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Ex-Cable Analyst Returns, as a Bull

6/16/2002 8:00 PM Eastern

After a nearly two-year hiatus, former Janco Partners cable analyst Ted Henderson has resurfaced, with a new firm and a renewed bullishness on cable.

Henderson, who joined the Denver office of St. Louis-based investment banker Stifel Nicolaus & Co. in April as senior vice president of equity research, has issued a sweeping report on the cable sector. There hasn't been a better time in recent memory to invest in cable operators, he said.

Henderson left Janco in August 2000 to become CEO of Golf-Tek, a golf instruction company in Denver, his home base — bailing out just as the cable sector was starting its current decline.

But now, Henderson is singing a different tune, rating most of the cable sector either "strong buy" or "buy." Adelphia Communications Corp. is the lone exception, with a "no rating." Cable stocks are rapidly approaching their bottom and represent a strong buying opportunity, he claimed.

'LIKE FALLING BLADES'

The sector is down about 50 percent since the beginning of the year, so it's certainly arguable that stocks are near the bottom.

"These stocks have been like falling blades," Henderson said in an interview. "And if you've tried to catch a falling knife over the last couple of months in these cable stocks, it's pierced your heart as it continued to fall."

But Henderson believes that the cable story is playing itself out right now. The sector has shown steady growth in new revenue-generating units over the past three quarters, while revenue and earnings before interest, taxes, depreciation and amortization (EBIDTA, also known as cash flow) has been growing at double-digit rates.

"That would lead you to a reasonable terminal multiple of about 10 times [yearly cash flow]," Henderson said.

Henderson stressed that he is not predicting an immediate turnaround in the cable sector. But he said the industry has little room to go anywhere but up.

"We're trying to put these [stocks] on people's radar screens," Henderson said. "There is no inflection point where these stocks are going to turn on a dime."

CHARTER'S COURSE

Instead, Henderson sees an upside to cable stocks beginning in the next 18 to 24 months. Among his best picks are Charter Communications Inc., Comcast Corp. and Cox Communications Inc.

Charter, which has been hammered lately mainly because of its highly leveraged balance sheet, is being treated unfairly by the market, Henderson contended. The stock, which hit a new 52-week low last week of $4.35 — it closed at $4.74 June 12 — has also been troubled by the controversy surrounding Adelphia and its off-balance sheet debt.

While Charter has not been accused of any similar wrongdoing, it has been hurt by its association with Adelphia in the press. It was rumored to have been in talks to buy Adelphia's Los Angeles systems, discussions that reportedly broke down over price.

Charter stock has fallen about 71 percent since the beginning of the year. Henderson initiated coverage of Charter when the stock was at $8 per share, and has set an $18-per-share target price on the stock.

"We weren't banging the table at $8 saying, 'You've got to own this now,' " Henderson said. "Now it's at $4.74, and I'm banging the table at meetings today."

Henderson said another issue surrounding Charter — its loss of 149,000 mostly non-paying subscribers in the first quarter — could prove to be a good move.

"[Charter CEO] Carl Vogel wrote off those subscribers in first-quarter of '02. He quickly came in and said 'Let's clean house.' At the end of the day I think it's the right move — bite the bullet and move forward."

FREE CASH FLOW?

Comcast and Cox have simply the best balance sheets in the industry and their stocks, until recently, have proven it. Cox has also been at the forefront of bundling a "triple play" of new services — voice, video and data — and has a growing percentage of customers taking all three services.

But what ultimately will spike cable stocks is a return to positive free cash flow (EBITDA minus capital expenditures), a metric that was touted about two years ago, but abandoned after MSOs accelerated their capital-expenditure plans to modernize their plant.

But with most operators nearing the end of the rebuild cycle, Henderson said that free cash flow will become commonplace in the industry in the next few years.

Comcast is expected to be the first MSO to show free cash flow this year; others should follow suit by 2003 and 2004.

"You absolutely want to own these stocks before they get to free cash flow," Henderson said. "When they can cover interest and cap ex, they will make the argument that will stand the test of time."

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