Cover Story: 9 Things You Need To Know About the Market Meltdown


No matter what you call it — meltdown, bloodbath, downturn, carnage, bloody carnage or, as one trader put it, a ”negative uptick” — the recent gyrations in the stock market have been the country’s obsession in the past few weeks. Last week produced historic moments — the Dow Jones Industrial Average fell 777 points on Sept. 29, the largest single-day point drop in the Dow’s 112-year history. That was followed by a 485-point gain in the index on Sept. 30 (the third- largest single-day point gain ever). Congress rejected a $700 billion Wall Street bailout plan on Sept. 29 — the largest government bailout ever and the trigger for the market decline that day. The Senate passed a revised bill, and the House passed the new deal last Friday. Interviews with cable-TV operators, programmers, advertisers and investors — who’ve been along for the ride, like everyone else — yield some answers to the most pressing questions.

1. Will cable stocks continue to hold their own through this mess?
So far, cable stocks held their ground for the first few weeks of the market downturn, falling 1% between Sept. 2 and Sept. 9, 8% between Sept. 8 and 15, and 4% between Sept. 15 and 22. For the month of September, the Dow Jones Industrial Average was down about 10%, while cable shares were down almost 15%.

Fundamentally, the businesses remain sound — most analysts expect strong growth in the third quarter. Miller Tabak media analyst David Joyce said the stocks should hold up for two reasons: they’re already cheap, and cable’s main source of revenue — subscriptions — is not as tied to the vagaries of the economy as the advertising market is. Ad sales represent less than 5% of most cable operators’ business. “Cable companies have the benefit of monthly cash flows, and they invested in subscriber growth for the first half of the year,” Joyce said.

Moreover, cable stocks are generally trading at a multiple of about 6 times cash flow, compared with 16 times cash flow in the go-go late 1990s. And though cable stocks took a big hit last year — the sector was down about 28% — Joyce believes that the stocks have basically bottomed out.

“They are cheap as it is,” Joyce said. “Last year, there was more fear of what the telcos were going to do to them, but they have proven that they can pretty much hold their own.”

2. Will consumers begin dropping premium services?
It seems logical to assume that cash-strapped consumers will trim spending by dropping premium services such as HBO, Showtime and Starz. And that appears to have happened during at least one period of recession.

From 1990 to 1991, pay TV households dipped to 33.735 million from 34.357 million, a decline of 622,000, according to SNL Kagan. The pay services rebounded a bit in 1992.

“There were the tough years during the ’91 recession when it was pretty flat for the full-pay totals,” SNL Kagan senior analyst Deana Myers said.

In the early 1990s, the cable industry was undergoing rate regulation and was in a bit of turmoil, which may have affected pay TV subscriptions, said Tom Southwick, Starz’s senior vice president of corporate communications.

So despite that period in the 1990s, Myers, other analysts and Southwick said that, in general, premium-service subscriptions have held up pretty well during recessions. For example, the pay services overall didn’t lose subscribers during the troubled financial period after the Sept. 11, 2001, terrorist attacks, Myers said.

“Premium services have done pretty well traditionally in economic downturns,” Southwick said. “It’s mostly because it’s such a terrific value versus other forms of entertainment.”

For the first six months of this year, a period when the economy was already in trouble, growth at HBO was sluggish, but there weren’t any subscriber losses. As of June 30, HBO had 28.946 million subscribers, up 88,000 from 28.858 million the same year-ago period, according to SNL Kagan.

Showtime, in contrast, has seen a strong bump up. In the first six months this year Showtime had 15.779 million subscribers, a gain of 1.354 million from 14.425 million a year ago, according to SNL Kagan.

3. What about pay-per-view movies and events?
Pay-per-view and on-demand providers said they’ve seen “robust business” from cable subscribers this year.

In Demand CEO Rob Jacobson said he didn’t know whether that’s because people are opting to save gas by staying home and watching a movie, eating their own popcorn, or because of a robust slate of movie titles, events and concerts for sale.

“We’re seeing healthy growth … and we remain confident the business will remain healthy,” he said.

