Its bad, but it could be worse
By John Higgins -- Broadcasting & Cable, 10/22/2000 8:00:00 PM
Ask cable operators what's at the top of their list of financial worries, and they don't cite drought of mergers, the IPO market or climbing interest rates.
"I'm worried about all of us executing," said the CEO of one MSO, echoing the private sentiment of many industry executives.
Operators have so heavily touted the financial promise of all the new video, data and telephone products their upgraded systems can deliver, the market is transfixed on the smallest signs of problems and will freely hammer all operators for the flaws of one. Cox Communications proved that when a tiny, tiny $3 million problem sank all cable stocks after the end of the second quarter.
At the same time, clear delivery on promises about new "revenue-generating units," operators 'parlance of the day, could immunize MSOs from the anxieties plaguing Internet start-ups, TV stations and failing competitve local-telephone companies.
While cable stocks have gotten hammered along with the rest of the market in recent months, there are bits of good financial news. MSOs generally took full advantage of the favorable equity and debt markets of the past two years and raised enough money to complete the system rebuilds so important to adding new products, staving off competition from digital broadcast satellite, and growing cash flow.
"I've never been more bullish about the business," said Time Warner Inc. Chairman Jerry Levin. His cable operations, along with those of Charter Communications, have generated strong, stable cash-flow growth over the past two years and are starting to put up strong numbers on digital cable and high-speed Internet. "The margin on these things is incredible," Levin said.
Cable stocks haven't been battered as badly as Internet issues, but MSOs have little to brag about. The Broadcasting & Cable/Bloomberg cable index is off 30% for the year vs. 58% for Internet stock. But the S & P 500 is off just 8%, and even the battered Nasdaq Composite has fallen only 20%.
That's a stark contrast to last year when four MSOs went public, raising $4 billion, and everyone used inflated shares as currency to gobble up all the cable systems they could find.
MediaOne Group Inc., Bresnan Communications Inc., Century Communications Corp. all got swallowed by even bigger players.
Selling stock at recent low prices would be unappealing to any operator today. "The market is just in disarray," said Insight Communications President Michael Willner, who took his company public last year. "Some of the telecom stuff has overflowed to us. But cable companies are not some underfunded CLEC [competitive local exchange carrier]."
The good news is that, for those that need cash, the debt markets seem to be open. No. 3 MSO Comcast Corp. recently refinanced the bulk of its balance sheet, part of it with short-term, low-cost commercial paper, a thought that would have been a joke for a cable operator three years ago. A month ago, Adelphia Communications completed a $750 million junk-bond deal, and Insight is in the market for $500 million.
But debt is certainly more expensive, not just because broad interest rates have risen but because cable is perceived as a greater risk. At the beginning of 1999, investors were willing to buy cable junk bonds yielding interest of just 2% to 2.5% above comparable high-grade treasury bonds. Now the spread to treasuries is 5% to 6%. So operators' interest costs may have gone from 8% to as much as 12% to 13%.
This market is shaping up to be a nightmare for financiers whose bonuses are dependent on cable deals. A few major investment bankers will be fattened by America Online's takeover of Time Warner Inc., Cablevision's sale of its non-New York systems and the likely sale of DBS service DirecTV.
But when it comes to straight system sales, the market looks pretty quiet. "We're not seeing anything," said Comcast CFO John Alchin. "Maybe a few thousand subs at a time."
The only recent buzz is Adelphia Communcations' willingness to pay record prices for system groups that aren't obvious fits with the company's existing clusters-and then clouding the price. The company agreed to pay $750 million, or around $5,800 per subscriber, for a group of Maryland systems from GS Communications. But Adelphia sought to avoid detailing the price by blending it with a smaller deal and announcing a package bought for $5,400 per sub.
The company has quietly agreed to pay an even higher price, $6,200 per sub, for Daniels Cablevision's systems in California but hasn't actually announced the deal or its price.
But those properties combined involve fewer than 200,000 subscribers. "If we're all getting excited about those, that proves there's nothing going on," said one investment banker.
Adelphia is widely expected to be the next seller, but dealmakers don't expect the Rigas family that controls the company to do anything unless stock prices dramatically recover. Most of the other top-10 players are seen as in it for at least another three to five years, save for AT & T's perhaps spinning off its cable operation into a separate company.
More good news is that investors' fear of competition is starting to abate. Telephone companies, notably divisions of SBC Corp., were once considered a harsh threat but now are looking to abandon their video ventures.
Bad news for competitors helps. After being trapped in a downdraft most of the year, cable stocks rallied three weeks ago on news that DirecTV's subscriber growth was starting to fall short of expectation. DirecTV and fellow DBS provider EchoStar are MSOs' most formidable enemies, already capturing more than 12 million homes that were cable's to lose.
The good news for operators about the dark capital markets is that it makes it hugely difficult and expensive for overbuilders to raise cash.
Companies like Knology and Wide Open West can cause more pain for operators because they tend to provoke price wars that DBS services have avoided. The biggest overbuilder, RCN, raised about $4 billion when the markets were good, so it is likely it's sufficiently funded to continue its buildout. But other companies need further rounds of fund-raising to continue their quest. With the market soured, though, being needy is a more of a major corporate flaw than it was a year ago.
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