The Great Divide

Cable systems seem to surge, but stocks still sag

There is a Great Divide in the cable-TV industry, and it isn’t a ridge of mountains in the West. It’s the disconnect between Wall Street’s valuation of cable stocks, say the nation’s largest cable operators, and their actual performance.

I was witness to this divide at a recent Bank of America media conference in New York. At one session, a top cable executive expressed unwavering confidence in the industry’s prospects to a crowd of money managers and analysts. The biggest cable operators, he said, are flourishing: Revenues and operating cash flow are strong, sales of cable phone and other new services are surprising even bulls, and video-on-demand is expected to be a big moneymaker.

A hedge-fund manager had a much different opinion. He left the Manhattan hotel and declared to Wall Street pals outside, “He’s delusional! He’s delusional!” The money manager believes that the telephone companies will crunch—and possibly crush—cable.

“Telcos don’t look at broadband and video as a profit center,” he said later. “They look at it as securing market share to defend their telephone business against cable. They’ll spend whatever it takes.”

That’s the sentiment cable operators have to grapple with every day; it casts a financial pall over the entire cable industry. Even for cable companies whose systems demonstrate strong operating performance with cash-flow growth of 10% or more on average—Comcast, Time Warner, Cablevision Systems—stocks are in a slump, off 15%-25% over the past year. That makes it difficult to raise capital and use stock for acquisitions to grow.

Comcast President Steve Burke finds the skepticism maddening: “Look at our stock. It’s trading below where it was five years ago, but operating cash flow has doubled.” Indeed, after the crash of media and tech stocks, Comcast shares traded around 14 times annual cash flow. Today, it trades around seven times, about the same as broadcast TV and radio stations and only a bit better than telcos.

Bank of America media analyst Doug Shapiro also sees a disconnect. He expects major operators’ system revenues and cash flow to increase again this year, particularly as Comcast and Time Warner get their hands on Adelphia Communications’ ailing systems.

Shapiro is bullish, saying he has “rarely seen such a large disconnect between investor perception of the competitive dynamic and what is actually occurring in the marketplace.”

There’s evidence to support the bulls’ case:

  • Telcos have a miserable track record in video. “If you look at the history of the Bells, it has been a lot of bluster,” says Cablevision Systems COO Tom Rutledge. Both Verizon and what is now AT&T (formerly SBC Communications) saw the cable-telephone push coming in the 1990s, then spent hundreds of millions of dollars building or buying video systems. But they faltered and either shut down or sold the ventures.
    But the telcos’ splash into video accomplished two goals: 1) Bolstered their lobbying campaigns for favorable treatment in the 1996 overhaul of the Telecom Act. 2) Scared investors and lenders, making it hard and expensive for cable-TV companies to raise cash.
    In any case, the telcos can’t move into video swiftly because they have to rebuild their networks.
  • Cable’s success in selling telephone service is startling. Two years after launching phone service throughout its metro New York systems, Cablevision has sold telephone service to 24% of its customers. That’s higher than even Cox Communications, which started offering such services in 1998. Cablevision may hit 34% this year. Time Warner could top 10%.
    Comcast has approached digital phone service slowly, preferring to iron out the kinks in systems acquired from AT&T Broadband. Burke says Comcast won’t lag much behind its successful peers.
  • Telcos’ big discounts in DSL (direct subscriber line) service haven’t stymied cable’s growth in high-speed data. Privately held Cox shows the way. During 2005, Cox posted a 24% gain in high-speed–data customers, despite maintaining prices at more than $40, much higher than the $20-$25 list price of telcos’ DSL service.
    That could signal that telcos might not provoke much of a price war in video. AT&T COO Randall Stephenson notes that, because cheap DSL is bundled with expensive telephone services, his prices aren’t really any cheaper than cable’s own bundle of expensive data service and discounted voice service. “The reality is,” he says, “over the last couple of years, 18 months, pricing in the consumer market has been very stable.”

On the other hand, the bears’ ammunition is powerful:

  • Cable is not an entirely healthy industry. Three top-10 operators are in deep financial or operating trouble. Paul Allen’s Charter Communications—the third-largest operator—can’t get its operating together and continues to lose basic subscribers. There’s a reason Verizon picked Keller, Texas, to launch its first video system: Charter’s the local operator, so Verizon’s numbers were bound to look good.
    Adelphia Communications and Mediacom are also having trouble keeping subscribers. All three are a long way from becoming a formidable foe in cable phone services. Add that to the Shakespearean wackiness of Cablevision’s Dolan family, and cable is far from a picture of stability.
  • Telcos are immensely powerful and will hurt if they follow through on their promises. AT&T’s Stephenson says his company can launch video in half of its service area in three years. That’s a quick overbuild.
  • What is cable’s next New Big Thing to power growth? High-speed Internet was that product for the past few years; residential telephone will be for the near future. What’s next? Interactive advertising? Gaming? Business services?

That’s a big worry. A former sell-side analyst said a decade ago, he had modeled video-on-demand as a major revenue source. “Now operators virtually give it away to keep people from defecting to satellite,” he says.

I’m no stock-picker, but from where I sit, cable stocks are cheap. Here’s the rub: I don’t see what will trigger a revival. A rally requires big commitments outside the usual crowd of media investors. And the telcos’ clear threat and negative message are powerful enough to keep the mutual funds and pensions from plunging in.

Cable operators have no choice. They must continue to post great results. With luck, Wall Street will notice.

E-mail comments to