Ops Returns Tough, S&P Analyst Declares

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Cable operators that have paid the going rate for systems
in the past year may have a rough time justifying the cost of growth, a Standard &
Poor's Corp. analyst said last week.

S&P managing director Richard Siderman said that given
the average price for a cable system today -- about $4,500 per subscriber -- cable
operators will have to generate about $100 per month in revenue from virtually all of
their subscribers in order to realize a sufficient return on their investment.

Siderman, speaking at S&P's "Telecommunications
& Cable Industry" seminar, said that in order to realize a conservative 11
percent return on investment, the acquiring company will have to pare down the cost of its
purchase to about nine times cash flow.

Given that benchmark, the company would have to realize
$500 in cash flow per year, per customer, Siderman said. At a profit margin of 42 percent,
this means each subscriber would have to generate $1,190 in revenue per year, or about
$100 each month.

"Contrast that with the typical cable subscriber, who
is paying about $40 per month, and cable operators are going to have to double or more
than double monthly revenue," Siderman said. "That is a formidable
challenge."

But not an impossible one, he added.

Siderman classified cable subscribers in three categories:
"stickers," or customers who are going to stay with their $45-per-month basic
services and resist purchasing any new cable products; "upgraders," who will
take an additional $20 per month in new services, be it either a digital tier or
additional pay-per-view services; and "takers," those customers who will buy
just about everything the cable company has to offer.

Siderman mapped out three scenarios: one where 100 percent
of subscribers are takers, the second where revenue is split equally among the three
categories and the third where 50 percent of the customer base are stickers, 30 percent
are upgraders and 20 percent are takers.

In the first scenario, cash-flow multiples after three or
four years are nine times; in the second, the multiple rises to 13 times; and in the third
-- which, he said, was the most likely configuration -- the multiple is 14.7 times.

Siderman added that his three scenarios do not take into
account organic growth in basic services and rate increases. However, they also don't
include the significant capital expenditures needed to upgrade cable plant to be able to
offer additional services.

"The purpose of this is not to suggest that it can't
be done," Siderman said. "The purpose of this is just to suggest that to
rationalize, or to make these investments at $4,500 per sub or $5,300 per sub, means that
these operators clearly are looking at offering a whole bunch of services that really are
not out there now, and that these customers are going to be more than just cable customers
taking a pay service. It's really a sea change in the customer base."

Despite the challenge of rationalizing acquisitions, cable
companies are expected to continue to consolidate, Siderman said, although he expects many
of the deals to involve system swaps instead of outright purchases.

"There's a lot of potential over the next two or three
years to see systems traded," he said. "Clearly, we are going to see a lot of
activity there, and I would expect to see trades and companies trying to get bigger pieces
of clusters, maybe selling off some systems that are better managed by smaller
operators."

Siderman also foresees a moderate increase in core services
but more growth in advanced services.

Despite the uncertainties, he also expects a moderate
improvement in the credit markets for cable companies, based on the potential for new
services and the growing trend by some cable companies -- like Adelphia Communications
Corp. and Charter Communications -- to offset some of the costs of acquisitions by issuing
equity.

"These are moderating factors to the prices being
paid," he said. "Cable modems are probably more popular and being taken at a
higher rate than even the most optimistic cable company thought two or three years ago,
with some nodes getting 20 percent and 30 percent penetration. Digital offerings are being
rolled out -- the more choices you give people, the more they will take."

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