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RCN takes step back

RCN Corp. may be sharply curtailing its plans to overbuild cable operators and telcos, but that's far from the end of the company's problems.

The aggressive overbuilder of cable and telephone companies is in the midst of a dramatic retrenchment, paring is plans to jump into new markets to curtail capital spending and conserve precious cash. The Princeton, N.J.-based company will stop skipping around the country looking for new markets and will focus on areas already under construction, including New York, Boston, Washington, Philadelphia, San Francisco and Chicago.

That means capital spending will run $700 million-$775 million, half of what the company had been predicting. That also means that instead of passing 3 million homes at the end of next year, RCN will only pass 1.8 million. Instead of passing 8 million homes in 2009, RCN plans only to pass 4 million.

Because RCN raised equity and debt aggressively when the capital markets loved telecom startups, RCN has lots of cash. Chairman David McCourt said that at the end of next year he will have about $500 million in cash and bank lines for another $500 million. "2001 is all about controlled growth," McCourt said. "We're in a position of leadership because of our balance sheet."

But rather than rallying behind RCN's restraint, investors are alarmed over numbers McCourt isn't touting. Despite chopping its expansion plans roughly in half, RCN's operating losses are accelerating rather than shrinking. Before the cutback, analysts were expecting RCN's negative cash flow to total $200 million-$250 million. McCourt now says operating losses should surge to $350 million.

This is all bad news, said Merrill Lynch media bond analyst Oren Cohen. "They don't seem to have control over their expenses," Cohen said. "As you scale back and attack your more mature markets, your cash flow losses should go down not up."

At the same time, there will be far fewer potential customers to support the company's debt load. Even if the company is a successful in securing subscribers, its $2.4 billion in debt will come to $5,000 per subscriber. That's more than double the debt load of the most scarily leveraged cable operator, Adelphia Communications. At a towering 10 times cash flow, Adelphia's $10.7 billion in debt comes to $1,900 per subscriber.

Even if cable system values hold up, RCN has very little margin for error. The best conventional cable systems, the ones with proven cash flows and local monopolies, sold for $5,500 per subscriber at the very top of the market. There's no assurance that even a successful overbuilder's systems would sell for that much.

So investors have hammered the company's stock down 50% to $6.25 since news of the cutbacks broke. Some RCN bonds are trading at about 50 cents on the dollar and yielding interest rates of 20%-plus.