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Blame the Street, Not the Dolans

Wall Street taught Cablevision Systems an important lesson last week. Before the market opened, the cable operator disclosed that it has been caught up in corporate America's scandal du jour: backdating stock options granted to executives. The company couldn't produce an audited earnings statement for the most recent quarter and might have to restate earnings going back nearly a decade.

Investors winced only briefly. Cablevision's stock price dipped at first but, within an hour, had jumped back up and was 3% over the previous day's closing.

What's the lesson? That top management can stagger from one corporate gaffe to the next with little risk of punishment from Wall Street—as long as the company performs. Many times, Cablevision stock has taken a bad hit, but investors have always rallied back as if the company will sin no more.

Cablevision acknowledged last week that it had misdated some stock options and grants awarded to its executives from 1997 to 2002. Company executives did not precisely identify which transactions are in question. However, in recent months, federal regulators began investigating the obscure practice of improperly backdating stock options to give insiders an extra pay windfall.

Typically, the exercise price of a stock option is pegged to the stock's trading price on the day the option is actually awarded. If a company's stock has been on the rise, backdating the option artificially lowers the exercise price, giving executives an extra bonus by allowing them to buy shares at an even greater discount off the market price.

Executives at two companies, Brocade Communications Systems Inc. and Comverse Technology Inc., face not just civil but criminal charges over options-backdating issues. However, the practice may be dicey but not necessarily illegal. More than 80 companies have admitted playing options games, including Apple Corp. and Home Depot.

After a review of the options transactions, Cablevision said in a statement, “management has concluded that the financial statements for all the periods beginning Jan. 1, 1997, should not be relied upon.” The company added that it will not issue a full quarterly report until the review is complete and it does not know how long that will take.

Ultimately, the options issue could prove to be financially minor. However, it should be viewed through the prism of Cablevision's long history of missteps.

Last year, controlling shareholder and Chairman Chuck Dolan and his son, CEO Jim Dolan, fought bitterly over failed satellite-TV venture Voom, valued at $1.4 billion. Then the company stunned investors with a last-minute $16.5 billion bid to buy Adelphia Communications, renouncing years of preaching about the benefits of focusing on its strong metro-New York clusters. Suddenly, it was trying for systems across 21 states. The bid failed.

Subsequently, Chuck Dolan made a serious attempt to take Cablevision private. That plan fizzled when the board demanded a better price.

Dolan then devised a new plan to pay an enormous $3 billion dividend, amounting to $10 per share. Oops. Cablevision had stumbled into violation of bank-loan agreements and had to shelve the plan in December. The company restructured the agreements and the dividend plan, eventually paying out the money in April.

Cablevision has twice aborted plans to spin off its Rainbow Media networks division; has been investigated by the Securities & Exchange Commission for an accounting scandal; and been mired in a debt crisis over bad investments in such things as movie theaters and a consumer-electronics chain.

Merrill Lynch media analyst Jessica Reif Cohen declared in a harsh note to investors that the options game is “consistent with the unorthodox stewardship of the company by the Dolan family, whose actions can at times be considered at odds with the interests of public shareholders.”

But her recommendation on Cablevision stock: “Buy.”

Why? Because Cohen's job isn't to judge the company but to figure out if the stock will go up or down. She knows that investors will probably shrug off the latest scandal.

Anxiety over the Dolans' corporate management is offset by Cablevision's amazingly strong systems. The company says that, for the second quarter ended June, cable-system revenue surged 17.2% to $1 billion and the company posted strong growth in high-speed–data, telephone and even basic-cable subscribers. “They have the best results in the business,” Cohen says.

And every Cablevision investor figures there's one big hedge against a downside: Time Warner. Cablevision's operations ring Time Warner Cable's New York City cluster, and TWC executives have long coveted the Long Island-based operator. If 80-year-old Chuck Dolan—one of the smartest guys in the media business—ever decides to sell, Time Warner will be at the front of the auction house, no doubt flanked by Comcast and even Cox Communications.

So my advice to the Dolans: Don't change a thing. The occasional regulatory inquiry is a survivable annoyance. If Wall Street isn't going to make you any poorer, why bother to change?

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