Maverick Plays and Wins by Its Own Rules
By Mike Farrell -- Multichannel News, 9/23/2007 8:00:00 PM
NOT TAKEN LIGHTLY
SECOND TO NONE
KEEPING HD FREE
EXTENDED PLAY
BUSINESS AS USUAL
FREE CASH FLOW
SUBPRIME BOOST
Sidebars:
'Cash. Lots of Cash’
Cablevision Through the Decades
NOT TAKEN LIGHTLY
SECOND TO NONE
KEEPING HD FREE
EXTENDED PLAY
BUSINESS AS USUAL
FREE CASH FLOW
SUBPRIME BOOST
Sidebars:
'Cash. Lots of Cash’
Cablevision Through the Decades
Cablevision Systems chief operating officer Tom Rutledge used to poke fun at the impending threat on his cable fiefdom from upstart Verizon Communications a few years ago, when the telephone company was beginning to roll out its FiOS voice, video and data service.
The competitive threat of FiOS was a popular question during quarterly conference calls and analysts’ conferences, and Rutledge generally offered the same reply: “They have about as many customers as employees in our region.”
He’s not saying that anymore.
But in Rutledge’s defense, he doesn’t have to. And there is a big difference between poking fun at questions about a competitor and not taking that rival seriously.
NOT TAKEN LIGHTLY
“We take them seriously; we always have,” Rutledge said in an interview in September. “All of our strategies for a long period of time were with full recognition that they would be our competitor and are our competitor. Our video, data and voice strategy have all contemplated telephone competition.”
Although the full brunt of Verizon FiOS competition is arguably to be felt in the future, the telco hasn’t been the 800-pound gorilla that most analysts have expected it to be. Cablevision has been able to hold it own.
That steadfastness, coupled with the impact it could have on the rest of the industry — which has not yet felt the full wrath of the telcos, but is obviously watching Cablevision very closely — is why the Bethpage, N.Y.-based cable giant is the Multichannel News Operator of the Year.
Rutledge would not discuss Verizon’s impact, but in a Sept. 13 Securities and Exchange Commission filing, the cable company estimated that FiOS passed 1.08 million homes within its footprint as of Aug. 31.
The proxy also contained an internal sensitivity analysis of Verizon’s possible impact and concluded that if the telco reached 1.6 million homes and had 10% video penetration by 2011, Cablevision could offset those gains with modest rate increases and cost containment.
As of June 30, Verizon had about 515,000 FiOS video customers nationwide, and according to a January research report by Citigroup media analyst Jason Bazinet, Verizon offered FiOS video to about 21% of Cablevision homes, by far the largest single telco exposure of any other cable operator.
While the phone company doesn’t break out the regions in which those customers reside, the safe bet is that a good portion of them are smack dab in Cablevision territory. Some of Verizon’s most mature video markets are in Westchester County and Long Island in New York state, and in northern New Jersey, longtime Cablevision strongholds.
Although analysts and doomsayers have been predicting the downfall of cable once the telcos begin to gain steam on the video front for years, Cablevision had yet another strong 2006. Last year, Cablevision reported revenue of $5.93 billion (up 14.6%); adjusted operating cash flow of $1.82 billion (up 13%); and 3.13 million basic subscribers, an increase of 3.2% over 2005.
In addition, digital subscribers rose 25% to 2.447 million; high-speed Internet customers increased 20.4% to 2.039 million; and telephone customers increased 65.4% to 1.209 million in 2006. And despite the fears that Cablevision’s $90 triple-play promotional pricing would spark a price war with Verizon, average monthly revenue per subscriber rose 15% to $115.30 that year.
The picture changed in the second quarter of this year, when Cablevision reported lower-than-expected subscriber-growth metrics and revised its full-year guidance downward. Now, instead of 1% to 2% basic-subscriber growth, the cable operator is expecting basic customers to be flat for 2007. Cablevision also lowered full-year revenue growth guidance from the mid-teens to 11%; adjusted operating cash-flow growth from the mid-teens to 10%; and revised revenue generating unit additions from 850,000 to 900,000 to between 825,000 and 900,000.
