MEDIA GIANTS: Bleeding5/09/2004 08:00:00 PM Eastern
Brian Roberts was at his breaking point. In a closed-door meeting at the National Cable Show May 4, financial analysts peppered the Comcast CEO and a group of cable chiefs with questions about their Internet phone business, the swarm of new rivals, and whether cable could deliver results.
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Finally, Roberts fired back. The questions, he said, verged on, "Do you beat your wife? Do you beat your wife? When are you going tobeat your wife?" He protested that Wall Street is in "crazy mode"—with investors obsessed that "only bad things are going to happen," even to companies whose operations are rock solid.
Roberts' complaints could easily have been spoken by Viacom's Sumner Redstone, Cox Communications' Jim Robbins, or EchoStar's Charlie Ergen. Their major media companies and others have posted strong earnings results, but see their stocks slumping at a time when the broader stock market is up.
At the same convention, Time Warner's Dick Parsons said investors "get scared into a herd mentality" even if a company's performance is improving. "The Street—they'll get the joke sooner or later."
Of 10 big players chosen by B&C, eight have lagged the broader market over the past six months. Despite rebounding a bit from its aborted bid for Disney, Comcast has lagged the Dow Jones Industrial Average over the past six months by 17 percentage points. Comcast is down 12%, while the Dow has risen 5%. Viacom is trailing the Dow by 9 points, EchoStar Communications by 12 points, Clear Channel by 18 points, and the Tribune Co. by 5 points.
But the slump is more than a short-term swing in sentiment. Investors have dramatically changed their perception of media companies for a variety of reasons, from concerns over future growth to more-attractive returns in other sectors. (Transportation and coal are hot at the moment.)
According to Morgan Stanley media analyst Richard Bilotti, companies such as Time Warner, Fox Entertainment, Cox, and Comcast are trading at just nine to 11 times expected 2004 operating cash flow. Two years ago, even as the recession was in full swing, they were trading 15-17 times annual cash flow.
The low valuation is particularly maddening to cable operators, who consider themselves a less risky investment. At the same time, the strongest companies—Comcast, Cox, and Time Warner Cable—have continued to post double-digit percentage gains in cash flow. Their need for expensive and extensive system upgrades has eased, so they've cut capital spending. New products like high-speed Internet and digital cable are clear wins, and now they are rolling out new telephone services.
Cable executives may have a point. When Microsoft invested $5 billion to help Comcast fund its takeover of AT&T Broadband, the deal was priced at $42 per share. Since then, Comcast increased earnings 25% last year and 21% in the first quarter of this year, but its stock is 30% lower.
Moreover, Roberts argues that the cable industry is beginning to deliver on one loud investor demand. Two years ago, investors screamed for cable companies to generate more solid "free" cash flow, which basically calls for restraining capital spending. It's not quite the measure investors are most comfortable with—net income—but it's closer.
Cable operators aren't getting much credit for meeting that demand. At a separate dinner during the National Show last week, money-management executives fretted over how cable operators will spend the newfound free cash flow.
"For a long time, it was 'show free cash flow,'" Roberts complained at the meeting. "Now, it's 'what are we going to do with free cash flow?'"
Some of Wall Street's concerns over the threats to cable are understandable. Telcos are starting to add more high-speed Internet customers than cable systems. Cable operators face a flood of new phone competitors as it rolls out Internet phone services. With so many new products ahead, investors fear that cable operators will renege on their promise to reduce capital spending.
As media executives spar with Wall Street over values, both sides concede to myriad factors weighing their shares down. Here are a few:
Blame the Economy
For all the heat generated by the buildup to the networks' upfront selling season, the ad market isn't really all that hot. Even with the expected surge of political and Olympic spending, TV-station groups are looking for 5%-8% sales growth. Analysts are now saying a "radio recovery" is in the works after a period of depression; but 6% growth is hardly a cause for a rally in the eyes of investors.
Weak radio ad sales is a big reason Viacom is in a slump, in part because President Mel Karmazin failed to deliver on promises of a turnaround in his Infinity radio division.
Don't expect an exciting upfront sales market to translate into a stock rally. Big upfront numbers don't always translate into strong full-year growth. Sanford Bernstein media analyst Tom Wolzien notes that, while the Big Three broadcast networks booked 13%-21% growth in orders during last year's upfront, full-year ad sales were up only 1%. The upfront was overwhelmed by weak ratings, canceled shows, and a slumped scatter market. "Obviously," he says, "there's a disconnect between the upfront and actual results."
Although Roberts emphasizes that the hostile-takeover attempt on Disney is dead and "we're moving on," investors won't move on as quickly. Many were angered by the bid because they thought Comcast was overreaching into businesses outside its traditional domain: movies and theme parks.
And by making a play for Disney's content, Comcast spooked investors into believing that Roberts and his crew fear that the distribution business is a loser over the long term. (Remember, that's why America Online acquired Time Warner.) Roberts denies that theory, but lingering suspicion plagues the stock.
Finally, investors were annoyed that, even though Roberts believes that his stock is so cheap, he was still willing to give so much of it to Disney shareholders. To many investors, Comcast's owning Disney's crown jewels, its TV networks, wasn't worth the dilution.
Investors worry that one of cable's leading players will overpay in the upcoming auction for Adelphia Communications. Big clusters like Los Angeles, Cleveland, and South Florida don't come on the market very often, and deal fever can cause folks to pay too much. (Even the conservative Cox Communications paid a huge $5,000 per subscriber for one system during the dotcom boom.)
Adelphia's own Chapter 11 investment bankers peg its 5.1 million subscribers at about $3,300 each, or a total of $17 billion. Analysts see an auction easily pushing that to $3,900 per subscriber, or $20 billion. And, although Adelphia's new management is working to upgrade the systems while still in bankruptcy protection, whoever buys it will doubtless have to start a new cycle of capital spending to get it up to its standards.
The problem is that even ailing Charter Communications is dangling the idea that it may bid. Comcast and Time Warner are openly interested. Cox Communications CEO Robbins is trying to keep speculation from poisoning his stock price by declaring in no uncertain terms—publicly—that he's out of the hunt as long as Adelphia is being sold in one piece, as management intends.
Still, Robbins lamented that, at last week's National Show, he was privately asked "at least a dozen times" whether he was actually secretly plotting an Adelphia bid.
Rupert Murdoch plans to steal customers from cable with his DirecTV DBS service, but EchoStar is just as vulnerable.
As News Corp. flexes its marketing, programming, and political muscles against both, it's crimping the shares of cable and EchoStar. So far, EchoStar continues to briskly add customers, but doing so is getting more expensive.
EchoStar posted a 26% jump in subscriber-acquisition cost, which covers advertising, sales commissions, and satellite receivers. In the satellite business, these are considered huge investments that can be lost overnight if a customer suddenly switches. Despite EchoStar chief Charlie Ergen's previous promises to reduce such costs, investors think he'll have to spend big to win more subscribers.
For Ergen and his counterparts in the media business, managing expectations is the new priority. But don't expect the blame game to end any time soon.