Investors Wary of Slow Cable Growth

Aug 19, 2007  •  Post A Comment

Stock analysts, by and large, seem to love cable stocks, but investors have remained wary — a situation the analysts have noticed and have addressed from time to time.
Last week, Craig Moffett of Bernstein Research looked at this disparity in a report to clients. The title pretty much says it all: “Comcast and Time Warner Cable: Valuations Are Near ’06 Lows, Despite Much Faster Growth.”
In his report, Mr. Moffett pointed out that the old reason for investor unease about the cable industry — a renewed need for increased capital investment — appears to have been replaced by a new reason to worry.
“Fears of perpetually rising capital intensity have, in short order, been replaced by fears of slowing growth as cable investors’ anxiety No. 1,” he said. “Underlying the concern is the fear that the broadband market is nearing saturation.”
But while investors are bearish about growth prospects for cable and have pushed valuations downward, “these valuations appear unsustainably low,” Mr. Moffett said. “We continue to rate Comcast and Time Warner Cable ‘outperform,'” setting target prices for their stocks at $40 and $53, respectively.
Cable stocks were not helped by what Mr. Moffett described as a disappointing second-quarter earnings season. But he suggests a closer look at the numbers presents a stronger case, particularly for the two largest players in the industry.
Mr. Moffett said the broadband market appears to be significantly healthier than investors seem to believe and that digital voice subscriber additions are accelerating at both companies.
In the report, he focused on what he calls core subscription growth. This excludes advertising revenues, which can swing back and forth based on the election cycle, and items such as franchise fees.
For Comcast, revenue growth on a core subscription basis is even more pronounced than its reported earnings indicate. Mr. Moffett pegged this growth at more than 16 percent, or 40 percent higher than last year when valuations were at similar troughs. At the same time, margins (based on earnings before interest, taxes, depreciation and amortization) have expanded significantly since the stock hit its low last year.
Making comparisons at Time Warner Cable is trickier because about 28 percent of its subscribers come from systems that were recently acquired and have only recently started to be able to offer the triple play of video, high-speed Internet and digital telephone services that fuels subscriber and revenue-per-subscriber growth. While that may mean flatter core subscription growth for Time Warner Cable, Mr. Moffett said, on the flipside, free cash flow growth should come sooner.
Back to the topic of advertising, Mr. Moffett noted that since 2008 is an election year, advertising will be a boon to cable operators, who can better target ads geographically for districts that are smaller than the footprint of their broadcast television station competitors.
Over the long term, he said, addressable advertising has the potential to make advertising a “major growth engine” of the cable business.
He concluded that cable is a more compelling investment opportunity that it has been in more than a year, especially given the trend in companies buying back their own stock when they deem it undervalued.
“While we don’t expect a rapid recovery for the leverage-based expectations of earlier this year, we believe the dramatic free cash-flow growth for these companies over the next few years continue to enable aggressive shrinkage of the equity base, irrespective of incremental leverage, as free cash flow is returned to shareholders in the form of share repurchases,” the report said.

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