Debt, Digital Slowdown Hit Stocks

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Cable's latest earnings season got off to a rocky start, as MSO stocks fell 8.3 percent in the nine days that led up to Feb. 7.

Analysts were mixed as to why. Some attributed the drop to investors' aversion to debt-laden companies in the wake of the Enron Corp. flameout, while others noted an expected decline in digital subscriber additions or just general market volatility.

Jan. 30 marked the beginning of the MSO sector's earnings season. AOL Time Warner Inc. and AT&T Corp. each reported their fourth-quarter results, touching off a decline in the sector.

Both companies reported somewhat disappointing results. AT&T reported its cable cash-flow margin fell by 2.2 percentage points in the fourth quarter, to 22.9 percent. That was due largely to a one-time charge associated with the transition of high-speed data customers from Excite@Home Corp.'s network to its own.

AT&T's results were followed on Feb. 6 by the revelation that Comcast Corp. — which agreed in December to purchase the AT&T Broadband cable unit for $72 billion in stock and debt —expects digital-cable subscriber additions to tail off to 600,000 to 700,000 in 2002, from 815,000 additions in 2001.

That announcement, coupled with a $321 million loss for the quarter, sent Comcast stock into a tailspin, even though the MSO reported strong revenue and cash-flow growth.

Comcast's revenue grew by 9 percent in the fourth quarter, while cash flow rose 12 percent, excluding a $140 million charge related to Excite@Home.

Still, Comcast's stock sank 7.1 percent, or $2.45, to $32.04 on Feb. 6. It made up ground on Feb. 7, closing at $32.95, up 91 cents.

Comcast executive vice president and treasurer John Alchin said he was puzzled by the decline.

"We had a very solid fourth quarter," he said. "We put out, I think, generally aggressive and encouraging guidance for 2002, and we got beaten up in the market yesterday [Feb. 6], seemingly for reasons that had nothing to do with us. This is an incredibly nervous and volatile marketplace."

SunTrust Robinson Humphrey cable analyst Gary Farber said several factors were to blame.

"I think the leverage, the Enron things, those have had some impact, but I don't think that is the full picture," Farber said. "You had AT&T's results come out soft, that started the downward spiral.

"This group has pretty defined valuation ranges, pretty defined metrics on which they trade on, and when you see [merger partner AT&T] roll into Comcast, the so-called leader in the group, that's going to have some impact."

Cable stocks with the most debt relative to size were hit hard. Adelphia Communications Corp. shares lost $4.55 each (17.1 percent) in the nine-day period. After Adelphia came Charter Communications Inc., down 12.9 percent; and Mediacom Communications Corp., down 12 percent.

Mediacom, one of the most stable MSO stocks in 2001, dropped mainly because it announced a $1.5 billion securities registration on Feb. 4. The next day, the stock lost $1.36 and closed at $15.90. It closed at $15.83 on Feb. 7.

Banc of America Securities LLC analyst Doug Shapiro said debt levels were a factor in the sector's decline, as were problems at wireless telecom companies.

"The answer is that nobody really knows," Shapiro said. "In general, the Enron stuff is freaking people out and anything that is levered — and this is a highly levered industry — is making people more skittish.

"The second thing is, the wireless sector has fallen apart," he added. "Basically, everything in telecom has fallen apart, and wireless and cable have been the last two holdouts.

"With what's happened in the wireless sector, there's some sense by people that, 'I don't want to be the last guy to get out of cable, too.' "

Adding to the uncertainty is the trend toward a decline in digital-cable additions, once one of the main drivers of cable valuations.

Most analysts had expected a decline in digital subscriber additions. That's primarily because the service was first aimed at premium-channel customers, which represent about 30 to 35 percent of the cable universe.

As the number of non-digital premium subscribers dwindles, so does growth. Virtually every MSO except Insight Communications Co. expects digital growth to cool in 2002.

AT&T, AOL TAKEDOWNS

In a mid-January report, Shapiro wrote that he expected AT&T Broadband to take down its digital additions — which numbered 1.2 million digital subscribers in 2001 — by about 22 percent, to 940,000 adds in 2002. He also expected AOL unit Time Warner Cable's digital additions to decline 10 percent, to 1.44 million in 2002 from 1.6 million in 2001.

Cablevision Systems Corp., which began rolling out its "iO: Interactive Optimum" digital product in September, said last month that its digital subscribers in 2001 would number 17,200. Analysts had expected at least 30,000 customers.

Cablevision also trimmed its 2002 forecast from 300,000 digital additions to a range of 125,000 to 150,000.

In his report, Shapiro estimated that industry-wide digital additions would decline about 12 percent, to 5.5 million in 2002. In an interview, the analyst said that should come as no surprise.

"Anybody who was not aware that digital sub growth is moderating hasn't been paying attention for probably about a year," Shapiro said last week. "You need to focus on what happens financially, not on the unit-growth line."

And cable operators are financially as strong as ever, according to Shapiro's report. Most MSO guidance points toward revenue growth of 10 to 12 percent and cash-flow growth of 12 to 14 percent.

The lower digital guidance was part of the product's overall nature, Alchin said.

"We put out a number that when you look at all of the sell-side analysts that are out there, yes, it's lower than what we did in 2001, but everybody is talking about this as a product that once you get up to around 30 percent [digital] penetration, you begin to slow down," Alchin said. "It's a little bit like the pay product. There's the point where you reach the saturation mark of people that want to pay extra for that type of product."

Comcast's digital penetration now stands at 28 percent.

Alchin was encouraged by VOD and SVOD's potential to bring in new subscribers, he said. Comcast now has VOD available in about 3 million homes and expects to expand that footprint to 6 million by the end of 2002. It's currently testing its VOD service in several markets and plans to begin introducing it in the second half of this year.

"We fully expect that's going to help us lift digital penetration even further than where we are now," Alchin said.

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