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Three Simple Rules

When the Dolans withdrew their offer to buy out public investors for nearly $8 billion, ending their effort to take Cablevision Systems private, I was reminded of three firm rules passed on to me by one of the company's most ardent followers on Wall Street.

Rule No. 1: There is no “smart money” on Cablevision. Many investors may appear to have special insight into the company, but they still haven't learned from its short-term moves.

Rule No. 2: The only thing you can truly expect out of Cablevision Chairman Chuck Dolan is the unexpected.

Rule No. 3: “Don't get greedy on this stock,” the analyst says. In the event that you start seeing gains, cash in.

Investors who ignored Rule No. 3 are howling, stung by the decision by Chuck and his son, Cablevision CEO Jim Dolan, to abandon their plan to take Cablevision private, slamming the company's stock price.

Instead of having their shares bought out for $33 or more, investors watched Cablevision shares drop to $24 last Tuesday. Some were long-term players who had hung in too long. Others were short-term hedge funds, which jumped in after the Dolans first made their offer in June, betting on a higher bid. Some were Cablevision employees, who had been overjoyed over the value of their stock options. All are in pain.

Something else has been injured: Cablevision's credibility. The Dolans demonstrate yet again how a reputation for controversy and erratic management can throw their stock off course. The aborted buyout is the latest in a string of examples in which Cablevision rushes into a plan, then abruptly pulls back.

The Dolans pay for this erratic management because it depresses their company's stock price. Last June, I wrote a cover story that talked about “the Dolan discount,” how investors are so wary of the Dolans' next surprise that they value the company's stock 20%-25% less than other cable operators, notably Comcast.

In June, the Dolans offered to pay outside shareholders $7.9 billion, or $21 per share, in cash for Cablevision's systems operations. The Rainbow Media networks unit would be spun back out to investors at a purported value of $12 per share. The Dolans control 20% of Cablevision's equity and 70% of its shareholder votes.

Two independent board members evaluated the offer and asked for more cash. (Just how much hasn't been disclosed.) Instead of making a counteroffer, the Dolans scrapped the offer.

The discount following last week's trauma is somewhat improved from June. UBS media analyst Aryeh Bourkoff estimates that Cablevision is trading at 6.6 times annual operating cash flow, 15% less than Comcast's multiple (itself terribly low). DBS rivals EchoStar and DirecTV, by contrast, trade at eight and 12 times, respectively. The higher the cash-flow multiple, the greater investors' confidence in future growth.

It's fair to say that Cablevision's current price is being propped up by the Dolans' expansive call for the board to approve a $3 billion special dividend that would pay investors a rich $10.25 per share. It's not likely that the board will approve a dividend that large, which would cause the company to substantially increase its debt load. Still, the possibility of a fat dividend keeps air in the company's stock.

The list of missteps at Cablevision's Long Island headquarters is lengthy. Just last winter, Cablevision was gripped by family warfare over the disastrous launch of DBS venture Voom. Chuck Dolan, hooked on the idea of a satellite service focusing on high-definition programming, committed $1.4 billion. He hoped to shelter Cablevision by spinning Voom off with programming arm Rainbow Media. Wall Street hated the venture, and so did Jim, who pushed the board of directors to scrap the project and sell the pieces.

That fight was barely over when Cable­vision stunned investors by throwing in a last-minute bid to buy Adelphia Communications for $16.5 billion. For years, the company had focused on systems in the metro-New York market. Suddenly, it was trying to buy a cable operator with systems across 21 states. The bid failed.

Investors also remember Cablevision's older slips, such as a late-'90s shopping spree far afield from its core skills, including a movie-theater chain and The Wiz electronics stores.

Why do investors keep coming back for more? Anxiety over the Dolans' corporate management is partly offset by Cablevision's amazingly strong system operation. With 3 million subscribers concentrated around New York City, the company has the best-run system operation in the industry. When it discloses third-quarter earnings next week, the systems are expected to post 17% growth in revenue and a 13% increase in operating cash flow. Analysts say Cablevision's base of phone customers has tripled to 600,000 in the past year.

Results for 2006 look almost as strong, although the company could face a slowdown in 2007.

If Cablevision were ever sold—a constant rumor—Time Warner has openly coveted its properties for years, and Comcast would clearly jump in. Is it possible that the point of taking the systems private was to allow the Dolans to run the company for a while, eliminate the perceived Dolan discount and pocket the difference?

It wouldn't surprise me if a parade of bankers approach the Dolans about selling. The Dolans would likely encourage speculation. Time will dull investors' senses a bit, and they'll probably seize on the inevitable rumors and push the stock price back up.

If they do, folks, just remember Rule No. 3.

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