SECOND TO NONE
Unlike other cable operators, who brace the market for second-quarter seasonal declines as snowbirds and college students disconnect service as they move to summer residences, Cablevision — with its strong base in resort communities like the Hamptons and the New Jersey shore — usually posted gains. In fact, over the past seven years, Cablevision has only reported a second-quarter loss of basic subscribers once — 10,000 customers in 2003.
That wasn’t the case in the most recent second quarter. Cablevision said that basic customer growth was flat — it actually lost 348 customers in the period — much better than its peers, but still disappointing to some analysts. And digital and high-speed data growth — at 39,000 and 50,000 customers respectively — was sluggish compared to prior years. Even voice services, a driver of the triple-play package for the past three years, was showing signs of a slowdown, with Cablevision adding 81,000 Optimum Voice customers in the period.
Despite those numbers, Cablevision is outpacing its 2006 results in the first half of this year — revenue, at $3.130 billion, is 12.4% ahead of first-half 2006 sales of $2.784 billion and adjusted operating cash flow of $982.24 million is 15.4% ahead of the last year’s mark of $851 million.
“They’ve really moved the most aggressively to get their products out as soon as possible to fend off competition,” Pali Research media analyst Richard Greenfield said of Cablevision. “Competition is really a 'me-too’ product [and] as they’re offering phone to their entire footprint, they’re offering a broader HD tier than most operators to their entire footprint.”
KEEPING HD FREE
Cablevision has focused more heavily on HD than its peers, who have directed their efforts more toward video on demand. Cablevision currently has 40 high-definition channels (and capacity to carry 500 HD channels), tops in the cable and satellite industry. And unlike other cable operators, Cablevision does not charge for HD service, but does charge for VOD. Many other cable operators do the opposite.
“We think HD is a format change, not a product,” Rutledge said. “The content delivered in HD is the same as the transition from black and white to color. We don’t think that it’s something that should be charged for. And we don’t think it’s something we should pay for either, separate and apart from the underlying content rights. That philosophy led us to the pricing structure that we have.
“We believe that people are all going to buy HD sets over a period of time,” Rutledge added. “I think at the end of this year, one-third of our customers will be HD customers. I’m not sure that will happen, but given the numbers I’ve seen in the marketplace, I think that’s probable.”
Greenfield also pointed to triple-play promotions from other operators like Comcast and Time Warner Cable, which usually offer a slimmed-down data product, a digital tier consisting primarily of basic-cable networks and a digital box, along with phone service.
“At Cablevision, you get the full shebang; you really do get the best-in-breed products,” Greenfield said. “It is a level of aggressiveness in their marketing that no one else has really followed.”
From the get-go, Rutledge said, the strategy was to offer the best products possible, and that mindset was the driving force behind the construction of its state-of-the-art, fiber-rich network. With that robust and versatile network — Cablevision essentially operates from a single headend and has a flexible node structure — the company is able to improve quality of service and continue to innovate with new products quickly without huge capital-expenditure outlays.
“Then we put all of that value in a package that truly drives perceived value in the home,” Rutledge said. “With that comes loyalty and positive customer relationships. That is what our business objective is all about — growing positive customer relationships.”
Cable and Communications division president John Bickham added that offering a lower grade product and hoping to upsell customers doesn’t work.
“In some ways when you try to be too cute, it makes the sale more difficult,” Bickham said. “Today, if you listen to a triple-product sale by a phone rep, it could take 20 or 30 minutes, depending on the nature of how many lines the person has and all kinds of other things related to the kind of products they want to buy from us.
“If your strategy is to offer something that the customer really doesn’t want, get them on the phone and upsell them, it lengthens the call, it confuses the customer and it annoys the customer. Frankly, we found it’s just a lot better to offer the best and almost everyone buys everything you’re offering.”
