WALL STREET CAN BANK ON IT TCI Lands First Tenants to Subsidize Digital Boxes

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Denver --TCI has signed the firstof its promised "anchor tenants" to subsidize digital-box costs, making a dentin its future capital costs.

After hinting of strategic partnerships to help subsidizethe upcoming OpenCable advanced set-tops, Tele-Communications Inc., BankAmericaCorp. and Intuit Inc. announced last week that they'dsigned an agreement in principle for the bank and the financial-services-software providerto offer their services over TCI's cable systems.

TCI president and chief operating officer Leo J. HinderyJr. said the new company, to be part of TCI Ventures Group, was created mainly to addservices that would appeal to consumers, such as paying bills via a TV remote.

But analysts here last week at a three-day TCI conferencefor lenders and investors were most impressed with the deal terms. BankAmerica and Intuithave agreed in principle to pay TCI a fee upon activation of each OpenCable box. The boxesare expected to be in service next year.

TCI, BankAmerica and Intuit executives wouldn't revealthe fee. But TCI officials, including Hindery, didn't discourage speculation that thepayment would be in the $50-per-box range.

Several Wall Street analysts said TCI predicted that itcould strike similar deals that could slice the cost of advanced digital boxes in half.That could change the economics of digital services significantly, some said.

Prudential Securities Inc. cable analyst Laura Martin saidthe BankAmerica-Intuit deal alone added to her "strongly positive" feeling aboutTCI's prospects. Combined with other TCI forecasts, she estimated that the companywill shave some $2.5 billion from its capital costs over five years.

That, combined with what TCI said were strong financialresults from its digital-video customers so far, goes a long way toward reducing thecompany's execution risks for digital services, Martin said. TCI is showing that ithas a good business model with current digital boxes, providing a cushion if the rolloutof advanced boxes is pushed back from the current forecast of early next year, she said.

Some analysts were less positive: They focused on increasedcapital expenditures and projections that free cash flow -- or cash left over after payingcapital expenditures, interest and preferred-dividend payments -- would be down topossibly between $100 million and $300 million this year, from $913 million in 1997. Whileit is a new phenomenon in the cable industry, free cash flow has become a key goal forinvestors trying to decide whether cable stocks will continue to rise.

Cable analyst Fred Moran of Furman Selz & Co. said hedowngraded TCI last week to "buy" from "strong buy," based onnear-term concerns. He said he still likes TCI's strategy, but his target stock priceof $40 per share could take longer to achieve.

TCI's share price ticked down last Wednesday andThursday, after rising to $32.56 on Tuesday, when the BankAmerica deal was announced.

Ray Katz, Bear Sterns & Co.'s cable analyst, saidnear-term free cash flow doesn't concern him all that much. The company is trying tostrike a balance between spending on bandwidth and freeing up cash to buy back shares, hesaid.

Maybe more important, TCI showed that it could exceed itsfinancial goals while progressing on strategic moves, like ramping up digital video."This is the first year that I've been to a TCI analysts' meeting where thestory hasn't changed from the prior year," Katz added.

When the new BankAmerica-Intuit-TCIventure is operational, and when OpenCable set-tops are deployed, customers will be ableto check account balances and transfer funds between accounts at participating financialinstitutions; electronically receive and pay bills; and manage investment portfolios,executives said.

High-speed-data service @Home Network also figures into thedeal as the chief systems integrator for the service. Specifically, the Intuit andBankAmerica software and servers will sit inside @Home's secure network, executivessaid.

"By incorporating trusted information from Bank ofAmerica and technology from Intuit directly into the @Home service, we are providingcustomers with an unparalleled, one-stop shop for services and resources that will helpthem to reach their financial goals -- through the PC [personal computer] or the TV,"said Tom Jermoluk, chairman and CEO of @Home.

Other deals could involve revenue sharing, but not upfrontpayments, TCI officials said. Negotiations with many companies, primarily in retail ormerchandising businesses, are under way. Hindery said he hopes to see all of TCI'searly "anchor-tenant" agreements done by the end of 1998.

The first of those other agreements, with Internetbookseller Amazon.com, was to be announced last week, but it didn't come together intime for the meetings, sources said. As it was, negotiations between TCI, BankAmerica andIntuit ran until 2:30 Tuesday morning.

Analysts speculated that companies that TCI officials spokeabout hypothetically -- Ticketmaster Group Inc., now controlled by Barry Diller's USANetworks Inc., as well as Amazon.com -- could be high on the partnership list.

TCI chairman and CEO John Malone said a priority would befirms that "have a powerful Web position" and that have proven that they canbuild a business on the Internet.

Cynthia Brumfield, senior analyst for Paul Kagan AssociatesInc., said the Intuit-BankAmerica-TCI deal is indicative of a growing and important trendrelated to electronic commerce over managed broadband networks.

