Chicago — Morgan Stanley Dean Witter & Co. cable analyst Richard Bilotti told a group of operators and investors that if cable wants to continue to ride the growth wave in the midst of the economic downturn, it should focus on rolling out new services.
Bilotti, speaking as part of a Wall Street panel at the National Show here on June 11, was an early champion of free cash flow — cash flow minus capital expenditures — as a meter by which to gauge cable operators' success. But apparently he has had a change of heart, urging operators to instead focus on growing the subscriber base for new services.
"Enough about this free cash flow nonsense," Bilotti said. "It's the worst benchmark. Phillip Morris has tons of free cash flow and trades at about eight times [cash flow]. What you need to focus on is return on invested capital."
He added that the ROIC on digital cable and cable modems is so far above their cost of capital that operators should be "reinvesting every dime of cash flow you can get your hands on" into new services.
Bilotti added that while cable currently holds an advantage over direct-broadcast satellite and the regional Bell operating companies with digital cable and high-speed data, now is not the time to ease the pressure. "You should be taking it to the RBOCs with a meat cleaver," he said.
Not everyone on the panel shared Bilotti's views, although they agreed that cable's long-term outlook was bright.
Merrill Lynch & Co. analyst Jessica Reif Cohen considered current cable cash flow multiples "stretched." She expected money to continue to flow out of the cable operator sector in the short-term, especially if News Corp. or Echostar Communications Corp. acquire DBS powerhouse DirecTV Inc.
"[News Corp.] will use all of their leverage points in competition with cable operators in rolling out a more robust platform," she said.
Cohen added that any sign of a rebound in the advertising market could trigger a rotation of money from cable operator stocks into other media stocks.
"Every time we've seen a sentiment change, we've seen money flow out of cable into diversified media stocks," Cohen said.
Still, Cohen was optimistic about the industry's long-term outlook, citing its high cash flow and revenue growth, a benign regulatory environment and the promise of new services.
Cohen placed an 18 times cash flow target multiple on cable operators, adding that she did not include interactive services, which could add another four points to that valuation when they are rolled out.
Salomon Smith Barney Inc. analyst Niraj Gupta also was bullish on cable, although he disagreed with the notion that investors will bail once the ad market shows improvement.
"I don't think we will see sector rotation," Gupta said. "I think cable is in a very strong position."
For his part, Bear Stearns & Co. Inc. analyst Ray Katz said DBS providers hold the "marketing high ground," because of their national footprint, but that cable has the tools and the products to come out ahead.
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