Cable Operators

Taking Stock and Looking Ahead To the Next Big Deal

9/22/2006 8:00 PM Eastern

With its stock up 35% since the beginning of the year and its operations firing on all cylinders — revenue and cash flow are up by double digits and subscriber metrics are outpacing analyst estimates — Comcast Corp.’s tandem chief financial officers, John Alchin and Lawrence Smith, are two understandably happy guys.

Former banker Alchin, who is executive vice president and treasurer, as well as co-CFO, is Comcast’s primary face for Wall Street. Smith, an 18-year Comcast veteran and also executive vice president and co-CFO, has been the cable giant’s primary deal-maker.

Alchin is obviously pleased with Comcast’s performance in the first half of the year. In an interview last month, he said while Comcast has outperformed Wall Street expectations so far, that shouldn’t come as a surprise. Alchin added, with two solid quarters of growth in its telephony product behind it — and more to come — Wall Street is beginning to get the idea that the threat from regional Bell operating companies isn’t quite as dire as once anticipated.

The bump in the stock price is largely because of recent operating performance, but also “reflects the changing perception of the company’s and the industry’s ability to compete against the likes of the telcos getting into businesses we had been in traditionally,” Alchin said.

“What got too little credit is what we saw with the results in the fourth quarter last year and the first quarter of this year,” Alchin continued. “Right around the NCTA [National Show in April], the stock really started to appreciate. I don’t think there are any doubts in the minds of investors that the triple play is an incredibly successful package.”

And even with the joint purchase of Adelphia Communications Corp. with Time Warner Cable completed in July, Smith said there are still a few more deals left on the agenda.

Lawerence Smith (l.) and John Alchin see more deals ahead on their post-Adelphia agenda.

UNWINDING INSIGHT

Next up will likely be the unwinding of Comcast’s 50% interest in Insight Communications Co., probably sometime in the fall. Comcast has had the right to initiate a dissolution of the partnership since Dec. 31, 2005. But the country’s largest cable operator has opted not to pull the trigger yet, which would give it control of about half of Insight’s 1.3 million subscribers mainly in Indiana, primarily because of tax reasons.

Comcast has waited because the original structure of the deal — first created by AT&T Broadband in 1999 — required that the partnership remain intact for at least seven years. Comcast inherited the Insight partnership in 2002 when it acquired AT&T Broadband for $54 billion.

“We could do something with Insight right now, but for tax reasons we’re not doing it,” Smith said. “We have had discussions with them but we’re not in active negotiations with them on how to break it up.”

Smith said that Comcast will revisit the Insight split in November, but there is no move to acquire the entire company.

“I don’t think they want that,” Smith said. “They’re a private company, and certainly we would never do anything hostile with them.”

While there are other systems deals on the horizon, none of them approaches the size of the Adelphia deal.

“There is still a lot of consolidation that can be done, believe it or not,” Smith said in an interview last month. “It’s relatively small, but there are still a number of cable companies that are out there. In our large markets, there are small pieces we can pick up.”

SURPRISE MOVE

One deal that appears to have gotten away from the company is the split of Kansas City Partners and Texas Cable Partners partnerships with Time Warner Inc. Either party had the right to trigger a split after June 1, with the non-triggering party getting the right to choose one of two pools of systems: either the 790,000-subscriber Kansas City Partners systems, with the bulk of its customers in southwest Texas, Kansas City and parts of New Mexico; or Time Warner’s Houston system, with about 800,000 subscribers. Analysts had expected Comcast to gain control of the Kansas City systems, mainly because it already had subscribers in that area. And Houston appeared to be one of Time Warner Cable’s jewels — it is one of the company’s premier turn-around stories.

Comcast apparently thought the same, and — as was its right — allocated almost all of the debt from both partnerships on the Houston systems. In a surprise move, Time Warner opted for the nearly debt-free Kansas City cluster.

“I think they overplayed their hand,” said Sanford Bernstein & Co. cable and satellite analyst Craig Moffett of Comcast. “They knew that Time Warner wanted Houston so badly, they put all of the debt on it.”

In an August conference call with analyst to discuss its second-quarter results, Time Warner chairman Richard Parsons said that the debt was the main reason the company chose the Kansas City cluster.

“As we looked at it, with the transfer of virtually all of the debt to the Houston pool … we simply concluded that the greater value from our shareholders’ point of view was to take the Kansas City, southwest Texas and the New Mexico pool,” Parsons said on the conference call.

Smith, while conceding that Time Warner’s selection was unexpected, still thinks the separation was a good one for both parties.

“We are very happy with the result,” Smith said. “We are surprised that Time Warner didn’t take Houston. But we’re very, very happy to have Houston.”

Smith said though content deals are an option, the climate isn’t much better than that for cable systems.

“Content is hard too,” he said. “We’ve really been doing more organic growing than acquisitions.”

Oppenheimer & Co. cable and satellite analyst Tom Eagan said that aside from small tuck-in systems acquisitions Comcast could either buy or swap with Charter Communications Inc. — particularly in the southeast, and northern California — content should be a likely target for the operator.

“I don’t think there’s a need for more systems acquisitions,” Eagan said. “The market would not like to see Comcast just be a serial acquirer.”

But he said that content, either in the form of regional sports networks or even premium channel Showtime Networks Inc., could be an attractive target.

“I think they should buy Showtime [Networks Inc.],” Eagan said. “Given their access, they could do for Showtime what Time Warner did for HBO.”

Aside from the deal market, Comcast has been active in buying back its shares — it has repurchased about $6.4 billion of its stock in the past 18 months — and has done several deals to extend maturities and lower interest rates on its existing debt.

With about $24 billion in debt as of June 30, Alchin said that the Adelphia deal will tick up its leverage to around $27 billion, or around 2.6 times cash flow. Alchin said the goal is for the leverage ratio to fall between 2.5 times to 3 times cash flow.

“One of the advantages to being as big as we are, we’re looking at cash flow this year in the $9.5 billion range, so it takes a lot to move those ratios,” Alchin said.

While analysts would like to see an expanded share buyback plan, Alchin said Comcast has several options to use additional debt.

“We’ve got the financial flexibility and liquidity that enables us to return sizeable amounts of capital to the shareholders. We’ve done that consistently,” Alchin said. “But what we’ve also done is to balance the investment strategy between reinvesting in the company and investing for strategic long-term purposes. It just so happens that prior to the Adelphia and Susquehanna [Communications] transactions, there really hadn’t been an awful lot of M&A activity that required incremental capital, so a lot of the capital had been going into the buyback program. But as we find opportunities, we’ll continue to balance between returning capital to shareholders and investing for our own long-term growth in the business.”

March