EXTENDED PLAY
Earlier this year, the company extended its $90 triple-play package to existing customers, which some analysts took as either a sign that FiOS was becoming a more formidable competitor or that penetration levels for advanced services were reaching the saturation point.
“I think it is defensive,” Miller Tabak analyst David Joyce said of the promotional extension. “It’s possible that the subscriber weakness we saw in the second quarter may have been a little worse than the company had planned.”
Rutledge said the reasoning for the extension was just another example of Cablevision’s normal business stance.
BUSINESS AS USUAL
“I would say it was us being aggressive at its core,” Rutledge said of extending the promotion. “When we implement any marketing strategy, it’s an integrated strategy with our operational strategy. When we did the triple-play offer, we thought long and hard about the implications to our service performance and how we would be able to manage rapid growth in the marketplace.
“I think that’s one of the things we do most effectively — integrate our marketing and operating strategies so we can actually perform at high volume. The extension of the triple play was more in line with our operational strategy and our general aggressiveness as opposed to any particular situation in the marketplace.”
Said Greenfield: “Cablevision has been a leader in getting out there to drive product penetration. I think this is yet another example of how they are trying to push the envelope to drive penetration of the triple play to bring down churn.”
Whatever the reasoning, Sanford Bernstein cable and satellite analyst Craig Moffett, in a research note in August, said Cablevision’s performance against Verizon so far is a rare window into the future for other cable operators.
“While growth at Cablevision is unmistakably slowing, it is also becoming clear that, after at least six quarters of head-to-head competition with Verizon, Cablevision is holding its own,” Moffett wrote. “Other cable operators are likely to take heart from the results, inasmuch as Cablevision’s overlap with Verizon is already larger than will be the case at Comcast and Time Warner Cable, even by 2012.”
Joyce took the Cablevision-as-crystal-ball concept a step further.
“They’re clearly the leader in penetration and they’re showing what products are topping out first,” Joyce said. “They’re also going to be the test case for how you get to 100% penetration of all the advanced services.”
Greenfield added that while Verizon should not be taken lightly, he believes the emphasis shouldn’t be on losing market share to the phone giant, but on whether Cablevision can manage to keep growing cash flow and free cash flow (cash flow after interest payments and capital expenditures are made, a key performance metric) while its subscriber base shrinks.
“We’ve always assumed that Verizon is going to take some share and that Cablevision’s growth, because of that, is going to suffer,” Greenfield said. “The issue is not so much is growth going to suffer, but what is the resulting free cash flow that this company generates over the next three to five years.”
FREE CASH FLOW
Cable free cash flow [cash flow after capital expenditures and interest payments are made] in 2006 was $75.3 million, compared to $153.75 million in 2005. By 2011, Cablevision has estimated — according to a proxy filing with the Securities and Exchange Commission earlier this year — that free cash flow will more than double from $1.24 billion in 2007 to $2.86 billion.
And free cash flow is just the tip of the iceberg. Cablevision also expects robust growth across all financial metrics for the next five years.
According to a proxy statement filed with the Securities and Exchange Commission in June (and updated in August), Cablevision’s own internal predictions are that revenue will grow nearly 43% company-wide between 2007 and 2011 to $9.79 billion and adjusted operating cash flow will rise 62% to $3.5 billion.
Also during that time, capital expenditures will dip 17% from $697 million in 2007 to $581 million in 2011.
That expected decline in capital expenditures was not lost on Moffett, who in an August research report noted that cable capital intensity was 12.6% of revenue (its lowest level ever) and down from 19.2% last year. He added that the company also reaffirmed capital-expenditure guidance for the year, saying it will come in at the low end of its previous range of $600 million to $650 million.
“All this translates into much higher free cash flow,” Moffett wrote, adding that unlevered free-cash-flow conversion in the second quarter (defined as cash flow less capex divided by cash flow) was 67.2% compared to 54.3% the previous year.
“Said another way, Cablevision is converting every dollar of [cash flow] into close to $0.70 of unlevered free cash flow, versus just $0.55 a year ago,” Moffett wrote.
