What a relief

12/21/2003 7:00 PM Eastern

After three years of significant declines, the cable sector rose to its feet in 2003, with the eight publicly traded MSOs reporting an 18.2% increase in their combined stock prices during the year.

Cable stocks had been down for three consecutive years — 55% in 2002, 15% in 2001 and 26% in 2000.

Leading the pack was Charter Communications Inc., which saw its stock price more than triple between Jan. 2, 2003 and Dec. 18 from $1.25 per share to $4.12 each. Other big gainers were Time Warner Inc. (up 34.3% to $17.87 from $13.31); Comcast Corp. (up 27.7% from $23.86 to $30.46); Cox Communications Inc. (up 15.7% from $29.78 to $34.47); Cablevision Systems Corp. (up 25.1% from $17.71 to $22.15) and Adelphia Communications Corp. (up 375% from 8 cents to 38 cents).

Only two MSOs saw their stock prices decline — Insight Communications Co. (down 21% from $12.80 to $10.11) and Mediacom Communications Corp. (down 7.6%, from $9.25 to $8.55) — the result of losing several thousand subscribers to direct-broadcast satellite during the year.

The lift in MSO stock prices also helped drive market capitalization in the sector up a healthy clip. The combined market cap of the eight MSOs rose 29.3% ($31.2 billion) in the period, to $137.8 billion from $106.6 billion.

Most analysts believed the reversal was due to several factors: A recovering economy, an effort by several MSOs to simplify their balance sheets, and significant debt reduction by three top cable operators.

The year 2003 was also one in which the long-held promise of free cash flow (cash flow after interest payments and capital expenditures are made) became a reality, with Cox reporting third-quarter free cash flow of $167.5 million — analysts expect it to end the year with $365 million in free cash flow — and several other MSOs expecting positive results.

While basic subscribers continued their decline — most MSOs except Cox and Comcast were predicting basic-customer losses of 0.5% to 1% for the year — advanced-services growth (mainly in high-speed data) more than took up the slack.

Stifel Nicolaus & Co. cable analyst Ted Henderson, who has been aggressively bullish on the cable space, said that investors are beginning to realize the potential of cable's robust infrastructure.

"I wasn't surprised, after three years of carnage, that these stocks performed well," Henderson said. "These stocks, fairly or unfairly, to their benefit during the bubble and to their detriment after the bubble, were tied to the telecom landscape."

Competition's Up

Henderson was most encouraged by cable's ability to report strong financial numbers as competition increased.

"2003 was a year when companies were getting their arms around their balance sheets, facing the final launches of local-to-local in all their markets by the DBS guys, facing extreme pricing competition from DBS and DSL, and they continued to post what I consider to be very attractive numbers for 2003," Henderson said. "I frankly think the stock performance in '03 didn't reflect that performance, it more reflected concern about the competitive landscape."

Henderson added that MSO stock performance was in line with the overall market (the Dow Jones Industrial Average rose 19.3% during the period) and was optimistic that 2004 would be an even stronger year for the sector as MSO's aggressively rollout voice-over-Internet-protocol service, introduce new video products like HDTV, digital video recorders and video-on-demand, and generate greater amounts of free cash flow.

Fulcrum Global Partners cable analyst Richard Greenfield was not nearly as bullish for 2004.

Greenfield said the growth in MSO stock prices in 2003 can be misleading, as most of it occurred in the first four months of the year. And he was mostly concerned about competitive threats from DirecTV Inc. — which is expected to be acquired by Rupert Murdoch's News Corp. before the end of the year — and a rejuvenated EchoStar Communications Corp.

Eighty three percent of the stock price appreciation occurred between January and April. After that time, several regional Bell operating companies began aggressively cutting prices for DSL service in an attempt to take share from cable operators.

"It's all front-end rated, driven by an overreaction on the downside in 2002," Greenfield said. "Looking forward to 2004, while I believe that cable has the best-positioned platform, in reality with growth rates that are slowing, free cash flow at its very early stages and as Rupert Murdoch and [EchoStar chairman] Charlie Ergen become more aggressive, the near-term view is very murky."

Cohen's Bullish

Merrill Lynch & Co. analyst Jessica Reif Cohen agreed that the future for cable isn't crystal clear, but she was still bullish on the opportunities in the sector.

While data growth is slowing, it is still pretty robust, Reif Cohen said, adding that new products could take up some of the slack.

She added that analysts may be underestimating the potential of VoIP, adding that the same was true early on in the evolution of high-speed data.

Reif Cohen said she is estimating Cablevision will add about 70,000 VoIP customers for all of 2004, but added that might be a very conservative estimate, given that Cablevision added 700,000 digital customers and 300,000 data subscribers in 2003.

"What nobody knows is, what does VoIP do?" Reif Cohen said. "Murky, yes, because you don't know what the response is going to be because it's just starting. I look at our models from years ago on data, and they were way too conservative."

Reif Cohen also gave the industry tremendous credit for simplifying its financial structure and paying down debt this year.

"The balance sheets have improved dramatically, they're finally generating free cash flow. There's a lot of potential that is beginning to be realized," Reif Cohen said.

Breathing Room

Several MSOs made major strides in simplifying their balance sheets in 2003. Cox eliminated a complex set of derivative instruments that had been used in the past to fund acquisitions; Time Warner reduced its debt by more than $4 billion, several months ahead of schedule; and Comcast shed about $7 billion in debt it accumulated in its November 2002 acquisition of AT&T Broadband.

Operationally, most of the MSOs were firing on all cylinders, with Comcast surprising Wall Street by reversing subscriber losses at AT&T Broadband after only two quarters at the helm.

Charter managed to conduct some pretty innovative financial engineering on its own. While basic subscribers continued to decline in the first half of the year — there was a slight uptick in the third quarter, mainly because of special promotions — Charter managed significant growth in digital and high-speed data subscribers.

That helped reverse a negative free cash flow trend: Charter generated $96 million in free cash flow in the first nine months of 2003, an improvement of $1.1 billion over the same period in 2002.

Stock By Stock
MSO stock prices rose an overall 18.2% through Dec. 18, 2003. A breakdown:
Price 1/2/03 Price 12/18/03 %Change
Source: NASDAQ Web site.
Time Warner$13.31$17.8734.3

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