New Four-Letter Word: Capex

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Hammered by investors for what seems to be a neverending spiral of spending, cable MSOs are now scrambling to curtail capital expenditures as they race to post free cash flow as soon as 2003.

In earnings call after earnings call, MSO executives vowed to reduce capital expenditures this year and next, in order to reach the often-promised state of free cash flow, in which cash is left over after capital and interest expenses are met.

Charter Communications Inc. said it would cut capex by $125 million this year, to $2.35 billion from $2.475 billion. Mediacom Communications Corp. will slice $20 million off its proposed $410 million capex budget for 2002, claiming it can find some savings on equipment.

Cablevision Systems Corp. will cut capex next year to between $500 million and $650 million, compared with $1 billion in 2002. It will achieve some of that by reworking its commitment to buy costly digital set-tops from Sony Corp., and by spending less on side businesses, such as its The Wiz consumer-electronics stores, as well as satellite-TV and wireless-telephony ventures that are still in the works.

One of Cox Communications Inc.'s plans to conserve cash would scale back video-on-demand launches to four markets this year, down from seven.

"They are playing to Wall Street's desire to see free cash flow," said Goldman Sachs & Co. financial analyst Rich Greenfield.

SPEND ON 'SUCCESS'

MSOs are marching to the drumbeat of "success-based" capital, which means they're willing to fulfill customer demands for modems and digital set-tops, thus driving new revenue-generating units, such as recurring digital-video or data subscribers.

There will likely be some "success-based" spending for telephony as well. Time Warner Cable plans Internet-protocol telephony launches this year, while Comcast Corp. and Cablevision look to rollouts next year.

"We have enough capital to do somewhat of an aggressive [IP] rollout," Cablevision CEO Jim Dolan said during a meeting with investors on Aug. 8. "We have to make sure revenue follows capital closely."

Rebuilds are marching toward conclusion later this year — or even 2003 — within an environment of capex cutbacks. Cablevision said it plans to accelerate its rebuild, which would pass 3.4 million digital-capable homes by year-end, up from an earlier estimate of 2 million. Charter also said it would increase capex on rebuilds by $25 million in 2002, to complete work on those projects, while making cuts in other areas.

"The savings will primarily come from efficiencies, decreased churn, increased self-installations, reduced installation times and improved inventory management," Charter executive vice president and chief financial officer Kent Kalkwarf said during the MSO's earnings conference call on Aug 6.

These moves to reduce capital expenditures, while accelerating rebuild efforts, are among several seemingly contradictory shifts being made by MSOs.

Operators are also reclassifying certain labor- and maintenance-related capex costs as the industry nears the end of its rebuild cycle and investors clamor to get a better handle on MSO spending.

For instance, Charter breaks its capital expenses down into three categories: installation, construction and "other." Within each of those areas, it breaks out direct labor, direct materials and overhead costs.

Direct labor includes what's spent on installers and outside contractors. Direct materials include wiring, connectors and other gear.

The "other" category includes modems, set-tops, high-speed provisioning and VOD equipment.

Of the $1.1 billion in Charter capex outlays during first-half 2002, $524 million was related to construction, $365 million to "other" expenses and $224 million to installation. The construction category relates almost entirely to rebuilds, which Charter and other MSOs expect to complete next year.

If rebuild costs weren't included in capex, Karlkwalf said, Charter's first-half operating cash flow would have been $298.6 million, compared to a loss of $163.6 million.

Mediacom is looking for similar capex efficiencies. Senior vice president and chief financial officer Mark Stephan said capex costs could drop, and that would affect RGUs because of "capital efficiencies and partly as a result of reducing unit purchases and lower prices on digital set-tops, cable modems and vehicles."

"More than 50 percent of our capital spending is tied to upgrades, which we expect to complete by June 30, 2002," Stephan said. "Beginning in the second half of 2003, we are in success-based maintenance mode of spending."

Cablevision plans to continue pushing new services despite its big capex cutback next year, said the MSO's New York president, Tom Rutledge.

Of the $550 million to $650 million Cablevision will spend in 2003, $150 million is earmarked for completion of its New York City-area. Another $150 million will go toward maintenance, with the remaining portion spent on set-tops and modems.

"Almost all the capital will be revenue-based," said Rutledge. "That capital can be timed to RGUs."

CYCLE NEARS END

Rutledge expects digital set-tops to cost the MSO around $215 next year — a huge reduction from the $350 or more the MSO spends on each Sony box — while cable modems will drop to $50 per unit.

And the voice-over-Internet protocol telephony service Cablevision intends to launch runs on the already built-and-paid-for high-speed data platform, Rutledge said. IP telephony is expected to cost $50 per home, he said.

Long-term, cable operators are nearing the end of a 10-year rebuilding cycle. Deutsche Bank Securities financial analyst Karim Zia expects the cable industry's total capex budget for 2002 to stand at about $17.4 billion — the same as in 2001. In the next few years, though, total industry capex will drop to $11.5 billion, even with VOD and telephony rollouts.

"Any new capital requirements, such as telephony and video-on-demand, will be dwarfed by the impending end of plant rebuild capital spending," Zia wrote recently.

But Greenfield said telephony and VOD spending may be cut back slightly until operators achieve free cash flow, noting Cox's plan to slow VOD rollouts. He said operators would focus on broadening VOD services — with add-ons like subscription offerings from premium channels — until operators reach the promised land of free cash flow next year.

Capex austerity rules, for now. "We're going to do it with just what we have," Dolan told analysts.

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