Earnings Season Has New Look

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The earnings season for cable operators kicks off this week — the first quarter the industry will face after concerns surrounding EBITDA-based stocks, or shares valued on earnings before interest, taxes, depreciation and amortization.

EBITDA, or cash flow, has been a benchmark for the cable industry for years. But in light of accounting scandals surrounding other EBITDA-valued companies — including MSO Adelphia Communications Corp. and telco WorldCom Inc. — analysts may be looking for a new metric on which to base their opinions.

"I think [the Street] will still look at EBITDA from a growth standpoint. I just don't think they're going to look at it from a valuation standpoint," said Goldman Sachs & Co. media and entertainment analyst Richard Greenfield.

"The question will be how the companies, on their conference calls, address return on capital, maintenance capex [capital expenditures] and how they look at the incremental returns on their investments."

'RETURN' YARDSTICK

Return on capital is a company's net income, minus dividends, divided by all long-term debt, plus common and preferred shares. Maintenance capex is generally defined by cable operators as the cost of maintaining the core business.

Banc of America Securities LLC cable analyst Doug Shapiro, in a research report, said that while EBITDA will remain an important metric, it will be one of several analysts use in valuating companies.

"EBITDA has always been controversial, but we believe it is as useful now as it has ever been, which is to say only marginally useful," Shapiro wrote. "It is a good measure of underlying operational performance and a good basis of relative value when comparing similar companies or valuations over time. But it has never been meant as an absolute determinant of value."

FREE CASH

Free cash flow, or EBITDA minus capital expenditures, is also another valuation metric on which analysts are expected to place more emphasis.

But with no cable company showing free cash flow (except for Comcast Corp., and that is not expected to recur after its merger with AT&T Broadband at year's end) most analysts are at least hoping for an acceleration to free cash flow.

Most analysts had expected the sector to reach free-cash-flow positive in 2004.

"We're hoping we will see it by mid-2003," Greenfield said. "That's what we're hoping is going to happen."

In a research report, Greenfield said he expected the MSOs to deliver an average of 14 percent EBITDA growth in the second quarter — up from the 12.8 percent in the first quarter — fueled mainly by solid additions in new services and video-rate increases.

Deutsche Bank Alex. Brown cable and satellite analyst Karim Zia saw average EBITDA growth at between 14 percent and 15 percent in the second quarter, sparked by strong gains in high-speed data and the additional pay-per-view revenue from the Mike Tyson-Lennox Lewis heavyweight championship bout in June.

But that growth may not be evident right off the bat. AT&T Corp., which kicks off the cable-earnings season on July 23, is not expected to shock Wall Street with its vastly improved results.

"I'm sure they [AT&T] will be disappointing on a relative basis, but Comcast will be very strong," he said. "You have Comcast and Cox [reporting] the week after, and I think both of them will be very good, and I expect Cox to be talking about accelerating free cash flow and moderating capex. I think Comcast will have great results."

Comcast is scheduled to report its second-quarter results on Aug. 1.

Following AT&T will be Insight Communications Co. (July 23), AOL Time Warner Inc. (July 24), Cox Communications Inc. (July 31), Mediacom Communications Corp. (the week of Aug. 5), Charter Communications Inc. (Aug. 6) and Cablevision Systems Corp. (Aug. 8).

CHARTER CUT

While Greenfield and Shapiro were optimistic about cable's second-quarter results, Merrill Lynch & Co. Inc. analyst Jessica Reif Cohen downgraded Charter stock from "strong buy" to "neutral" last Thursday, citing problems she had with the way the company accounts for basic-cable subscribers.

In a report, Cohen said Charter counts some cable-modem customers as basic-video subscribers. She also took issue with the way Charter accounted for about $100 million in launch fees. While other MSOs apply those fees against their continuing costs, Charter includes the fees as separate advertising revenue.

Cohen's downgrade caused a sell-off in Charter stock, which dropped by 14 percent, or 56 cents, on July 18 to close at $3.50.

In a statement, Charter spokesman Dave Andersen said the company's accounting practices "are properly reported in accordance with GAAP [generally accepted accounting principles] and have previously been disclosed in various SEC filings."

In a research note, UBS Warburg cable analyst Aryeh Bourkoff estimated that Charter only counted about 30,000 data-only customers as basic-cable subscribers.

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