Cablevision’s New Spin

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Over the past few decades, Cablevision Systems Corp. has been a model of vertical integration, acquiring regional and national programming, sports teams and venues, and a retail electronics chain to complement its cable assets. But for the last few years, the Bethpage, N.Y.-based MSO has been working hard to undo all of that, culminating in last October’s announcement that the company would split into two separate publicly traded entities.

The move to break up Cablevision’s assets is actually more in tune with the company’s strategy to concentrate on its New York-area holdings.

According to Cablevision, the split — slated for sometime in the fall — will cleave the company into one unit consisting of its cable systems, its Lightpath business telephony division, its New York regional sports networks, Madison Square Garden and Radio City Music Hall and its professional sports teams. The other entity will include its Rainbow Media national programming networks and its Rainbow DBS high-definition television service.

Current Cablevision CEO James Dolan will become chairman and CEO of the direct broadcast satellite unit after the split. His father, Cablevision founder and chairman Charles Dolan, will become chairman of Rainbow Media Entertainment.

Cablevision executives did not make themselves available for this story. But others shed some perspective on the drawing-board strategy.

Tom Eagan, a cable and satellite analyst for Oppenheimer & Co., notes that Cablevision’s past attempts at expanding its vertical-integration model didn’t exactly work out as planned — such as its acquisition of Clearview Cinemas movie theater chain and The Wiz Inc.’s chain of consumer electronics stores. Even though those moves ultimately failed, they did give Cablevision certain advantages, Eagan says. He points to Cablevision’s purchase of the then-bankrupt Wiz in 1998 as an example.

“I thought their idea of buying The Wiz was an interesting one,” Eagan says. “It just happened that the consumer-electronics market fell apart more than they expected. But it did allow them to jump-start the penetration in high-speed data [by selling cable modems in The Wiz] and they’ve kept that lead over most cable operators.

“I wouldn’t say they are unwinding the vertical-integration strategy as much as they have been opportunistic in trying to find the best way to take advantage of their assets,” adds Eagan. “At this point, they obviously feel that there is no reason to keep content together with the cable distribution. I would kind of agree with that.”

NEW YORK FOCUS

Cablevision initiated a New York-centric strategy in 2000, when it agreed to sell its Boston and Cleveland systems to AT&T Broadband (now Comcast Corp.) and Adelphia Communications Corp. for $1.8 billion and $1.5 billion respectively.

That strategy continued with the sale of national programming network Bravo to General Electric Co.’s NBC broadcast unit in 2002 for $1.25 billion.

Cablevision also sold its interest in wireless venture Northcoast Communications to Verizon Communications Inc. in 2002 for $750 million. (Chuck Dolan’s nephew, John Dolan, still owns 49% of Northcoast.)

The deals streamlined Cablevision’s operations while raising some needed cash to help pay down debt.

At the time, Cablevision had been under fire from analysts concerning a possible $500 million funding shortfall in 2003, an issue that was resolved with the sales. Cablevision further mollified Wall Street by shuttering its money-losing Wiz stores and putting Clearview Cinemas up for sale. (Unable to find a buyer for Clearview, the theater unit will become part of the Rainbow Media Entertainment unit once it is spun off.)

THE DBS CASH DRAIN

But analysts still hammered Cablevision for its Rainbow DBS effort, which they called too costly and too late. Even when Cablevision rolled out the service in October 2003 — renaming it Voom, and making it an HDTV-focused service — analysts still worried that Cablevision could be stuck holding a very large financing bag.

And that fear was warranted. Rainbow DBS had already blown through more than $400 million to fund the development and launch of its satellite, and more money was needed. By spinning off Rainbow DBS into a separate entity — buoyed by the cash flows from the national networks — the satellite venture would have a deal currency in a newly public stock and could seek its own debt financing without burdening Cablevision operations.

But not every analyst was initially enamored with the spinoff. In an October research report, Prudential Equity Group cable analyst Katherine Styponias called the move an effort by Cablevision to destroy shareholder value. She feared that without the content assets, Cablevision stock would plummet. Most analysts have put a $6 to $7 per-share value on the content assets.

“While the planned spinoff puts an end in sight to the potential exposure [Cablevision] shareholders face for the satellite venture, the fact that management is willing to destroy Cablevision shareholder value in order to meet its own strategic and financial goals suggests to us that the stock will continue to receive a hefty discount to its fair market value,” Styponias wrote.

Eagan sees the spinoff as a very good move. “What people say is that it [the spinoff] was a bad use of the cable-network cash flows,” he says. “I didn’t agree with that. I thought they created a more fulfilling Rainbow — obviously the previous spinoff didn’t work that well because they didn’t put enough assets into the spunoff company. To me, they are creating a bigger spinoff that I think will attract more investment.”

With the overhang of the DBS operations and other distractions out of the way, Cablevision can concentrate on selling advanced services like digital cable, high-speed data and telephony.

LATE DIGITAL BLOOMER

Cablevision was late to the game in its digital launch — hampered by a disastrous set-top-box agreement with Sony Corp. originally signed in 1999. But it quickly rectified that situation, scrapping the Sony deal and forging an agreement with Scientific-Atlanta Inc. in August 2002. Since then, it has been growing digital customers at a healthy clip. Branded iO: Interactive Optimum, the digital service now has about 1.1 million customers and has been adding new subscribers at a rate of about 50,000 per month.

High-speed data has been a much better story. Cablevision was extremely aggressive in rolling out its Optimum Online high-speed service early (it launched in 1997) and has one of the highest penetration rates (26%) in the cable industry.

Voice service — dubbed Optimum Voice — also appears to be catching on quickly. Launched late last year, Cablevision outpaced analysts’ expectations by signing on 5,000 voice customers in its first month of operation. Currently at 70,800 subscribers, analysts predict the service will add another 40,000 subscribers in the second quarter.

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