TVN Entertainment chief operating officer Doug Sylvester was equally bullish, citing the results of a consumer-usage study conducted this summer, at the height of the mortgage-foreclosure crisis. Seventy percent of those polled reported watching something on demand in the 30 days previous to the poll. The No. 1 reason given for using VOD, he added, was that consumers could save on gas and going out to eat by staying in for a movie. Consumers also said they liked immediate access to desired titles and the convenience of the application.

“We continue to grow [in usage] year to year, in low double digits,” Sylvester said, adding the growth is not just in the use of free VOD. The addition of more high-definition fare and movies that are available on the same day and date as DVD releases just add more value to both free and for-pay content, he said.

The fourth quarter should remain strong, vendors said, because of the release of such popular titles as Indiana Jones and the Kingdom of the Crystal Skull, Iron Man and Sex and the City.

4. How will the closing of the debt markets affect cable companies’ ability to borrow money and upgrade?
The closure of the lending markets won’t really have a long-term effect on cable, most analysts agree. In the short term, hardly anyone is lending large sums to anyone.

Still, cable is in an enviable position because it has completed its rebuild (costing $60 billion and lasting a decade) and most of its capital needs for the time being can be funded through existing credit lines and cash generated by the business.

For example, all of the major publicly traded cable operators — with the sole exception of Charter Communications — are free-cash-flow positive already, meaning that the business generates cash after capital expenditures and interest payments are made. And Charter, which has the highest leverage among cable operators — about $20 billion in debt — does not have a big payment due until 2010. Cablevision Systems, which generated $158.4 million in free cash flow in 2007 and is expected to generate more than $500 million in 2008, has a $1.7 billion debt payment due at the end of the third quarter of 2009.

“That’s a long time from now,” Joyce said.

At recent conferences, both Comcast chief financial officer Mike Angelakis and Cablevision CEO James Dolan said they were “comfortable” with their respective company’s debt situation, given existing credit lines and free-cash-flow generation.

5. What will the lending crisis do to cable’s competitors?
For the phone and satellite-TV players, the lending crisis should have little effect. Although Verizon Communications plans to spend $23 billion to lay fiber-optic cable in front of 18 million homes by 2010 and AT&T has committed about $6.5 billion over five years to roll out its U-Verse bundle of TV, Internet and phone service, there shouldn’t be a problem in funding those efforts.

Joyce said that the sheer size of the telcos puts them in a pretty enviable position — in 2007, Verizon had revenue of $93.5 billion and AT&T had revenue of $120 billion. In comparison, the largest cable operator, Comcast, had revenue of about $31 billion in 2007.

“They’re bigger, their absolute dollars are bigger, so they have more levers they can pull,” Joyce said. “AT&T and Verizon also have wireless businesses that are very high-margin and are supporting or maybe subsidizing some of their other efforts.”

6. Will tough economic times spark a price war with the phone companies?
Phone companies, like cable companies and all other publicly owned companies, have return-on-capital targets they have to meet or face the music in a big hit to their stock prices. Miller Tabak’s Joyce said Verizon tried to increase prices in March but quickly pulled them back after a customer backlash. “I’m not sure there is any race to the bottom on pricing,” he said.

Eagan said that, while telcos have experimented with various promotional offerings, they are beginning to be constrained by their return on investment.

“The more they drop their prices, the lower the return is,” Eagan said. “To some degree, that’s going to put some kind of floor on the amount of promotions that they are going to offer.”

Cable operators have vehemently opposed getting caught up in a price war with telcos — they resisted it earlier in the decade with high-speed data service — and they have managed to do the same as telcos have entered the video market.

According to the NCTA, the average monthly price for expanded-basic video in 2007 was $42.76; tack on digital high-speed data and telephone service, and the monthly bill rises to about $130 per month. Analysts say it’s likely that more people will opt for triple- or double-play cable packages in an attempt to cut their phone bills. Said Suddenlink Communications spokesman Pete Abel, “The economy is forcing some households to cut back, so they’re consolidating providers to cut costs but keep services. And we benefit from that.”

Cable has pushed the value proposition of the service while telcos have tried to win customers through low-priced promotional offerings. While Verizon has grown its FiOS TV product to more than 1.4 million customers and AT&T has about 500,000 U-Verse TV customers, cable has taken a substantial number of phone customers away from the telcos.

