Cable Operators

Get Ready to Measure 'Steady’ Cash Flow

3/13/2005 7:00 PM Eastern

As if cable operators haven’t had enough trouble finally getting their arms around the latest metric to value their operations — free cash flow — a top Wall Street analyst has introduced another new buzzword for the industry’s financial set: steady-state cash flow.

There could be a payoff for embracing the new term. Steady-state cash flow, as defined by Sanford Bernstein & Co. cable analyst Craig Moffett, could finally explain the huge valuation gap between cable and direct-broadcast satellite service providers.

The New Math
Enterprise Value Per Subscriber
Source: Sanford Bernstein estimates
Cablevision $4,365
Comcast $3,597
Insight $3,408
Charter $2,993
Mediacom $2,514
EchoStar $1,648
DirecTV $1,418
Source: Sanford Bernstein estimates
Steady-State Cash Flow Per Subscriber
Cablevision $260
Comcast $261
Insight $243
Charter $266
Mediacom $203
EchoStar $150
DirecTV $137
Source: Sanford Bernstein estimates
Steady-State Cash Flow Multiples
Cablevision 16.8x
Comcast 13.8x
Insight 14x
Charter 11.2x
Mediacom 12.4x
EchoStar 11x
DirecTV 10.4x

Steady-state cash flow is not meant to replace free cash flow — defined as cash flow after interest payments and capital expenditures are made — but to indicate the future potential of the latter metric.

SNAPSHOT OF CAPACITY

“The [steady-state cash flow] metric is intended to capture a snapshot of the cash-generation efficiency of the business when growth slows down,” Moffett wrote in a research report last week. “As such, it is a shorthand approximation of free cash-flow capacity, which will eventually become the appropriate basis for valuation.”

Moffett outlined the case for steady-state cash flow — which he defines as the cash generated by the business after the cost of replacing subscribers lost to churn, but before the cost of new-subscriber growth. More simply put, steady-state cash flow is cash flow (earnings before interest, taxes, depreciation and amortization), less the capital expenditures for customer-premises equipment (CPE) such as set-top boxes, cable modems, voice-over-Internet protocol telephony gear, digital video recorders or line extensions.

In short, CPE and line-extension capex is analogous to subscriber-acquisition costs for DBS, while the expansion of the cable footprint — new home passings — is analogous to churn replacement for satellite, Moffett wrote.

Moffett first used the steady-state cash flow metric to better evaluate DBS companies, which traditionally have high subscriber-acquisition costs and strong subscriber growth. The idea behind steady-state cash flow — which sits between the other often-used metrics of EBITDA and free cash flow — is that it more accurately measures the health of a business when subscriber growth begins to level off.

STEADY STATE NOW

According to Moffett, cable is already at steady state. Subscriber growth has been flat for several years.

But that isn’t necessarily bad, he says. With growth flat, cash flow per subscriber growth at MSOs basically mirrors overall cash-flow growth.

Another key to the metric is that it eliminates the controversy surrounding expensed versus capitalized subscriber acquisition costs. The argument in the past has been that cable companies subsidize equipment costs just as much as DBS operators do, but because MSOs capitalize the investment instead of expensing it, as the DBS providers do, most of those costs are excluded from the MSOs’ EBITDA line.

Steady-state cash flow deducts SAC spent, regardless of whether it is expensed or capitalized.

The metric, Moffett writes, goes “a long way towards answering the vexing question of why cable subscribers are worth $3,000 to $4,000 per subscriber, while satellite subscribers are worth only half that.”

What Moffett found after crunching the numbers is pretty surprising: cable operators, despite flat customer growth over the past few years, are generating oodles of steady-state cash flow, outpacing the DBS companies by as much as 90%.

According to Moffett’s calculations, the two largest generators of steady-state cash flow are Comcast Corp. and Cablevision Systems Corp.

COMCAST’S EFFICIENT

Although Comcast’s CPE and line extension capex was nearly five times greater (at $1.8 billion) than Cablevision’s (at $459 million) in 2004 — and Cablevision generated more EBITDA and revenue per subscriber — Comcast neutralized that advantage with greater capital efficiency, according to Moffett’s report.

Cablevision has the highest average revenue per unit in the industry ($87.17), the highest data penetration (at 30%) and is among the leaders in digital penetration (at 50%). Its steady-state cash flow was nearly identical to Comcast’s, which had $77.29 ARPU and 17.5% data and 40.2% digital penetration in 2004.

Comcast reported EBITDA of $7.5 billion in 2004 ($347.49 per subscriber), making its steady state cash flow for the year $5.62 billion, or $261 per subscriber, a 24% increase. Cablevision’s $1.2 billion in EBITDA ($415.37 per subscriber) translated into $768 million ($260 per subscriber) in steady state cash flow for the year, a 46% increase. In contrast, EchoStar Communications Corp. had steady-state cash flow of $150 per subscriber (flat compared to 2003) and DirecTV Inc.’s steady-state cash flow declined 2% in 2004, to $137 per subscriber. That was despite a 25% revenue increase at EchoStar and 27% revenue growth at DirecTV during the year.

Moffett said that while subscriber additions appear to be the main driver for steady-state cash flow growth for DBS for the foreseeable future, the catalyst for MSOs appears to be the additional revenue from selling more services to the same subscriber base.

CHARTER HIGH ON LIST

Charter Communications Inc. actually had the highest steady-state cash flow per subscriber among the public MSOs at $266, but Moffett wrote that more likely reflects under-investment in CPE rather than operational strength.

Rounding out the MSOs Moffett analyzed are Insight Communications Co., with $243 in steady-state cash flow per customer in 2004, and Mediacom Communications Corp., at $203.

And Moffett believes that the trend will continue at least for the next few years, as cable operators step up their telephony rollouts. Cablevision and Comcast will report steady-state cash flow growth of 15% to 20% for the next three to five years, he predicted.

Because of their faster steady state cash-flow growth rates, Moffett added, cable stocks enjoy a slight premium to their DBS competitors. It also translates into higher multiples for cable stocks as opposed to DBS shares. For example, Cablevision and Comcast trade at multiples of 16.8 times and 13.8 times steady-state cash flow, compared to 11 times for EchoStar and 10.4 times for DirecTV.

September