net impact of items that are of a one-time nature was not very material. Prior to an accounting change in 2006 we used net earnings to common after deducting equity entitlements rather than reported net income. In 2006 we used management's figure for adjusted earnings.
Quality of Earnings Measurement and Persistence: For a variety of reasons the earnings figures seem unreliable as an indication of "normal'" or sustainable earnings (although this has improved in recent quarters). On the plus side, free cash flow significantly exceeds net income. Also the accounting seems to be improving. In the past several quarters management has given a view of adjusted earnings. Items which affect the reliability of earnings include significant deferrals of revenues and expenses associated with new customers, arguably under-stated stock option expense, foreign exchange impacts, the deferral of most income taxes and other complexities as well.
P/E ratio based on latest four quarters earnings, adjusted	35.9
Latest fiscal year annual earnings:	$458.3
P/E ratio based on latest fiscal year earnings:	16.6
Fiscal earnings adjusted:	$211.7
P/E ratio for fiscal earnings adjusted:	35.9
Latest four quarters profit as percent of sales	8.6%
Dividend Yield:	2.9%
Price / Sales Ratio	3.09
BALANCE SHEET ITEMS
Price to (diluted) book value ratio:	4.15
Quality of Net Assets and Book Value Measurement: The largest asset is intangible broadcast licenses followed by property plant and equipment. In the cable business these assets are probably worth substantially more than their book value. With the shares trading at over 4 times book value, the asset value provides little cushion to the share price in the event that earnings and cash flow are inadequate. Liabilities include $1.1 billion in future income tax liabilities but we consider this to be a soft liability given that the company is continuing to grow this balance and this liability will probably not have to be paid for many years. Another $600 million "liability" appears to consist mostly of deferred revenue and this may also effectively be partly equity in substance. We are increasingly of the opinion that the past accounting income and net book value has been conservative to the point of being of little reliability.
Number of Diluted common shares in millions:	214.9
Controlling Shareholder: Controlled by founder J.R. Shaw and family who controls 78% of the voting shares. The trading shares are non-voting.
Market Equity Capitalization (Value) $ millions:	$7,501.5
Percentage of assets supported by common equity: (remainder is debt or other liabilities)	24%
Interest-bearing debt as a percentage of common equity	167%
Current assets / current liabilities:	0.4
Liquidity and capital structure: Fair to good. The company now appears to be generating substantial positive free cash flow. However, the debt level is relatively high. Recently they issued notes at 6.1%. This is indicative of moderately higher risk.
RETURN ON EQUITY AND ON MARKET VALUE
Latest four quarters adjusted (if applicable) net income return on average equity:	12.4%
Latest fiscal year adjusted (if applicable) net income return on average equity:	12.4%
Adjusted (if applicable) latest four quarters return on market capitalization:	2.8%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE
5 years compounded growth in sales/share	10.0%
Volatility of sales growth per share:	Exhibits huge growth
5 Years compounded growth in earnings/share	negative past earnings
5 years compounded growth in adjusted earnings per share	-206.5%
Volatility of earnings growth:	Highly volatile
Projected current year earnings $millions:	not available
Projected price to earnings ratio:	not available
Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share?	No
	No
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained:	-0.2%
More conservative estimate of compounded growth in earnings per share over the forecast period:	9.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period:	15.0%
OUTLOOK FOR BUSINESS: The outlook is probably very positive. Capital spending had declined moderately for fiscal 2004 but was increased for 2005 and 2006, but still well down from 2001 and 2002 levels. The company is likely to be more careful with acquisitions in the future (it has made unwise acquisitions in the past). Digital cable, Video-on-demand and pay-per-view are likely to be fast growing and profitable areas. Although continued high capital spending will decrease free cash flow, these appear to be good investments, although profitability on the digital phone service is not disclosed. There may be some risk of a price war with the telcos, but so far we see no sign of that.
Estimated present value per share: There is no basis for this calculation due to past earnings volatility and lack of earnings guidance from management.
ADDITIONAL COMMENTS
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. Has very high barriers to entry in cable and satellite, although there are alternative technologies including telephone. (pass). no issues with powerful suppliers (pass). no issues with dependence on powerful customers (pass), limited potential for substitute products (marginal pass) some tendency to compete ruinously on price (marginal pass at best). Overall this industry appears to be moderately attractive on this basis.