The expected bump in free cash flow is just one of the reasons Cablevision’s ruling Dolan family initiated its third attempt to take the company private in May, offering shareholders $36.26 per share for every share of Cablevision they own.
The $10.6 billion deal has received approval from a special committee of Cablevision’s independent directors. It still needs approval from a majority of the minority shareholders in the company. A date for a special meeting for that vote is expected before the end of the year.
But earlier this year, it was thought that the Dolans’ latest offer would go the same route as past attempts — nowhere. Cablevision stock was soaring in July — at one time during that month, it was trading at $38.52, more than $2 per share above the Dolan offer — and it looked like shareholders would reject the deal.
Several shareholders also lamented the fact that the latest offer did not include a public “stub,” a portion of the company that would remain public, which would allow current shareholders to participate in a future sale of the cable company, possibly to Time Warner Cable.
SUBPRIME BOOST
But a funny thing happened as the year progressed. The meltdown in the subprime lending industry rocked the stock market, dragging down the shares of practically every other public stock along with it. And less than stellar second-quarter results from the major cable operators — Cablevision included — drove down the cable sector even further.
The result: Cablevision stock was trading at $34.04 on Sept. 6, and most analysts believe if the stock remains at these levels, the privatization deal will finally go through.
“The way things have broken for them, in terms of the market getting skittish on cable, the high-yield market or the debt market in general collapsing, has created the perfect storm of elements that should enable them to close this transaction,” Greenfield said. “I think it would have been very difficult to get shareholder approval six months ago. I think given the current environment, this is the perfect storm that is going to enable them to actually get 'yes’ votes from the minority shareholders.”
Led by a pair of cable mavericks, chairman Charles Dolan and CEO James Dolan, Cablevision was not without controversy in 2006.
In March of that year, Cablevision announced its plan to test a network digital video recorder — dubbed the Remote Server DVR — which would take digital-recording functionality out of the set-top box and into central servers at Cablevision’s headend.
The company was promptly sued by a handful of programmers who claimed the RS-DVR violated their copyrights. In March 2007, a federal judge agreed and ordered Cablevision to cancel its plans to roll out the product. That ruling is currently being appealed.
Cablevision also weathered a minor scandal in September 2006, when it revealed in a filing that it had backdated stock options for a compensation consultant no longer with the company and a former executive who was dead before the options were granted.
Cablevision never revealed the names of those executives, but published reports and people familiar with the company said the deceased executive was former vice chairman Marc Lustgarten, a close friend of the Dolans, who died in 1999.
While the U.S. Attorney’s Office said it was investigating the matter, it wasn’t serious enough to block the Dolans from making another privatization bid for the company last October (rejected as too low in January), and it hasn’t seemed to hamper the current offer on the table from the family.
And investors have seemed to take it in stride. Despite the dust-ups, the sometimes bizarre happenings on the corporate level and the company’s occasional “Damn the Torpedoes” attitude, Cablevision continues to plug away.
And perhaps a large portion of their success is due to that attitude, an entrepreneurial vision that sometimes butts heads with peers as well as competitors, but more often than not comes out ahead.
“They’ve continued to be the mavericks even within the cable industry,” Joyce said. “They haven’t really been playing along with the bigger players.”
Maverick or not, Rutledge said that he is pleased with the progress made over the past five years since he first joined the company, beginning with his boss Jim Dolan’s vision to center the company’s focus on the New York market and aggressively roll out telephone service. Whether anyone else in the industry notices isn’t the primary goal.
“I don’t know what that’s worth,” Rutledge said of industry recognition. “We’re all about getting customers and treating them well and growing that relationship. Whether somebody thinks we’re good at it or not really doesn’t matter.”
Cover Story: Cash Business
09/06/2009Cablevision Follows Pack
03/02/2009Deal or No Deal: Dolan Bid May be Stymied
05/06/2007All Ears On Earnings
06/01/2009Cablevision’s Banner Year
09/25/2005