7. How will all of this downturn and pessimism affect cable-TV advertising?
Cable enjoyed a robust upfront market and managed to make ad gains through June, but cable networks aren’t sure their good luck will last, especially given the fortunes of financial firms and automakers.

Although overall U.S. ad expenditures were down 1.6% in the first six months, cable was up 3.1%, according to TNS Media.

Earlier this year, cable booked an estimated near $8 billion in ads for the new TV season, and there doesn’t appear to be widespread cancellations of those orders yet.

“This economic slowdown has been known for a while. This is just the latest,” said Brad Adgate, Horizon Media’s senior vice president and director of research.

“Unless people start to exercise their cancellation options, I think television should be relatively strong based on the upfront,” he said. “It could impact the scatter market, and it could impact certainly next year’s upfront if there’s not a turnaround or an uptick in the economy. For now, my guess is, it’s probably safe for the short term. Long term, it’s a little less bullish.”

One of the categories that has been strong for cable has been fast-food restaurants, but they may not be able to keep up their pace of spending, according to Jon Swallen, senior vice president of research for TNS.

And with a number of Wall Street firms and banks being swallowed up by others, the financial-advertising category will be impacted going forward, he said. Auto ad spending was already down 11.2% the first half of the year, and Swallen predicts automakers will continue to scale back advertising.

8. Won’t the mortgage crisis result in more disconnects as people lose their homes?
If you’re a pessimist, this is an area to worry about, especially since the lack of basic-subscriber growth in the industry has been partially blamed on the housing slump of the past few years.

Housing starts have been on the decline at least since 2005, and the slump is continuing. According to the National Association of Home Builders, total housing starts fell 6.2% to a seasonally adjusted annual rate of 895,000 units in August, the slowest pace since January 1991.

Sales of existing homes fell 2.2% in August to 4.91 million from 5.02 million in July, according to the National Association of Realtors, which blamed the decline partly on the difficulty in obtaining mortgage loans. Sales had been expected to drop by about 1.6% for the period.

There were 4.2 million unsold homes on the market in August, the NAR said, the steepest inventory drop since December 2006.

Foreclosures are also expected to be a problem for the cable industry. Said SNL Kagan analyst Robin Flynn, “We’ve never had this huge wave of foreclosures, people losing their homes and needing to move back with their parents. That is going to cause a lot of churn. And it’s going to iron itself out, but I think, in the short term, it will spread across cable, telcos, satellite.”

Leichtman Research Group president Bruce Leichtman called the lack of housing starts the biggest macro-economic problem plaguing the cable industry.

“That’s one of the major factors where the economy is affecting the multichannel video industry, probably more than anything else,” Leichtman said. “And [Dish Network chairman] Charlie [Ergen] has said this, and I agree with him 100%: it’s the lack of housing growth. The lack of housing growth represents fewer new opportunities [for cable and DBS] in a market that’s already fairly saturated.”

9. Is there any truth to the old tenet that “cable TV is recession-proof?”
If you base the assumption that cable companies are recession-proof on subscriber growth trends, the numbers appear to back that premise. According to the National Cable & Telecommunications Association, cable subscribers grew by about 20% per year in each year of the recession of 1981-83 and 6% a year during the recession of 1990-91 but declined by about 1% during the recession of 2001-03. The key to the changes appears to be competition: in 1981-83, cable was growing rapidly, was scrambling to meet demand and was essentially competition-free. In 1990, when satellite competition first emerged with the formation of several DBS services, cable growth slowed (in fact, 1990 was the last year that basic-subscriber growth topped 5% for the industry). In 2001 and 2003, with the entrance of the telephone companies into cable, the trend reversed to a basic-customer decline — 2001 was the last year of positive basic-customer growth for the industry, at 0.7%.

“I would say that cable subscriber-growth trends have been driven more by industry trends and competition than by the overall economy,” Flynn said.

Cable operators seem to have the same outlook. Said Angelakis recently, “What I really like about the business is, we have a defensive, resilient business that can take some body blows related to the economy, which we are feeling now.”