COMPETITIVE ADVANTAGE: The company's cable TV. service has enormous advantages as the incumbent. In regards to cable it is a near monopoly although customers can also subscribe to satellite services and telephone companies are just starting to offer TV. The company is also in the satellite business and there is only one other major competitor in satellite service. They appear to have a strong customer service focus, with same-day and next-day service.
RECENT EVENTS: Increased the dividend from 60 cents per year to $1.00 per year in October 2006. Fiscal 2006 subscriber growth was strong with 139,000 net new internet customers (total 1.31 million for a huge 60% penetration of basic cable. There were 41,000 new cable customers, and 71,000 more cable customers took digital service. 25,000 new satellite customers in 2006 and 156,000 new phone customers. Total cable customers are 2.19 million of which 670,000 are digital. Have started offering a cable-based phone service and so far acquired 213,000 customers. Total of 869,000 satellite TV customers.
ACCOUNTING AND DISCLOSURE ISSUES: (Based mostly on 2005 annual report) There are a number of very complex accounting issues. The accounting for this company has led to a very distorted and muddied view of reality. Thankfully some changes for the better have been made for 2006. However, the balance sheet includes a huge $1.03 billion deferred credit. This credit, presented as a liability appears to consist of largely deferred revenue items. Possibly much of this is in substance equity but it is difficult to decipher. However about $412 million of it is a deferred hedge loss, equivalent to debt. Shareholders Equity based on U.S. GAAP was 33% lower at the end of fiscal 2005 which also illustrates some complex accounting issues. I believe that the option compensation cost based on $0.815 or $2.55 per option (depending which figure I look at) for 10 year options is grossly understated, given that 5 month at-the-money options recently traded at about $2.00. The company has apparently recognised only $26 million of a $100 million obligation for executive pensions. It is unfortunate that management did not provide net income guidance for 2007.
COMMON SHARE STRUCTURE USED: Unfortunately, the trading shares are non-voting. This is a negative factor.
MANAGEMENT QUALITY: Operationally it appears that management is very strong. But financially the management has a mixed record. While growth and technology appear very strong, the company had written off huge amounts in bad investments and assets in each of 2001,2002, and 2003. Management tends to focus on figures akin to EBITDA rather than on net income per share. The fact that management allowed the financing to become so complex is a concern. The arguably excessive executive compensation and executive pensions does not give us a good feeling regarding fair treatment of shareholders. On the other hand, overly conservative accounting rules are contributing to the apparent lack of sufficient profitability. More recently profit is much improved and perhaps those write-offs are ancient history. Accounting is also improving as some complex "equity instruments" have been retired. Overall, our view of management is improving but remains cautious.
EXECUTIVE COMPENSATION: I believe that executive compensation has been excessive, although as profits have improved in recent years it becomes less of an issue. In particular, I view the non-executive chairman's bonus of $6.3 million as excessive. This bonus was on top of a $900,000 salary. Apparently the huge bonus is payable to JR Shaw as a result of a contract - reminds me of the Magna situation although not as bad. In fact JR did cap the bonus at $6.3 million, it could have been about to $8 million under his contract. The contract allows JR to collect 1% of (essentially EBITDA) as a bonus. I guess shareholders should be grateful the contract did not call for 2% - there seems to be little to stop any company from handing out huge bonuses. The CEO's bonus of $4 million plus 850k salary is hefty but perhaps not obscene given the performance. The company has what I consider to be an obscenely generous executive pension plan that cost $9.2 million in expenses in 2005. Jim Shaw is apparently eligible for a pension of $3.4 million per year!
BOARD OF DIRECTORS:(updated April 2006) 14 members including 3 family members. The family members and 5 of the non-family directors own very substantial amounts of shares. An impressive board and the high share holdings of the non-family members should align their interests with those of ordinary shareholders.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company's growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are "generic" in nature and do not take into account the unique circumstances and risk tolerance of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend Inc. itself does not have a position in any of the indicated securities while the authors may have a position.
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