"It's a bit of a watershed, especially if youcombine [TV-based financial activities] with retail," she said.

The announcement highlighted a conference during which TCIreported impressive fourth-quarter financial results and delivered 1998 projections fordata-over-cable and digital-video penetration.

Among the key fourth-quarter numbers: TCI added 155,000basic customers, believed to be a quarterly record for the company and a huge swing fromthe customer losses over the past year. Hindery said that gain, which works out to 4.3percent on an annualized basis, "exceeded even our highest expectations."

Marvin Jones, chief operating officer of TCI unit TCICommunications Inc., credited basic marketing with a local emphasis, which TCI had all buteliminated the year before.

Company officials predicted a gain of another 100,000subscribers in the first three months of 1998, and they said growth over the year would be2 percent to 2.5 percent -- at or above the industry's average.

Continued cost-containment efforts again producedhigher-than-expected cash flow of $743 million in the quarter, compared with $616 millionin the same period a year ago. TCI warned that cash flow is likely to be flat in the firstquarter, versus the $715 million reported in the same period last year. But they predictedthat a strong second half of the year would result in high-single-digit orlow-double-digit percentage growth in cash flow for 1998.

Also looking ahead, TCI officials predicted that thecompany would end this year with 800,000 to 1 million digital-cable customers, up from150,000 now.

And the year-end number would represent 8 percent to 10percent of the 10.5 million subscribers that TCI will control after its numerous systempartnerships close.

TCI-controlled @Home has somewhat more than 10,000customers now, concentrated in the San Francisco Bay area. TCI predicted that it would end1998 with 85,000 to 100,000 @Home customers.

The MSO also slashed $807 million in debt during 1997,trimming its debt-to-cash flow ratio to 4.75 from 6.05 at the end of 1996. TCI generated$913 million in free cash flow last year, compared with $977 million in negative cash flowthe year before.

One analyst said he was impressed with a presentation bycorporate-development executive vice president Bill Fitzgerald, who outlined the array of"partnership" joint ventures, swaps and system sales that will winnow TCI'sconsolidated subscriber base to 10.5 million from 14.4 million.

Fitzgerald estimated that the cost savings, advertisinggains and other benefits amounted to four points of operating-margin improvement in thosesystems, the analyst said.

TCI's cable systems have cash-flow margins of about 45percent.

Malone also talked extensively about the economics ofdigital. Among other digital-related benefits, he said, much of the programming expensesfor TCI's early deployment of 36- to 72-channel digital "three-packs" and"six-packs" go to companies affiliated with TCI, either through its LibertyMedia Group or through Cablevision Systems Corp., which TCI owns about one-third of.

"It tells you that all of the money that we'vespent and all of the energy that we've spent developing our own channels -- theDiscovery [Communications Inc.] multiplexing, the Starz!/Encore multiplexing -- it'sall paying off, because we can add those channels with very little incremental cost. Andwhat little incremental cost there is, it is all inside the family," Malone said.

With the incremental cash-flow gains from digital-basicpayments, higher pay-per-view orders and equipment charges, the cost of current digitalboxes might be paid back in about 18 months, he said.

Malone gave what he called a representative breakdown ofdigital-cable costs and revenue, concluding that the service added some $16 per month incash flow per subscriber. Martin said most analysts had previously thought that theincremental bump was about $10.

Throughout the three-day meeting, Malone talked frequentlyabout high-definition TV, saying that the most palatable outcome, technically, has more todo with how many bits have to be sent at what speed than with the three display types --1080I, 720p and 480p -- that are often tagged to HDTV discussions.

While operators could simply pass a 1080I HDTV signalthrough digital set-tops to a decoder nested inside a digital TV, it's not anefficient use of spectrum, he said.

"What we're pushing for is a technology that letsus multiplex high-definition signals to make better use of [spectral and set-top] realestate," Malone said.

"If the standard evolves to 720p, which is a sort ofcompromise that is also about a 10-megabit-per-second system, we could put four of them inone 6-megahertz channel," he said. "That's probably optimal for cabletransport."

In other news at the conference, Hindery confirmed reportsthat talks aimed at merging @Home with Time Warner Inc.'s Road Runner and U S WestMedia Group's MediaOne Express data services have been "terminated."

Hindery also said he expects the partners in the Sprint PCSdigital-wireless-telephone venture to conclude talks soon about possibly restructuring thepartnership. Sprint Corp. owns 40 percent; TCI (through Ventures Group) owns 30 percent;and Comcast Corp. and Cox Communications Inc. each own 15 percent. Several analysts at theconference predicted that the wireless venture will attempt an initial public stockoffering.

3/30/98

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