Moody's Report Warns MSOs on Debt


Cable operators, anxious to distance themselves from the troubles at Adelphia Communications Corp., aren't going to be able to improve their debt ratings unless they make moves to significantly pare down what they owe, according to a top Moody's Investors Service analyst.

Moody's senior vice president and high-yield cable analyst Russell Solomon took a detailed look at the major high-yield cable issuers: Cablevision Systems Corp., Charter Communications Inc. and Adelphia Communications Corp.

Solomon also looked at the smaller, high-yielding MSOs: Insight Communications Co., Mediacom Communications Corp., James Cable Partners, Northland Communications and RCN Corp.

His conclusion was simple: heavy debt is bad.

Solomon's current verdict on all of the high-yield cable operators he rates is "negative," with the exception of Charter, which he rates as "stable."

He characterized the Adelphia situation as a "one-off situation," and said the market negativity that currently surrounds the cable industry is overdone.

But though cable operators still appear to be immune to downturns in the economy and fundamentals continue to improve, he added, "We remain concerned about the almost universal balance sheet weakness and corresponding lack of financial flexibility among high-yield operators."


Cable's high-yield issuers still carry high per-subscriber debt loads, according to Solomon, with RCN leading the pack at $6,184 in total debt and preferred stock per customer. Adelphia led the larger MSOs with $2,916 in total debt and preferreds per customers, followed by Charter ($2,357 per subscriber) and Cablevision ($2,178 per sub).

Adelphia also leads the pack with the highest debt-to-cash flow ratio of 13.2 times cash flow, followed by James Cable at 8.7 times, Charter at 8.2 times and Cablevision 7.8 times.

Leverage ratios for Insight and Mediacom are 7.5 times and 7.7 times, respectively.

While operators have said for months that leverage ratios will improve, especially as capital expenditures decline, Solomon wrote that cable may have missed opportunities to deleverage in the past few years when their cash flow was rising at a rapid rate.

That failure to retire debt, he wrote, has constrained operators' financial flexibility, especially as further revelations of Adelphia's financial improprieties come to light. It also is making lenders and financial institutions less quick to provide capital to MSOs.

"Now is not the time to be over-leveraged, capital-constrained and subsequently lacking in financial flexibility," Solomon wrote. "Most of the high-yield industry participants that we rate, though, seem to be pretty clearly best characterized in this regard at the present time, nonetheless."

Although it has long been expected that cash-flow growth — historically in the 10 percent range — would outpace debt growth, Moody's is less optimistic on this front. Solomon wrote that he did not expect significant balance-sheet strengthening in the high-yield cable sector until 2004.

Solomon said that while cash flow growth could be impacted by slower basic-subscriber growth — currently at about 1 percent per year, compared to 4 percent annually in the 1990s — new services like digital cable and high-speed data should take up the slack.


Solomon was especially high on the data front, adding that with plant upgrades virtually completed and little or no programming cost associated with cable-modem service, profit margins could approach 60 percent. Solomon also predicted that penetration rates for data — already near 20 percent of PC/cable households — could reach 30 percent in the next few years.

Solomon also had high hopes for bundled voice, video and data services.

Bundling's improved subscriber economics "should more than offset losses on the basic-subscription line to competing service providers," Solomon said. "This should enable them to garner improved economic returns through enhanced ARPU, greater subscriber 'stickiness' and correspondingly reduced churn, and the implicit flow-through effect of greater cash flow generation and retention."

While Solomon noted gains in digital subscribers, as well as an increased number of customers for high-speed-data service, he also made note of high digital churn rates, programming cost increases and correspondingly reduced cash-flow margins.

Digital churn rates, which average 4 percent to 6 percent per month, should trend down to about 3 percent per month as aggressive promotional marketing initiatives slow down.

But Solomon cautioned that any improvements hinge on the ability of the MSOs's management to execute their business plans. Investors should watch for any increases in churn, rising programming and promotional costs and heightened competition, he added.

"Keep an eye out for higher bad debt reserve and experience, and other write-offs for items such as non-retrievable equipment, as well, particularly given the aggressive deployment of digital boxes to date," Solomon wrote.