Debt Load, CLEC Woes Undermine the Adelphia Story

Watching Adelphia Communications (ADLAC Quote - Cramer on ADLAC - Stock Picks) manage its obligations is like watching the Flying Wallendas on the highwire.

On the one hand, you've got to admire the nerve and talent of the Rigas family that controls Adelphia, tested over years of running one of the most highly leveraged major cable operators. On the other, as Moody's Investors Service reminded investors last week, with one wrong step the whole venture could come crashing down to earth.

The indebtedness of Adelphia and the other major cable operators is worth particular scrutiny amid the current economic downturn, slowing basic cable growth and growing satellite TV competition. Over the past few years, cable operators have borrowed billions of dollars to fund upgrades enabling them to offer services such as high-speed Internet access, phone service and expanded menus of TV channels. That's putting pressure on operators to make these investments pay off, and to pay off their debts.

The pressure appears especially heavy on the Pennsylvania-based Adelphia, which has less room for error than other operators, judging by traditional yardsticks: It has more debt and dedicates a greater proportion of its cash flow to interest payments than do rivals. Adding to Adelphia's burden is its entry in the late 1990s telecom sweepstakes, its cash-hungry Adelphia Business Solutions (ABIZ Quote - Cramer on ABIZ - Stock Picks) unit.

Balls in the Air

Adelphia is run by good, capable managers, and it's not in danger of going bust, says Merrill Lynch high-yield media analyst Oren Cohen. But its bonds and stock have suffered, and will continue to suffer, as a result of uncertainties related to its debt, he says. "The problem with Adelphia is it's got too many balls in the air," he says, employing a different big-top metaphor. "It's got to make sure its balance sheet doesn't spin out of control." Cohen has a neutral rating on Adelphia's debt; his firm hasn't done recent banking for the company.

Indeed, as of midyear, the company's $14.4 billion in debt amounted to 10.5 times annualized second-quarter earnings before interest, taxes, depreciation and amortization -- a measure of cash flow often used to gauge performance at media companies -- according to TheStreet.com's calculations. By comparison, the median figure among four other large operators was debt amounting to 5.5 times EBITDA. Adelphia's second-quarter EBITDA was just 1.25 times interest expense, compared with a 3 times median for the other operators.

The Borrowers Adelphia's debt load is heavy, and its interest coverage scant, compared with cable rivals

Source: Company SEC filings and press releases, TheStreet.com calculations * Based on debt as of June 30, 2001 and annualized EBITDA for quarter ended June 30, 2001. ** Based on figures for quarter ended June 30, 2001.

Adelphia closed at $31.50 Thursday, down 14 cents. For the year, the stock is down 40%, more than all other major operators except Cablevision Systems (CVC Quote - Cramer on CVC - Stock Picks).

The latest news to nudge Adelphia's stock downward was Moody's announcement Monday that it was downgrading its ratings on Adelphia's debt and preferred stock to negative. Moody's, which is giving Adelphia a year and a half or so to demonstrate "the ability and the desire" to deleverage its balance sheet, alluded to difficulties Adelphia might face in funding capital expenditures while paying its debts. But the ratings agency expressed most concern about the company's funding of its cash-hungry competitive local exchange carrier subsidiary, Adelphia Business Solutions.

ABIZ, down 97% from its heights in March 2000, has the potential to be a money pit for Adelphia. The parent company effectively cosigned a bank loan of $500 million for ABIZ, of which the competitive local exchange carrier, or CLEC, had drawn down about $450 million by the end of June; ABIZ says it needs another $500 million to keep going through mid-2002. Moody's and others wonder how much deeper Adelphia will dip into its wallet for ABIZ. Adelphia executives told analysts earlier this month they wouldn't provide further funding to ABIZ, but Adelphia's suggestion that it might buy more than $100 million in assets from ABIZ looks to Moody's a lot like disguised child support.

Cotton Candy

Adelphia -- founded by CEO John Rigas nearly four decades ago and employing three Rigas sons in the executive office -- didn't respond to a request for comment about the Moody's report. But shareholders say that even the worst-case scenario for the majority-owned CLEC wouldn't justify the beating Adelphia Communications has taken in the stock market recently. Plus, they say, Adelphia's management is smart enough not to let its flailing ABIZ cause permanent damage to the cable business at the heart of Adelphia and the Rigas family.

Rick Lawson, portfolio manager of the (WEHIX Quote - Cramer on WEHIX - Stock Picks)Weitz Hickory fund, an Adelphia shareholder, estimates that the ABIZ obligation represents a downside of about $2.50 per share for Adelphia. He also suggests that the Rigas family knows where its bread is buttered -- on Adelphia, with its $5.5 billion market cap, not on ABIZ, whose capitalization is hovering around $250 million. "I don't worry that the Rigases will do something for ABIZ that puts ADLAC at risk," he says. "Their incentives are just too clear, and I think they understand those incentives."

Putting ABIZ aside, Lawson runs through a back-of-the-envelope calculation that ends up valuing Adelphia at around $80 per share, more or less. "I'm not saying that 80 is the right number," he says. "All I'm trying to do is suggest that the number is a lot higher than 30."

Another Adelphia shareholder, speaking on condition of anonymity, estimates that Adelphia is trading at a multiple of 12 times 2002 EBITDA, below peers trading at around 14 times expected 2002 EBITDA. If Adelphia's multiple were to match its comparables, the stock would be up about $20, says the buy-sider.

"Adelphia has always been in dire straits before," says Merrill's Cohen. "They've always come back."

All Adelphia has to do, then, is persuade investors this time around that it's not operating without a net.