2006 Gains Lost in '07

1/04/2008 7:00 PM Eastern

Cable stocks, on the heels of a 40% rise in 2006, gave most of those gains back in 2007 as investor sentiment shifted from giddiness over the success of cable phone service to concern over the growing competitive threat of telephone companies and satellite-TV service providers.

The five publicly traded cable stocks were down a collective 28% in 2007, as investors grew more and more concerned about heavy basic-subscriber losses at top operators, better-than-expected gains from telephone companies like Verizon Communications and late-year hints that cable companies may have to spend more to compete.

Charter Communications posted the biggest decline for the year, dropping 61.6%, from $3.05 per share on Jan. 3 to $1.17 each on Dec. 31. Mediacom Communications had the second-largest decline (41.5%, or $3.26 per share), followed by Comcast (35.8%, or $10.18 per share); Time Warner Cable (29.1%, or $11.33 each); and Time Warner Inc. (25.1%, or $5.52 each). Cablevision Systems, which weathered the third rejection by shareholders in as many years of a Dolan family proposal to take the company private, fared the best. Shares of the Bethpage, N.Y.-based cable operator declined just 14.5% ($4.14 per share) for the year.

All Pain, No Gain
Cable stocks in 2007:
Company 1/03/07 12/31/07 % Change
*Time Warner Cable began trading on March 1, 2007.
SOURCE: Nasdaq Web site and Multichannel News research
Time Warner Cable$38.93*$27.60-29.1%
Time Warner Inc.$22.03$16.51-25.1%

Fueling most of the declines was a big drop in basic subscribers as competition grew. Comcast, Time Warner Cable, Cablevision Systems and Charter Communications lost a collective 236,000 basic customers in the first nine months of the year. Verizon Communications and AT&T both became rivals in video services, with the former the biggest surprise.

Verizon ended the third quarter with about 700,000 subscribers for its FiOS TV service, well ahead of expectations. AT&T's U-Verse TV IP-video product, thought by many to be ready for the scrap heap, also enjoyed a late resurgence, ending the quarter with 126,000 customers — more than twice the 51,000 it had in the previous quarter.

“It was a perfect storm of recessionary fears, competitive fears, and maturation of some of the products,” Miller Tabak media analyst David Joyce said. “That said, on the whole, the industry should still be growing [cash flow] north of 10% a year for the foreseeable future.”

That healthy cash-flow growth — and the potential for even more robust growth in the future — is what has some analysts puzzled at the market's reaction to the cable industry.

Joyce estimated that cable stocks in general trade at between 6 times and 6.5 times estimated 2008 cash flow, low for companies that generate as much cash as cable operators. He pointed to the 18-to-20-times-cash-flow multiples the stocks were trading at in 2000, the height of the Internet bubble.

“A lot of cable companies were burning cash then,” Joyce said. “It's odd that when they were burning cash they were trading at a 20 times multiple and now that they are generating cash, they're trading at 6 times.”

But it's those low multiples that Joyce believes will ultimately lead to a resurgence in cable stock prices.

“Based on my price targets, there is quite an unusual and extreme opportunity here,” Joyce said. “There is a great opportunity to buy when there is blood on the streets.”

Joyce estimated that given the potential for 11% to 13% cash flow growth in 2008 and beyond, cable companies should be trading at 11 to 13 times cash-flow multiples.

Pali Research analyst Richard Greenfield said that while a reduction in the value of the sector was expected in 2007, the extent of that reduction was not.

“The reality is that competition is here to stay and probably gets more intense,” Greenfield said. “Any of the competitors should be emboldened by their progress in 2007. Not to mention how the competition's stock prices didn't suffer nearly as much.”

In contrast to the cable industry, Verizon Communications shares rose 15.5% ($5.87 per share) in 2007 and AT&T stock increased 18.9% ($6.61 per share). That, Greenfield added, should serve as an incentive for the phone companies to spend even more money in 2008 to gain video market share.

Greenfield believes that the stock to beat in 2008 will be Cablevision.

Despite its exposure to Verizon — the telco's FiOS product is available to about one in every four Cablevision subscribers — Greenfield believes the operator is one of the best prepared to fight back. And he added that the $544 million in free cash flow that Cablevision is expected to generate in 2008 makes the stock even more attractive.

“A key question to focus on is, what do the Dolans decide to do with their cash? Do they buy back stock? Do they pay a dividend? Or do they go out and buy something stupid? If it's one of the first two, I think the stock goes up dramatically,” Greenfield said.

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