'Inquiry,' 'Impairment' Hit Stocks

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Cable's second-quarter earnings season kicked off last week, with AT&T Corp. and AOL Time Warner Inc. reporting on July 23 and July 24, respectively. But what was expected to be a harbinger of improved results for the rest of the year instead became an indicator of the substantial decline in the value of cable assets.

And in AOL Time Warner's case, it also served notice of a Securities and Exchange Commission investigation.

In its second-quarter conference call July 23, AT&T disclosed that it took a $13.1 billion charge to earnings, reflecting the decline in value of its cable assets. The next day, AOL Time Warner revealed in its conference call that the SEC was conducting a "fact-finding inquiry" into its accounting practices.

The SEC probe stemmed from a July 18 article in The Washington Post, which criticized the way the company's America Online Internet unit booked some of its revenue.

Predictably, cable stocks were hammered, with AOL Time Warner hitting a new 52-week low of $8.70 on July 25.

Between July 22 and July 25, MSO stocks plunged 16 percent. The biggest losers were AOL (down 19.7 percent); Comcast Corp. (down 13.6 percent); Cox Communications Inc. (down 10.8 percent); Insight Communications Co. (down 23.2 percent) and Cablevision Systems Corp. (down 33.9 percent).

'NO RELIEF'

"There's no relief for cable stocks," said Banc of America Securities LLC cable analyst Doug Shapiro in a research note last week. "After seeming like they might buck their underperforming trend over the last few weeks, the stocks were hammered on Tuesday and failed to recover much yesterday [Wednesday], even as the market rallied."

But Shapiro saw some solace in Comcast Corp., which is scheduled to report its second-quarter earnings on Aug. 1.

Comcast is on track to generate $190 in free cash flow per subscriber next year, Shapiro wrote, which makes its stock one of the cheapest in the sector. It's trading at about 7 times 2003 estimated free cash flow and implying no free-cash-flow growth beyond then.

"We continue to believe the downdraft in the group is far more tied to temporary psychological problems than fundamental problems," Shapiro wrote. "And, while the catalyst remains elusive, we think Comcast's results vividly illustrate that the stocks are extremely inexpensive."

On a conference call with analysts to discuss second-quarter results last Wednesday, AOL Time Warner CEO Richard Parsons said he believes the allegations brought up by the Post are groundless.

The Post had previously reported that America Online Inc. conducted a series of "unconventional" transactions between 2000 and 2002 to artificially increase its revenue.

Those transactions — which included shifting revenue from one division to another to boost the online unit's business, booking the sale of ads it sold on behalf of online auction site eBay Inc. as its own and counting stock rights as advertising and commerce revenue in a deal with a Las Vegas firm — may have boosted revenue for those periods by about $270 million.

Q2 NUMBERS

Aside from the SEC inquiry, AOL Time Warner had a pretty good quarter, with revenue up 10 percent to $10.6 billion. Cash flow rose 2 percent, to $2.5 billion.

That growth was fueled mainly by the company's cable networks and systems. Cash flow at the cable segment rose 13 percent, to $1.7 billion. At the AOL unit, cash flow was down 39.6 percent in the quarter, fueled by a 42 percent decline in advertising and commerce revenue.

In releasing its second-quarter results, AT&T said it took the charge — which resulted in a net loss of $12.7 billion, or $3.49 per share, for the period — as a result of new accounting rules that require companies to write down goodwill asset impairments all at once. Without the charge, it would have reported earnings of 7 cents per share for the period.

At AT&T Broadband, revenue rose 9.8 percent, to $2.53 billion and cash flow rose 59 percent, to $641 million.

AT&T Broadband's cash-flow margin (cash flow as a percentage of revenue) — among the lowest in the industry — improved by 5 percentage points in the period, to 25.4 percent.

In a conference call with analysts, AT&T Broadband CEO William Schleyer said the cable unit added 105,000 new telephony customers, 202,000 digital-video subscribers and 137,000 high-speed-data customers in the period.

Schleyer added that his only disappointment was the loss of basic customers, which he said was due mainly to seasonal disconnects and increased competitive pressures in nonrebuilt areas.

The company is working hard to rebuild its network, said Schleyer. Of the $950 million in capital spending over the period, 45 percent was related directly to the rebuild.

IMPAIRMENTS

The asset-impairment charge for the cable unit caused a near-panic in the MSO sector, with five other publicly traded cable companies and AT&T reaching 52-week lows on July 23.

AT&T dropped as low as $8.75 per share on that day, rising slightly to close at $8.77, down 75 cents. Other stocks hitting 52-week lows included Charter, Comcast, Cox, Cablevision and Mediacom Communications Corp.

For Insight, which released its second-quarter results on July 23, revenue was up 10 percent and cash flow rose 16 percent. While those were impressive numbers, Insight's stock took hits related to the general malaise in the sector, as well as questions brought up during its analyst call on July 24 regarding loans the company made to executives, including $9.6 million lent to chief operating officer Kim Kelly.

Responding to a question during the call, Insight president Michael Willner confirmed that loans had been made to executives in the past, but that was mainly to help them offset significant tax implications resulting from its initial public offering in 2000.

"The company, when it went public, was converted from a privately held partnership that had some significant negative tax implications to certain officers of the company, myself not included by the way, and that program has been in place since the IPO," Willner said. "The details are disclosed, and have been disclosed, in every public filing where it's required. Nobody's every invested in this company without that disclosure."

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