Improper Returns - Multichannel

Improper Returns

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The accounting woes at Cablevision Systems Corp.'s Rainbow Media Holdings programming networks continued last week, after the parent company reported additional irregularities, amounting to less than $5 million over three years.

In its second-quarter financial results on Aug. 5, Cablevision disclosed that its independent auditor — Wilmer, Cutler & Pickering — identified additional improper expense accruals at AMC and WE: Women's Entertainment.

Cablevision said the additional amounts are immaterial — less than $1 million for original production costs from 2000 through 2002 and about $3.4 million in 2003.

Those costs come on top of the $18 million in improper expense accruals over a three-year period that Cablevision said it uncovered on June 18. Those findings prompted the Bethpage, N.Y.-based company to fire 14 employees at AMC — including president Kate McEnroe — and to hire Wilmer Cutler to conduct an internal investigation.

On July 3, in a Securities and Exchange Commission filing, Cablevision revealed it had received a formal order of investigation from the SEC, as well as a subpoena in connection with the investigation. According to reports, the U.S. Department of Justice had launched their own investigations into Rainbow.

As a result of the latest discoveries, Cablevision auditor KPMG LLC said that it is unable to complete its review of the company's financial statements.

Most analysts were not concerned with the new accounting revelations, mainly because they are so small relative to Cablevision's $1 billion in company-wide cash flow.

"Although an accounting review is always a cause for some concern, after five months of internal review and six weeks of outside forensic accountant investigation, the absolute numbers involved are still de minimus, in our view," wrote Banc of America Securities LLC cable analyst Doug Shapiro in a research note.

Fulcrum Global Partners media analyst Richard Greenfield shared Shapiro's view.

"While the improper accounting is disappointing, we believe the totals are irrelevant to the [Cablevision] investment thesis and are far better than worst-case scenarios feared by investors," Greenfield wrote in a report. "Furthermore, the company has taken aggressive steps (firing 14 employees, alerting the government to the accounting issues and hiring forensic accountants) to ensure its health going forward and reassure investors."

The improper expense accruals apparently were a means to ensure that AMC made its budget targets, and had no effect on overall Cablevision earnings. While some reports have said that shifting expenses around could have given AMC a head start on meeting its earnings targets, one analyst who asked not to be named said it made little difference to investors.

"Nobody really cares. People don't buy that stock for what Rainbow is doing," the analyst said. "It's all about the cable business. It's not like the performance of AMC is really moving the stock."

Spinoff delays?

Cablevision has said it does not expect to restate its financial figures as a result of the investigations. However, on the conference call, vice chairman Bill Bell said the probes could delay financing.

"If we don't have comfort at some point in time, we will have to delay financing until we do," Bell said. "We are actively trying to resolve that situation."

That could have an effect on Cablevision's ability to spin off its Rainbow DBS unit, which was expected by year-end.

Most analysts have expected that Cablevision would refinance its high-coupon preferred stock, but that wasn't something the company had to take care of immediately.

"That 's something that's at their discretion — they'd like to do something there, but it's isn't anything that absolutely has to be done now," said Janco Partners cable analyst Matt Harrigan. "It's more of an inconvenience than anything else."

Other analysts had feared that a protracted investigation could delay Cablevision's plans to spin off its Rainbow DBS unit, which would force Cablevision to pump even more money into the venture, which is scheduled to launch service in October. Cablevision said it would invest an additional $564 million in the satellite venture — $114 million this year and $450 million after the spin-off. Cablevision already has invested about $900 million in the project so far.

However, on a conference call with analysts, Cablevision president and CEO James Dolan said the spin-off plans were on track.

"There is no change in our intention to do the spin," Dolan said.

Q2 scorecard

While the accounting problems have put pressure on the stock — it was down 8.2%, or $1.73 per share, to $19.27 on Aug. 5, the day of the announcement — Cablevision's poor financial result for the quarter also contributed to the decline.

The good news was that Cablevision added 12,000 basic customers in the period — ahead of its DBS competitors — fueled by strong growth in digital cable. Digital additions for the period totaled 196,000 (up from 185,000 additions in the first quarter). High-speed data additions were 68,000, below the 83,000 customers the Bethpage, N.Y.-based MSO added during the previous quarter.

Cablevision increased its high-speed data guidance to between 1.025 million and 1.05 million (compared to their prior forecast of 1 million to 1.05 million) and upped its digital year-end guidance to between 875,000 and 900,000 (compared to the prior range of 800,000 to 825,000).

Cable systems adjusted operating cash flow (AOCF) rose just 5.6% (behind analysts' expectations of 8.5% growth), mainly because of higher-than-expected legal fees associated with Cablevision's past fight with the Yankees Entertainment & Sports Network. Cable-system revenue growth for the period was 10%, outpacing expectations of 8.4% growth.

In the conference call, Dolan said that the MSO spent about $8.4 million in legal fees and indemnity claims during the quarter tied to YES.

Rainbow's core cable networks — AMC, WE, the Independent Film Channel and its consolidated regional sports networks — fared better, with revenue up 33% to $152.7 million and AOCF up 55% to $61.9 million, mainly because of strong affiliate-fee revenue and advertising sales.

Lowered guidance

Cablevision revised downward its 2003 guidance for adjusted operating cash flow for its telecommunications division (which includes its cable operations) to between 14% and 16% from 16% to 18%.

In a research report, Sun Trust Robinson Humphrey cable analyst Gary Farber said that even meeting the lower guidance targets will be difficult.

Farber estimated that hitting the new targets will require Cablevision to increase cash flow by 16% to 20% in the second half of the year "which appears challenging, given the 18% year-over-year increase in [the second half of 2002."

For the entire company, Cablevision reiterated is 2003 revenue guidance of between 10% and 12% and operating cash flow guidance of between 17% and 19%.

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