Analyst Says Cable Stocks Have Bottomed

By MIKE FARRELL -- Multichannel News, 9/11/2000

Cable stocks, down a disappointing 30 percent since the beginning of the year, may have hit bottom, according to one analyst, meaning that bargains may abound in the cable sector.

In a report entitled Where's the Bottom for Cable?, Banc of America Securities LLC analyst Doug Shapiro said that based on his conservative valuations, the market is not taking into consideration the impact of new services on current cable valuations.

Shapiro used three different methods in determining the value of cable stocks. He compared current valuations to the "perpetuity," or long-term, value of video subscribers; applied telcolike takeout multiples to cable stocks; and looked at the relative premium of the average cable cash-flow multiple to the average cash-flow multiple for the Standard & Poor's Corp. Industrial index.

What Shapiro found, according to the report, is that pure-play cable stocks-Adelphia Communications Corp., Comcast Corp., Cox Communications Inc., Charter Communications Inc., Insight Communications Co. Inc., Cablevision Systems Corp. and Mediacom Communications Corp.-are at or near bottom-trading limits.

For example, he put the per-subscriber values for Adelphia at $2,491, Cablevision at $3,779, Charter at $3,364, Comcast at $3,349, Cox at $3,310, Insight at $2,731 and Mediacom at $2,842.

LAGGING THE PRIVATES

Those ranges, Shapiro wrote, are substantially below private-market values, which have averaged between $4,500 and $5,000 per subscriber.

And recent deals have shown that private-market values for cable, at least in some instances, surpass the $5,000-per- subscriber average, "suggesting that the 'smart money' believes cable subs are worth a lot more than $3,000 each."

Shapiro's formula found that the perpetuity value of a cable subscriber is about $2,700, and when public values reach that level, "the market is essentially assuming that cable is a no-growth video utility with little or no prospect for success in deploying high-speed-data, telephony, video-on-demand, interactive-TV, small-business data and telephony services, or anything else."

The picture isn't much different when the other methods are employed. Shapiro tacked a terminal-value multiple of nine times cash flow (the average regional Bell operating company takeout multiple) onto cable stocks and came up with target prices that were either higher or slightly lower than the stocks' current prices.

The only exception was Cox, and Shapiro said this was most likely due to that MSO's high visibility and its viable cable-telephony revenue stream (about $81.4 million in the first half of this year).

In that analysis, Adelphia stock would trade at $50.17 per share, 46 percent over its Sept. 5 close of $34.38. Cox, which closed at $35.50 Sept. 5, would trade at $27.81 using that benchmark, a 22 percent decrease from its current trading value.

"For Cox in particular, we view this as an overly conservative valuation method," Shapiro wrote.

Cable stocks had traded as low as six times to 11 times forward 12-month cash flow for most of the 1990s until they broke out of that range in 1997.

That year-the year Microsoft Corp. invested $1 billion in Comcast stock-cable multiples shot up to the 16 times to 21 times cash-flow range. But that growth was not sustained, as cable stocks are currently trading at between 10 times and 14 times cash flow.

MULTIPLE REASONING

Finally, Shapiro noted that while cable multiples are higher than in the earlier part of the 1990s-causing some investors to claim that cable stocks are not cheap-he questioned the validity of looking at current multiples versus multiples over time.

Shapiro said it was more common to compare earnings-valued stocks by looking at the premium or discount of a stock's multiple relative to the market multiple, rather than against what multiples the stock has achieved at other times.

When that analysis is done-comparing the average cable multiple to the S & P Industrial multiple during the past 10 years-a much different conclusion is raised. The average cable multiple is in the 20 percent range, well below the high of nearly an 80 percent premium the group reached on several occasions and the average premium of about 40 percent for the group since 1990.

"So while the absolute range of cable [cash-flow] multiples today is still not cheap relative to the absolute historical range, a relative analysis shows that the multiples are historically cheaper than they look," he wrote.

Shapiro's conclusion is that while cable stocks may not have bottomed out yet, many are closer than most investors realize.

While other analysts may not share Shapiro's conclusions exactly, most agreed that cable stocks are undervalued.

SG Cowen Securities Corp. analyst Gary Farber said that by his estimates, cable stocks are trading at between 11.2 times and 13 times year-2000 cash flow.

"That's near the bottom," he said. "But the value players aren't the guys that are going to take these stocks ripping out of their current states."

JUMP-START NEEDED

Farber said that while there appear to be a few bargains in the cable sector-he pointed out Cablevision and Comcast-the sector as a whole will have to exceed cash-flow growth expectations and new-service benchmarks to break out of the doldrums.

"There are a couple of inflection points to look at," Farber said. "By the second half of the year, you're probably going to start to see digital [cable] begin to outstrip the satellite business. For the data market, the inflection point is retail. You'll start to see that in the third and fourth quarter."

He added, "I think the stocks clearly move up from where they are, but just the fact that they're cheap isn't going to be enough of a catalyst. They've been cheap all year, and the companies have been putting up good numbers."

PaineWebber Inc. vice president of research Thomas Eagan said the downturn in cable stocks this year is due to several factors, including lingering regulatory uncertainty and concerns about competition, particularly from digital-subscriber-line services.

Eagan added that cable companies are well positioned to capture a large portion of the high-speed-data market from their DSL competitors. But he said cable operators don't need to gain a huge market share right away to be profitable, stating that a 14 percent take-rate for data would give operators significant returns on their investments.

For example, Eagan estimated that Comcast could get a 45 percent return on investment in the data segment even if it never gets beyond a 14.5 percent take-rate for the service by 2002.

"There is enough business out there," he added. "This is not a VHS-[Betamax] battle of the 1970s, where one technology won and one lost."

And though Eagan agreed that cable stocks are currently undervalued-he estimated that as a sector, cable is trading at between 9.5 times and 12 times cash flow-he wondered whether it matters if the sector has hit bottom.

"There were lower multiples in 1997, before Microsoft made its investment in Comcast," he said. "The current investment atmosphere reminds me of early 1997-cable companies had double-digit cash-flow growth, and the stock market couldn't give a damn."

Eagan said the main benchmark for cable stocks is maintaining cash-flow growth of 10 percent to 12 percent per quarter. Although most operators have been meeting that goal-with the exception of Cox-some cable stocks are getting hammered due to market trepidation, he added.

Most cable companies are hitting or meeting targets for install rates for digital cable and high-speed data. While there have been some pullbacks on install rates, Eagan said that for the most part, cable operators are doing what they said they would do.

"We think there are companies where the baby is being thrown out with the bathwater," Eagan said. "Certain companies that are well-positioned are being hurt by the overall concerns for the industry. And that, to me, doesn't make sense."