Oh, those glum overachievers

MSO execs at NCTA bemoan stocks' fall even as the business seems healthy as ever
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In some ways, the recession has really let the cable business shine. TV and radio stations' operations wilted as local ad spending declined. TV networks suffered almost as badly. Telcom companies saw the value of new, multibillion-dollar fiber networks crash to just pennies on the dollar.

Meanwhile, even the worst-performing cable operators have proved rather resistant to recession. Operators have increased their sales and profits. They see themselves as proudly expanding new digital, high-speed Internet and telephone services. New products that barely existed in 1999 should generate 18% of operators' $50 billion in revenue this year and perhaps 40% by 2005. Broadcasters? They're selling the same commercials they sold in the 1960s.

But, as conventioneers trickled into the National Cable & Telecommunications Association convention in New Orleans last week, MSO executives were particularly infuriated that the financial markets are trashing their stocks. Investors hate cable stocks, slashing their prices an average of 40% so far this year. Investors now value MSO stocks around 10.4 times the cash flow expected for the current year. A year ago, stocks traded around 17.2 times cash flow.

That saps the wealth of executives and their senior employees, makes it hard to raise money, and makes it unappealing to pursue major acquisitions calling for stock as the currency.

Of course, it's not as if there's nothing going wrong in the cable industry. A few bothersome operating snags are popping up, and, of course, there's the Enron-esque financial scandal gripping Adelphia Communications, forcing the company to shrink dramatically by liquidating cable systems.

But MSO executives express frustration that, as other media and telcom companies are bleeding, cable gets hammered, not because their cash flow is sliding but because they are growing at "only" 8%-9% instead of 10%-11%.

The aggravation cast a pall over last week's show. "You come to this convention, everybody's stock options are down, everyone's tired, and it's only Monday morning," lamented Comcast President Brian Roberts. "I think we're typical. We just had the best revenue growth and best [cash-flow] growth in any quarter of the last five years, yet the stocks are down 30%-40%."

Cox Communications President Jim Robbins complained, "I'm totally frustrated," even though he posted one of his best quarters ever. "I think it's everything beyond our control. I wish that stuff would go away, and [investors would] look at the fundamentals more and give us credit for it in the market."

Indeed, MSOs like Cox, Comcast and Insight Communications are posting strong operating results. "Mediacom came out with a 16%-17% cash-flow growth rate this year," said Mediacom Chairman Rocco Commisso.

There are some misfires.

Adelphia's insider dealing and debt poisoned the sector, with suspicious investors fearing problems at other MSOs. After years of small sweetheart deals favoring the Rigas family that controls Adelphia, the company ran its numbers way up by helping finance the family purchases of nearly $1 billion in Adelphia stock. The stock-related loans and some other family deals could leave Adelphia—already loaded with debt—on the hook for an unexpected $1.6 billion-$3 billion.

"It's the cockroach theory," said Bank of America Securities media analyst Doug Shapiro. "Investors see one, and they assume there are others."

At Comcast, investors are bracing for the takeover of AT&T Broadband. Even if Comcast and AT&T's operations were running brilliantly, many of the 1 billion shares Comcast plans to pay to AT&T shareholders will probably get dumped back into the open market early next year. The overhang of such a huge supply hitting the market means Comcast shares could take two to four months to build up market momentum after a takeover.

But, of course, operations aren't going brilliantly. AT&T Broadband continues to misfire, with cash-flow margin sliding from the improved but still meager 25% that new Chairman Bill Schleyer had been posting. The cable unit also posted an unexpected loss of 179,000 subscribers in the first quarter. Comcast will be saddled with the myriad problems Schleyer won't have time to work out.

AOL Time Warner's cable operations may be fine, but the company has plenty of other problems, mostly recession-related but also tied to a lack of confidence in the growth prospects of America Online itself.

Cablevision Systems doesn't have its digital-cable act together, standing at just 25,000 subscribers. At one time, analysts were expecting 500,000 units by the end of 2002.

Charter Communications surprised investors by losing 150,000 of its 6.8 million basic subscribers in the quarter. And the company's high leverage—9.1 times annual cash flow—makes the company a magnet for Adelphia-related anxiety.

The upside is that these are more glitch than disaster. Granted, Adelphia has put its best clusters—including metro Miami and Los Angeles—on the block for $5 billion-$6 billion to calm lenders. But the problems of other operators are more easily surmountable.

"To be sure, we've seen better days on Wall Street," said NCTA President Robert Sachs at the convention. "Just about every industry has. Markets go up and down. Sectors fall in and out of favor. But the fundamentals of our business remain solid. And the most important one is this: Cable plays a central role in Americans' lives and will, even more so, in the years ahead."

Morgan Stanley media analyst Richard Bilotti was more blunt. The stocks Wall Street loves right now are old-line cyclicals benefiting from what looks like an economic rebound: retailing, mining and transportation.

"To hell with Wall Street," Bilotti said at a panel session. "Growth stocks are out of favor. You are a growth industry. Does that mean you should change yourself to become the flavor of the month? Absolutely not. When measured on any operating metric, cable has strung together four really great quarters."

Added Tom Wolzien, media analyst for Sanford Bernstein & Co.: "The irony of all this is that cable is better-positioned than any time in the past five years. They may well be in the process of leapfrogging DBS."

That looks about right. DBS companies are reporting slower growth, partly because cable operators have upgraded their own systems. And here's what else is right with cable: While the pace of digital-cable sales is slowing, they are still growing. MSOs are expected to boost digital penetration to an average of 35% by year-end, up from 27% last December. Cable executives who once believed digital would stall out at 30% penetration now believe 50% is achievable.

High-speed data is a less popular product, but unit growth is accelerating. Bank of America's Shapiro sees average penetration rising from 9% to 12.7%.

Video-on-demand seems to be developing into a real business. The numbers aren't good enough for MSOs to brag about—or even disclose—but studios and TV networks are starting to loosen up and provide quality product.

Industry executives and analysts say the big plus is how the industry's heavy capital spending is changing. After DBS companies started grabbing millions of customers with the multi-hundred–channel packages, operators have poured around $65 billion into fundamental system upgrades since 1995. That has been a huge drain of about $1,000 per subscriber, with some operators spending far more each year on capital expenditures—"capex" to the investing crowd—than they've generated in cash flow (thanks to friendly lenders).

Analysts say that campaign is over. Shapiro says that, except for AT&T, every major operator will have 90%-100% of its system rebuilt by the end this year. Capital investment will move away from fixed infrastructure serving all customers to equipment in the home like digital set-tops tied to immediate revenues.

"You should believe that the capex for highways is over," Wolzien said. "The need to spend capital for defensive positions to stop satellite is over."

<p>Company</p><p>12/31/01</p><p>5/8/02</p><p>% chg.</p>

Cox

$40.47

$34.49

-14.8

Comcast

$34.90

$29.00

-16.9

Insight

$23.92

$15.61

-34.7

Charter

$16.09

$8.29

-48.5

Cablevision

$47.57

$23.85

-49.9

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