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A Year In the Penalty Box

Coming off a decent gain in 2003, cable stocks reverted back to old habits in 2004, losing about 8% of their value between January and December.

The decline was one of the smallest in the past four years, but comes after an 18% increase in 2003. Stocks of the publicly traded MSOs were down 55% in 2002, 15% in 2001 and 26% in 2000.

The 2004 list was a bit shorter than last year’s — Cox Communications Inc., which went private on Dec. 8, was left off. If Cox was included, the decline would have been about 5% for the year.

Also left off the list were smaller MSOs Adelphia Communications Corp. — in the middle of an auction for its assets — and overbuilders Knology Inc. and RCN Corp. With those three included, the hit is greater: a 10.3% decline.

Practically every MSO stock that made the list declined in 2004 (Time Warner was the sole gainer, at 6.4%), but results were skewed by steep declines at Charter Communications Inc., Insight Communications Co. and Mediacom Communications Corp.

Charter led the decliners in 2004, losing 48.1% of its value ($1.94 per share), mainly because of concerns over basic-subscriber losses and industry-leading debt.

Smaller MSOs Insight Communications Co. and Mediacom Communications Corp., down 15.6% and 38.3%, respectively, reflected investor concerns about eroding basic-subscriber growth in the wake of strong customer gains by direct-broadcast satellite competitors.

“It was a tough year,” Janco Partners cable analyst Matt Harrigan said. “But if you look at the group and step back, the clear issue is that you’re still losing basic customers and satellite is growing. My bias is that satellite probably hits the wall sometime over the next two years. They don’t have the diverse product bouquet that cable companies have.”

For the first nine months of 2004, MSOs lost about 300,000 basic customers, while direct-broadcast satellite added 1.45 million.


Still, DBS stocks didn’t have a great year.

EchoStar Communications Corp.’s share price declined 3.3% between Jan. 2 and Dec. 15 to $32.95 from $34.09. DirecTV Group Inc. rose 4.2% in the same time frame, from to $16.69 from $16.01.

What was most surprising about the decline in MSO stocks in 2004 was that it happened so quickly. Most of cable’s 2003 gain occurred in the last four months of the year — momentum many hoped would continue into 2004.

But actions by some cable companies early in the year — especially Comcast’s Feb. 11 bid for The Walt Disney Co. (which Comcast abandoned in April) — sent some investors to the exits.

Sanford Bernstein & Co. cable analyst Craig Moffett said the decline began about two weeks before Comcast’s bid for Disney.

“It’s hard to say what the issue there was, whether it was the beginning of a downward trend or just a momentary blip, because everything was drowned out by the Disney bid,” Moffett said.

“Comcast stock took a monumental hit associated with their bid for Disney, which shareholders viewed to be free-cash-flow dilutive, but, more importantly, investors took it to be a vote of no confidence in the cable business. It’s taken the better part of a year for investors to let Comcast and the rest of the cable industry out of that penalty box.” (Time Warner chief Richard Parsons used that phrase during a panel session at the National Show in May, alluding to the impact of Time Warner’s own merger with America Online on investor confidence in cable deal-making.)

Failing subscriber growth and the Disney adventure weren’t the only factors depressing cable stocks. The threat of competition from regional Bell operating companies also played a major role.


Moffett said another critical juncture for cable stocks was June 22. That’s when SBC Communications Corp. announced a $6 billion plan to build a fiber-to-the-premises network — one that would offer video service — over the next five years.

About two days prior, Cablevision Systems Corp. announced a discount program for its triple-play bundle, offering voice, video and data service to new customers for about $90 per month.

“That played right into investors’ worst fears about a looming price war,” Moffett said. “Capped by the RBOC fiber announcement, the market went into a months-long decline.”

Investor reaction to Cablevision’s bundling discount and the RBOC fiber buildout may have been premature. By December, Cablevision had crossed the 250,000-subscriber mark with its Optimum Voice product, and customers were spending an average $110 per month on the bundle, the result of taking higher tiers of digital service.

Investors also began to realize that RBOC fiber plans — Verizon has announced a similar strategy — would take several years to complete.

“You get a sense that just in the last few weeks, investors are starting to take a more moderate view of the real threat of RBOC competition,” Moffett said. “Effectively, investors have treated cable stocks as though there are few, if any, barriers to entry in the video business.

“I think investors have taken a more-moderate view that says the barriers to entry facing the RBOCs are quite significant, with everything from franchise obligations, to the capital-investment requirements, to their ability to access attractive content at reasonable costs. You’ve seen cable stocks recover a bit as investors started to adopt a more reasonable set of expectations.”


Most cable operators reported some of their strongest financial numbers ever, yet their stocks would not respond. That was a factor in Cox Communications Inc.’s December move to go private.

Other than Charter and Mediacom, all the major MSOs are on track for double-digit revenue and cash-flow growth. (Insight does not issue guidance, but had 11% revenue growth and 10% operating cash flow growth in the first nine months of 2004.)

All except Charter are on track to report positive free cash flow (cash flow after interest payments and capital expenditures are made) for the year.

“It’s really frustrating,” Harrigan said. “I look at the satellite companies as such a one-trick pony and the RGU numbers for most of the cable MSOs have been very good this year. And some of the financial metrics [for Comcast] have been the best in the company’s history.”

Investors appear to be pinning their hopes on cable’s telephone rollout, expected to hit high gear in 2005.

“There is no question that VoIP is likely to be the big catalyst for 2005,” Moffett said. “The big question mark for 2005 is: whither Adelphia?”


Adelphia put itself on the block in April, and final bids for its 5.2 million subscribers are expected in mid-January. The Denver-based MSO has said that it will make a decision as whether to sell or remain intact and emerge from bankruptcy protection in the first quarter of 2005. Adelphia is expected to attract a price of between $17 billion and $20 billion.

So far, more than 40 parties have expressed interest in Adelphia. Time Warner Inc. and Comcast Corp., which are considering a joint bid for the assets, are seen as the front-runners.

Moffett said that whether Adelphia is sold — and who it is sold to — could affect cable valuations into the foreseeable future.

At $17 billion to $20 billion, Moffett said, Adelphia would sell for about 15 times 2005 cash flow — a hefty price, given that Time Warner and Comcast trade at about 8.5 times cash flow.

“There is still a very good chance that the best available option for Adelphia is to emerge from bankruptcy and operate for a few years, because the bids that come back could well turn out to be disappointing,” Moffett said.

Moffett sees 2005 as a good year for cable stocks, but cautioned that at least some volatility will remain.

“There’s an old adage in the stock market that stocks climb a wall of worry,” Moffett said. “Cable stocks remain subject to an inordinate amount of headline risk.

“Every time there is a new press release from Verizon or SBC, cable stocks will predictably take a hit. The question is, how much they will rise above that background noise?”