The bad drowns out cable’s good

May 27, 2002  •  Post A Comment

Red flags are going up on Wall Street in response to a 43 percent decline this year in cable television stock prices, which industry analysts attribute to largely unfounded concerns about rising debt, costly system upgrades and the slow rollout of digital services.
A slew of new research reports from leading analysts attempt to reconcile what generally are strong industrywide fundamentals, led by 14 percent annual cash flow growth in each of the next two years and historically low cable stock prices.
The stock of near-bankrupt Adelphia Communications has declined more than 80 percent in response to the scandal concerning the founding Rigas family’s accounting and investment discrepancies, grand jury and regulatory probes and the company’s incomplete internal audit and annual filings.
However, nearly all cable operators’ stock has been adversely impacted by the Adelphia fiasco. Since the beginning of the year, Cablevision Systems stock is down 60 percent, Charter Communications is down 51 percent, AOL Time Warner stock is down more than 40 percent, and Cox Communications and Comcast Corp. each are down about 20 percent. Even many of the cable programming stocks, which are vexed by other complicating factors, have been scorched despite widespread expectation that even a gradual solid advertising recovery will increase revenues and earnings.
But on Wall Street, perception is everything, which is why it is so important to address one overriding matter that analysts haven’t focused on but could be a major culprit in sliding cable stocks.
It is the massive number of business miscalculations that have devastated cable-related companies, careers and stocks. Consider the following:
* Gerald Levin, who initially was lauded for his foresight and courage in bringing together AOL and Time Warner, has by his own admission “faded away” 16 months following the merger that created the world’s largest media company. Having stuck to his ambitious earnings and revenue growth targets long after it was prudent, Mr. Levin’s mistake was to overestimate the value a new/old media combination could immediately deliver. The way things are going, it could take years. Last quarter, the company took a record $54 billion write-down for lost merger value.
* EchoStar Communications has been arguing from the get-go that its proposed merger with rival DirecTV, while clearly creating a domestic satellite monopoly, should be allowed because it is the only real defense against cable’s consolidating power. Washington regulators do not appear to be buying that. Eventual rejection of the deal could result in two things: proof that the shrillest voice in the pack (belonging to EchoStar founding Chairman Charlie Ergen) doesn’t always get its way and the ultimate dominance of Rupert Murdoch’s global satellite play.
* AT&T spent $120 billion in record time buying valuable cable television systems it didn’t know how to manage or mine. In fact, in the relatively brief time it has held them, the unstable telephone giant seriously jeopardized the well-being of the systems that Comcast Corp. hopes to quickly revitalize when it completes its $39 billion acquisition of AT&T Broadband later this year. The operative word is “quickly.” Even with Comcast’s cable experts at the helm, nothing is guaranteed to happen quickly. It will take time and money to fully upgrade and properly manage most of AT&T’s systems. The ultimate irony: AT&T Chairman Michael Armstrong will remain at the top of the merged heap.
* It seems as if everyone working in, analyzing and investing in cable overestimated how rapidly new digital services would roll out and how quickly the payback on costly cable upgrades would come. The bad news is that the big payoff remains at least several years away, slowed by a more gradual and uncertain economic recovery. The good news is that once established, high-margin services such as video-on-demand will be the golden egg that makes cable gatekeepers a commanding competitive and economic force.
* One of the worst miscalculations may actually be an outright miss. It took a matter-of-fact disclosure by Adelphia management-not a revelation from industry analysts or press-to break open its destructive accounting scandal. The company is moving quickly to avoid even more disaster. There’s been a general tendency to underestimate how deep the problems are at Adelphia-the breakup of which appears inevitable-and where else in the industry there could be similar concerns. Many on Wall Street say Adelphia’s problems are unique to the company.
Such formidable miscalculations would be quite enough on their own to undercut cable investor confidence. But when they are compounded by other widely acknowledged factors, it is easy to see why cable stocks have tanked.
For instance, there is a tremendous amount of corporate leverage that could dull any new service gains made over the next two years.
In a recent report to clients, Tom Wolzien of Sanford Bernstein pointed out that Time Warner Cable, AT&T Broadband, Comcast and Cox Communications maintain strong investment-grade ratings despite nearly $70 billion in collective debt. That compares with the more speculative, less than investment-grade status of $37 billion in collective debt belonging to Charter Communications, Cablevision Systems and Adelphia.
Comcast this week said that it would sell its stake in AT&T Corp. and portions of its Sprint holdings to raise cash to protect its investment grade status.
Mr. Wolzien cautions that even as overall capital expenditures begin to decline dramatically, now that system upgrades are being completed, much of that heavy spending will continue in the form of new service rollout expenses, such as funding new set-top boxes and swapping or acquiring more properties.
The amount of corporate debt on the books at even the best-managed cable companies is stunning, even in light of the dramatically improving cash flows and earnings that are expected the second half of the year, according to Jessica Reif Cohen, analyst at Merrill Lynch.
The inability to use undervalued stock as currency could stifle deals in the short term.
Potential near-term catalysts for cable balance sheets and stocks include a resolution of Cablevision’s $1 billion funding gap with the sale of its PCS licenses, AOL being able to secure long-awaited Internet service provider agreements with other cable operators and the completion of the Comcast-AT&T merger, Ms. Cohen said.
Ms. Cohen said cable operators enjoy a stable regulatory and competitive environment, pricing power and increasing free cash flow driven by new incremental digital services. Even most of the high-leverage spread across major operators is “fully funded” for the next two years.
As the economic recovery comes, its upward impact will be swift and sure. Ms. Cohen said cable companies and their stocks could experience “an upside surprise the second half of the year” given advertising’s 70-percent-plus cash flow margin impact and high-speed data’s improving 45 percent margins.
Bear Stearns analyst Raymond Katz estimates a turnaround in advertising and continued growth in services such as high-speed data could translate into 24 percent to 100 percent appreciation in cable stock prices over the next year. But that will not occur without concrete gains from new products such as video-on-demand, wholesale broadband and bundled services, he cautions.
And that brings us full circle, back to the matter of industry miscalculations.
No one thought just a few months ago that the sixth-largest cable operator would be brought down in record time by a stunning accounting disclosure. Although no one is saying much out loud, the Adelphia Communications meltdown has raised new concerns abut whether there might be undisclosed accounting discrepancies elsewhere in the cable industry, since so many major cable operators are still controlled by their founding families. The recent telecom meltdown and Enron debacle could make it worse.
Clearly, reversing the fortune of cable stocks requires more than a strong outlook or perf
ormance by single companies or the entire industry. Cable issues will trade higher when there is convincing evidence that the worst of all the unknown problems is over and the best of what cable can become is reflected in tangible financial returns.
In the meantime, the stock of cable operators and even many cable program and service providers will continue to be pounded in a volatile stock market, which means their most immediate test may be their easiest: simply wait out the storm.