High-Yield Analyst Sees Safety in Cable
George Mannes
06/19/02 - 07:30 AM EDT
Investors have overreacted to the latest bad news in the cable business -- but perhaps they've paid insufficient attention to more substantive threats to the industry.
That paradoxical opinion comes from Moody's Investors Service high-yield cable debt analyst Russell Solomon, who issued a lengthy report Tuesday saying that the debt-laden operators of cable TV systems continue to face the challenge of delivering on their longtime promises for generating free cash flow.
Despite the risks, Solomon says the cable business still holds opportunities for debt investors.
"It's still a comparatively safe sector to invest money in," he says.
Solomon's report, covering leveraged operators including
Cablevision Systems (CVC),
Charter Communications (CHTR),
Insight Communications (ICCI) and
Mediacom Communications (MCCC), spotlights the continuing debate over appropriate valuation of cable TV operators.
Despite a recent bounceback -- Cablevision's shares, for example, closed up 4% on Tuesday -- cable investors have had a dismal year. In part, that's because the market has been beset by concerns that cable operators, once they've finished upgrading their infrastructure, won't throw off cash at the speed or in the quantities previously expected. They've also gotten the jitters from the misadventures of
Adelphia Communications (ADELA), wondering whether other operators will spring unwelcome surprises on Wall Street related to inaccurate financials or undisclosed business relationships.
Saying Adelphia's alleged financial shenanigans are unlikely to be found elsewhere in the industry, Solomon expresses concern about several industrywide issues that investors, he believes, are ignoring. For example, basic subscriber growth, which has slowed to a trickle in the past year, will likely stop completely within the next few years and turn into a net subscriber loss for the cable industry.
Now, Solomon isn't the first to predict that the cable industry, beset by competition from direct broadcast satellite service, will have a shrinking subscriber base for the first time in its history. Deutsche Bank cable analyst Karim Zia, for example, timed a subscriber-count retreat for 2005 in an April report. But, says Solomon, the inevitable decline in subscriber counts isn't as widely recognized as it should be.
To counter the dwindling basic cable growth, operators have upgraded their networks to reap more revenue from advanced services such as digital video, high-speed Internet connections and telephone. Those new services have helped generate greater cash flow from operations for cable system owners. (Hardly any, though, have been able to generate what's known as free cash flow, or cash flow after interest expense and capital expenditures have been subtracted out.)
Cash flow, says Solomon, should eventually be growing faster than debt levels at cable operators. But, he notes, that hasn't happened yet.
"We're still waiting for it," he says, "but we're not being quite as patient as we've been to date."
That's why, says Solomon, nearly all of the cable operators with high-yield debt that he covers either have a negative outlook covering the next 12 to 18 months or are under review for a downgrade within the next 90 days. The only exception is Charter, which Moody's says is committed to deleveraging its balance sheet.
Meanwhile, one other cable industry observer suggests that investors' concerns about cable are an overreaction.
"You look at the industry, the fundamentals are very strong," says Ron Rizzuto, professor of finance at the University of Denver and a senior fellow at the Cable Center, an industry-supported research and educational facility.
"Valuation is going in the opposite direction of operating performance. ... It's curious."
