MSOs Face Lower Margins in 4Q

Author:
Publish date:
Updated on

Fourth-quarter and year-end results are in for a handful of
the nation's top MSOs, and it appears that the trend toward lower cash-flow margins
is beginning to take hold in the industry.

In an analysis of five companies -- Adelphia Communications
Corp., Time Warner Inc., MediaOne Group Inc., Cox Communications Inc. and Jones Intercable
Inc. -- cash-flow margins have declined for the most part, reflecting added expenditures
to upgrade their respective networks.

Cash flow (earnings before interest, taxes, depreciation
and amortization, or EBITDA) is a common benchmark for the financial health of cable
operations. Cash-flow margins are cash flow as a percentage of revenue.

The companies were selected because each has issued its
most recent financial statement in the past two weeks. Some of the largest cable operators
in the country -- including Comcast Corp., Cablevision Systems Corp. and
Tele-Communications Inc. -- are expected to file their financial statements in the coming
weeks.

Cash flow margins were down in the fourth quarter for each
of the companies analyzed, with the exception of Jones Intercable Inc.:

• Cox dropped from a 42.8 percent EBITDA margin in the
1997 period to 40.9 percent in 1998;

• Adelphia dropped from 53.8 in its third quarter of
1997 to 52.5 in the similar period in 1998;

• MediaOne dipped from 43.3 percent in 1997 to 41.4
percent in 1998; and

• Time Warner's cable operations fell from 48
percent in the fourth quarter of last year to 41 percent in the most recent period.

Jones was the only operation that saw EBITDA margins grow
in both the fourth quarter and the total year, rising to 53.1 percent in fourth-quarter
1998 from 43.1 percent in 1997, and from 43.8 percent in fiscal 1997 to 49.5 percent in
fiscal 1998.

Jones' cash-flow growth was mainly attributed to the
company's strategy of purchasing partnerships in the cable systems that it operates.

For the year, most of the other cable operators also saw
drop-offs in EBITDA margin, with the exception of Jones and Time Warner, the latter of
which gained slightly, from 37.9 percent in 1997 to 38.7 in the most recent year.

• Cox's cash-flow margin dropped from 40.1
percent in 1997 to 39.3 percent;

• MediaOne's fell from 41.8 percent to 37.5
percent; and

• Adelphia saw its margin drop during the nine months
ended Dec. 31, to 50 percent, compared with 50.1 percent in the previous year.

But this isn't such a bad thing, according to most
analysts. In fact, many said it's an indication that cable operators are spending
money for the future.

Richard Read, an analyst with Credit Lyonnaise Securities
in New York, said lower cash-flow margins are expected for the next three to five years,
particularly as cable systems upgrade their networks for new products and services.

"We're seeing margin compression, but that's
a secular trend over the next three to five years," Read said. "Subscriber
growth is slowing somewhat, and competitive pressures are increasing. [Cable systems] are
spending more on marketing, not only because of competitive pressures, but because they
are rolling out new products and services."

Read added that once these new products and services become
widely available, investors should expect them to be cash-flow-negative for between 12
months and 18 months -- the industry norm. But once the market matures for these new
services, the EBITDA margins can get mighty hefty.

"All of these new businesses are 40 percent-plus
EBITDA-margin businesses," Read said. "In three years, the margins stabilize. I
don't think that there is anything to worry about."

Some of these companies are beginning to reap the benefits
of these new services, with several of the MSOs analyzed making strides in both customers
and revenue for new services.

For example, at Adelphia, new services -- which includes
long-distance resale, paging and high-speed data -- represented its biggest third-quarter
revenue increase: 127.7 percent, to $1.9 million. Digital services accounted for $1.1
million in sales for the quarter, compared with just $16,000 in 1997.

And MediaOne, which has been aggressive in rolling out
broadband services, saw that segment increase by 10.6 percent during the year.

Most of the companies analyzed reported revenue growth and
cash-flow growth according to the financial statements for the quarter and for the year.

For example, MediaOne grew its cash flow during the quarter
by 18 percent, to $423 million, Cox grew EBITDA by 17 percent, to $199.1 million during
the three-month period, and Jones grew cash flow by 67 percent, to $69.5 million.
Adelphia's cash flow during the third quarter was up by 30.3 percent, to $93.4
million.

Time Warner was the lone exception, with cable EBITDA
dropping by 19 percent in the quarterly period, but rebounding to finish the year up by 14
percent.

Ted Henderson, an analyst with Janco Partners, said the
expense involved in hiring the staff to upgrade systems, to create new marketing efforts
and to install the new services is high, but it is worth it.

And he added that most cable companies have expressed the
idea that as they develop and roll out new services, cash-flow margins will be impacted.
Those investors that don't take that into consideration may be in for a rude
awakening.

"That's got to be factored into your
expectations. Otherwise, you're going to be disappointed," Henderson said.
"It's a good place [where cable companies] are going, and it's a place
where they have to go."

Related