Turnaround for Cable Stocks in 2006

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Cable stocks came into their own in 2006, with the share prices of publicly traded multiple-system operators gaining 40% during the year.

That is the biggest single-year gain this decade and the first positive appreciation in cable stocks since 2003, when the sector rose about 18.2%. Over the previous two years, investors’ worries about the ability of operators to roll out voice services and the threat of competition in cable’s base product — video services — from deep-pocketed telephone companies had hammered the sector.

This year, investors instead found cable companies reporting better-than-expected performance in voice-over-Internet Protocol rollouts and a lack of competition from the dreaded telcos.

“It was a phenomenal turnaround year for the cable companies, because they had sort of been left for dead in 2004 and 2005,” said Miller Tabak media analyst David Joyce.

By comparison, the Dow Jones Industrial Average gained 16.3%, the tech-heavy NASDAQ Composite Index 9.5% and the Standard & Poor’s 500 Index 13.6%.

Even a year ago, in late 2005, investors and analysts feared that cable operators would be faced with stiff competition from telcos entering the video business, noted UBS Securities cable debt and equity analyst Aryeh Bourkoff.

That was not how the year played out.

“I think that the sentiment going into 2006 wasn’t incorrect,” Bourkoff said. “It was way too dire — and early — to expect the bloodbath that was discussed as if it was going to happen in 2006.’’

Charter Communications led the sector with a 152% gain in its stock price, reaching $3.06 per share on Dec. 29, compared to $1.21 per share on Jan. 3, 2006.

Comcast, the largest operator, came in a strong second. Its stock rose 61.4%, from $26.23 per share on Jan. 3 to $42.33 each on Dec. 29.

Unlike previous years, every publicly traded cable company showed gains in their stock prices. Two of the remaining operators, Mediacom Communications and Time Warner Inc., showed 42.3% and 23.4% gains, respectively, for the year. Oddly, one of the better performers in the cable sector — Cablevision Systems — was at the bottom of that growth wave, rising 22.9% to $28.48 per share on Dec. 29, compared to $23.17 per share on Jan. 3.

ONE PUZZLE

And while there are only five cable companies on U.S. stock exchanges, compared to eight just three years ago, each seemed to ride the wave of optimism that has swept up investors during the year.

Charter was the biggest recipient of overall optimism surrounding cable companies’ ability to get into the telephone business. While late to the voice game, the St. Louis-based operator added about 82,000 telephone customers in the third quarter, ending the period with 339,600 voice customers.

Voice service was available to about 6 million Charter homes at the end of the quarter, and the operator expected to end the year with between 6.5 million and 7 million homes in its 11.8-million home footprint able to get phone service.

Adding to the new interest in Charter stock were stronger than expected third-quarter results. Revenue rose 11% and cash flow was up 7%, closing in on the industry average. Refinancings pushed out maturities on bonds and Bourkoff, who follows both Charter’s debt and equity, upgraded the stock to “buy” in October when shares were in the $1.50 range.

While Bourkoff remains bullish on Charter, Joyce said that he was puzzled by the rise in its share price.

“Charter has really confounded,” Joyce said. “They probably have the worst fundamentals, because their systems are so geographically dispersed. But they’ve probably shown they are turning the corner in their subscriber retention in the phone product.”

SPECIAL CIRCUMSTANCE

Affecting Cablevision’s stock price was a $10-per-share special cash dividend issued to all company shareholders earlier in 2006. If not for that, the stock would have closed the year at $38.48 per share, a 66% increase.

Without the dividend, the stock’s performance was most likely hampered by Cablevision’s ruling Dolan family’s $19.2 billion offer to take the company private. That deal, still being evaluated by a special committee of independent directors, set a value of $27 per share on Cablevision stock. Some analysts believe that without the Dolan offer, stock in Bethpage, N.Y.-based Cablevision would have passed the $30-per-share mark during the year.

Driving the stocks was better-than-expected performance on the voice side for the top three cable operators. In the first nine months of the year, Time Warner added more than 600,000 voice customers (ending with 1.6 million voice subscribers); Cablevision added about 400,000 voice customers (ending with 1.1 million voice customers) and Comcast added more than 1 million voice subscribers (ending with 1.35 million voice customers).

In contrast, Verizon Communications, the most aggressive telco on the video side, ended the third quarter with 118,000 FiOS TV customers and expects to end the year with 175,000.

Joyce said that while the telco threat should not be ignored, it has so far proved to be minimal, pointing out that Comcast added seven times more phone subscribers in the first nine months of the year than Verizon added video customers.

“The scale is still tilted way in the favor of the cable companies,” Joyce said.

ROOM TO GROW

And though Time Warner Cable and Cablevision have begun to show a deceleration in their robust phone-subscriber growth, Joyce said that it is expected given the two companies’ higher voice-penetration rates. There is still room for telephony growth across the sector, he added.

“For the next several quarters, cable companies still have the upper hand,” Joyce said.

The phone rollout has proven to be a catalyst for high-speed Internet additions, Bourkoff said. This year, Bourkoff said he believed that adding more phone customers will lead to more additions of basic video subscribers, as well.

Already, companies that have offered cable phone for more than a year are beginning to see such results. Cablevision has added about 84,000 basic subscribers in the first nine months of 2006 and is on track for 3.5% to 4% basic growth for the full year. Time Warner added 133,000 basic customers in the period, but did not provide guidance for the full year.

“We could see some dramatic upside in the video business,” Bourkoff said. “The bundling of voice and data has proven out. The bundle of voice and video is just beginning to show.”

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