S&P Toughens Up on Cable's Credit Rating

Worried about the damage that DBS continues to inflict on cable systems, the Standard & Poor's debt-rating agency is tightening its credit standards for cable operators, making it harder for them to achieve the favorable grades that will, in turn, reduce their borrowing costs.

S&P officials said they want to see more financial comfort as operators continue to lose subscribers to DBS and feel constrained in raising basic rates.

Said S&P cable credit analyst Eric Geil, "We're not changing our view of the industry," which is generally positive. "We just want a little more cushion." He emphasized that no existing bonds will be downgraded but new bonds from existing companies will be viewed through the new prism.

Still, one junk-bond analyst called the move "monumental" because S&P infrequently spells out new credit ratios so explicitly.

The cable operators most likely to affected are the most highly leveraged. According to UBS Warburg cable analyst Aryeh Bourkoff, Charter Communications carries a debt load of nine times 2003 cash flow. Insight Communications runs at eight times, MediaCom at 7.4 times. (By comparison, the debt of highest-quality MSO borrowers Comcast and Cox comes to 3.3 times annual cash flow.)

Comcast has secured a BBB rating but, until recently, was on S&P's CreditWatch for a possible downgrade. "We're on a program to achieve even stronger BBB ratings," said Comcast CFO John Alchin. "I'm confident that we can go up the scale even with the new standards."

Debt ratings are hugely important to companies and bond investors. An S&P change from say, a BB to a BBB means a company will save about half a percentage point in interest expense.

High-quality borrowers like Cox and Comcast could issue bonds at just 5.5%-6%. More highly leveraged companies like Insight would have to pay 9%-12%, while truly troubled companies like Charter Communications would pay 14%-16%.

Because of their heavy capital spending to upgrade systems and their frequent acquisition sprees, cable operators have long been relatively low-quality borrowers. The best—Cox—boasts an "investment-grade" BBB.

Nevertheless, the company is a long, long way from top-grade AAA scores. Bonds rated lower than BB are considered "high-yield" or, more commonly, "junk" bonds.

Credit analysts balance debt load and interest costs against operating cash flow. They like low leverage, a low debt-to-cash flow ratio. And they like high interest coverage, a high ratio of cash flow to debt service.

The new standards make it a little harder for cable operators to get good scores. Graduating to an A rating is much more difficult, requiring a 17% improvement in a company's cash flow against a given level of debt. Getting a BBB will require an 11%-12% improvement in an operator's debt-to-cash flow level.

The most important move—from junk to an investment-grade BB—will require a 7%-10% improvement in debt-to-cash flow, 9%-16% less debt per subscriber.

But the toughest test is the interest-coverage ratio, which will require a 20%-25% improvement.

But, noted Geil, every company's cost of new borrowing has fallen 15%-25% over the past two years, with rates for decent-quality borrowers dropping from 8% to as low as 6% before rebounding to 7%.