Bilotti to Cable: Ignore Street's Pressure

Morgan Stanley & Co. cable and media analyst Richard Bilotti told a group at the National Show here last Monday that cable operators should continue to focus on growing revenue and cash flow — and disregard Wall Street pressures to become the flavor of the month.

"To Hell with Wall Street," Bilotti said in his remarks at a National Show finance panel. "Growth stocks are out of favor, and you are a growth industry. Should you change yourself to become the flavor of the month? Absolutely not."

Despite pressures on cable stocks this year, Bilotti said, operators have shown consistent growth by just about every operating metric that can be measured for the past four quarters.

"Focus on your operations, continue to drive your operations," Bilotti said. "Wall Street will get around to realizing that you have a good business."

If MSOs deliver on their operating metrics, Bilotti noted, cable stocks could have as much as a 30 percent upside. But to deliver that kind of return, cable operators will have to maintain their current revenue growth — Bilotti predicts 13.5 percent revenue growth between 2002 and 2005 — and capital spending will have to come down. He added they will have to sustain their operating margins.


Maintaining those margins will require robust new-services growth.

Salomon Smith Barney Inc. analyst Niraj Gupta predicted that digital penetration among the top eight MSOs will climb from its present 32 percent to 57 percent by 2005. High-speed-data penetration, now at 11 percent, should grow to 30 percent in that same period, Gupta predicted.

Telephony penetration, now at about 2 percent of households, should reach 11 percent by 2005, according to Gupta.

While that may be a tall order, considering the uncertain economy, Bilotti said that the biggest hurdle for operators — high programming costs — appears to be coming down.

"The biggest bugaboo — out-of-control programming costs — seems to be ending," Bilotti said, adding that while total programming costs continue to grow, per-channel programming costs are falling off.

Bilotti estimated that programming costs were going up at a rate of 12 percent per subscriber, per year. But with the advent of digital cable — and its increased number of channels — that number appears to be declining to 6 percent per subscriber going forward.

"When you disaggregate 12 percent in the push, about half was inflation on a per channel basis and the rest was you adding channels," Bilotti said. "Matching on revenue growth, you see the beginning of a surge in take up of digital premium packages. When you look at programming cost growth, another piece had to be disaggregated from the pool."


By growing digital, Bilotti added, operators are also increasing premium-channel subscriptions, which, in turn, bring in more revenue.

"By selling more premium services by selling digital, you're incurring costs that relate directly to revenue," Bilotti said. "That expands operating margins."

He estimated operating margins of 44 percent to 45 percent by the end of 2005.

Banc of America Securities LLC cable analyst Doug Shapiro added that the competitive environment also appears to be leaning in cable's favor.

Competition from direct-broadcast satellite providers and digital subscriber line carriers — once thought to be substantial — isn't playing out as once expected, Shapiro said.

DBS monthly subscriber additions, once in the hundreds of thousands, started turning negative in 2000. And the two major DBS carriers, EchoStar Communications Corp. and DirecTV Inc., are forecasting lower net additions in 2002, compared to 2001.

DSL, once expected to overtake cable-modem service, has proved just the opposite.

"Cable is pulling away from DSL," Shapiro said, adding that year-over-year growth for cable-modem service is up 12 percent, while DSL has experienced a 3 percent decline.

But while new services appear to be taking hold — and capital expenditure budgets are dropping, as operators have largely completed systems upgrades — the question of whether MSOs will soon begin to generate free cash flow (or cash flow after all debts are paid) remains unanswered.

Credit Suisse First Boston cable and telecommunications analyst Lara Warner said operators who fail to pare down debt will continue to feel pressure from investors.