Cable Operators

Cable Stocks Just Can’t Win for Losing

1/06/2006 7:00 PM Eastern

Despite continuing to report double-digit revenue and cash-flow growth, cable operators weathered another year of declining stock prices, as investors instead chose to hone in on basic-subscriber losses and the potential threat of telephone companies and other forms of distribution muscling in on their core video business.

On the whole, cable stocks were down about 10% in 2005, the second consecutive year of declines (MSO stocks dipped 8% in 2004).

Tale of the Tape
MSO Stock Prices 2005
Company 1/03/05 12/30/05 % Change
Insight $9.31 $11.75* 26.2
Cablevision $24.92 $23.47 -5.8
Time Warner $19.43 $17.44 -10.2
Mediacom $6.45 $5.49 -14.9
Comcast $32.39 $25.69 -20.7
Charter $2.23 $1.22 -45.3
Source: NASDAQ Web site
* Insight went private on Dec. 16. Its stock price is as of Dec. 16

COMCAST EXAMPLE

One glaring example of the disparity between financial performance and stock prices is Comcast Corp. The Philadelphia-based company’s cable operations reported 14.3% operating cash flow growth and 9.9% revenue growth for the nine months ended Sept. 30.

Also during that period, Comcast added 1 million high-speed Internet customers (ending the third quarter with 8.1 million subscribers, making it the second-largest Internet-service provider in the country); and added 790,000 digital-cable customers. Basic subscribers declined by 152,000 customers in the nine-month period.

But despite those gains — and mainly because of the basic-subscriber losses and the sluggish initial rollout of telephone service — Comcast stock was one of the worst performers in the MSO sector, declining 20.7% between Jan. 3 and Dec. 30.

Leading the list of decliners was Charter Communications Inc., which saw its stock dip 45.3% ($1.01 per share) between Jan. 3 and Dec. 30, followed by Comcast, Mediacom Communications Corp. (-14.9%), Time Warner Inc. (-10.2%) and Cablevision (-5.8%). Insight Communications Co., which completed its plans to go private on Dec. 16, was the sole MSO to show a gain for the year, up 26.2%.

“I think it’s wildly frustrating,” Janco Partners cable analyst Matt Harrigan said of the disparity between MSO stock prices and their financial performance. “The whole equity market is characterized by multiple compression. You can’t really lose sight of that. That’s an issue that pertains to everybody, not just to cable companies.”

UBS Warburg cable debt and equity analyst Aryeh Bourkoff said that the coming of true telco video competition, concerns over the spread of programming content to portable media devices like the iPod, concerns over rising capital expenditures and fears that broadband alternatives like wireless fidelity (Wi-Fi) and broadband over power lines will cut into cable’s high-speed Internet business, have all weighed heavily on the stocks.

According to Bourkoff, average cable valuations last year were about 6.5 times 2006 estimated cash flow, their lowest point since 1994, when the industry was bogged down by fears of increased federal regulation.

At the same time, private equity has shown strong interest in cable properties and has been paying robust prices in excess of public valuations for cable systems.

“The issue is, who’s wrong?” Bourkoff said. “The public equities in cable stocks are oversold, given the competitive positioning, and are priced for a destructive state, which may not materialize in 2006 and could lift the sector somewhat.”

Investor sentiment concerning cable stocks has been at its lowest levels in years, Bourkoff added, a situation which could change in 2006.

WHAT COULD HELP

“It’s hard to see sentiment getting much worse for cable, which usually is a sign of a bottom,” Bourkoff said. “I think that sentiment could shift sparked by a number of different factors.”

Those factors include a successful voice rollout by Comcast, free cash flow models holding to current expectations and transactions that would highlight value, like major stock buybacks.

The single factor that lifted some MSO stocks in 2005 wasn’t tied to performance, but more to the prospect of going private.

Cablevision experienced a big boost in its stock in June, when the Dolan family announced a plan to buy the remaining 80% of company stock it didn’t own for $7.9 billion. That deal, which would have given Cablevision shareholders $21 per share in cash and $12.50 per share in stock in a new, publicly traded Rainbow Media Holdings Inc., sent the stock soaring 19% from $26.87 on June 17 to $32 on June 20.

But by October, the Dolans’ withdrew their offer for the company — some say because they were unwilling to increase their price — and the stock settled back to earth. Cablevision closed at $23.47 on Dec. 30, down 5.8% from $24.92 on Jan. 3.

In contrast, Insight, which completed its plan to go private on Dec. 16, maintained the momentum it created in March — when chairman Sidney Knafel and CEO Michael Willner teamed up with private-equity firm The Carlyle Group to buy the remaining 86% of Insight shares they didn’t already own for $11.75 per share, or about $710 million — through the end of the year. Insight completed that transaction on Dec. 16 and the stock ceased trading that day, closing at $11.75.

Comcast got a taste of investor reaction to increased capex when it told analysts on its Nov. 3 third-quarter conference call that it was raising its capital expenditure guidance for the year to $3.5 billion from between $3.2 billion and $3.3 billion. Almost immediately after that announcement, Comcast stock took a body blow, dipping 5.3% ($1.50) to $26.80 from $28.30 the previous day. Comcast shares never really recovered, closing at $25.69 on Dec. 30.

That kind of reaction from Wall Street forced some cable companies to rethink spending late in 2005, which also affected vendors. On Jan. 4, cable-equipment maker C-COR Inc. said it would restructure operations and let go 225 workers in part because of operators that either pulled back on capital expenditures late in the year or concentrated their spending on a few key areas.

EAGAN SEES UPSIDE

Oppenheimer & Co. cable and satellite analyst Tom Eagan believes cable stocks will perform better in 2006, based mainly on what he sees as fewer basic-subscriber losses and delays in the rollout of video services from telephone companies.

Eagan said basic-subscriber losses in 2006 should be about 150,000 for the major cable companies, down from an estimated 232,000 in 2005.

Eagan also expects voice over Internet protocol telephone service from cable companies to double its subscribers in 2006, from 2.85 million to 5.95 million, with Comcast representing the biggest chunk at 3.1 million voice customers.

September