JPMorgan Upgrading Time Warner Telecom to Neutral

Analyst Mike McCormack upgrades the stock to neutral from underweight after a strong 3Q

We are upgrading shares of tw telecom from Underweight to Neutral following third quarter results. Performance in the quarter demonstrated management's ability to support margins even as the economy continues to pressure revenue performance. With shares down nearly 55% from mid-July, we think downside is significantly more limited given relative valuation, even with the prospect for continued macro deterioration.

• Enterprise growth drops further. Enterprise revenue grew 1.6% sequentially, a drop-off from the 3.6% growth last quarter and the lowest level in years. Results were attributed to timing of installations and revenue churn as well as economic pressures. Though revenue churn remained flat, at 1.2%, churn early in the quarter contributed to a larger loss of revenue. Customer churn also held steady, but remained at elevated levels, as smaller Xspedius customers and mortgage-related firms continue to disconnect service. Management sounded cautious, expecting churn levels to remain near current levels going forward.

• Cost cutting drives margin improvement. EBITDA of $102.6M beat our forecast by more than $2M despite slower revenue growth. Results were driven by a $4M sequential decline in SG&A, driven by operating efficiencies, cost synergies, and a lower headcount. Though results benefited from a $2M favorable tax settlement, this was offset by an equal increase in bad debt expense. Margins reached 35.2%, the highest level since mid-2006.

• Upside limited. To be clear, with trends likely to remain difficult for a prolonged period, we do not believe significant upside exists for the shares. We are introducing a December 2009 price objective of $8 based on a DCF analysis which assumes a 12.0% WACC and a 4.5x terminal EBITDA multiple, slightly lower than the peer group average but justified, in our view, due to the higher level of enterprise exposure.