Justified or not, the practice of valuing companies according to EBITDA came under attack Thursday in the wake of the WorldCom(WCOME Quote - Cramer on WCOME - Stock Picks) debacle. The accounting paranoia dragged down the cable and telecom sectors on concerns that companies similar to WorldCom could be just as prone to abuse.
For years, certain pundits have evangelized that the only credible way of valuing capital-expenditure intensive companies with little or no earnings is to look at their earnings before interest, taxes, depreciation and amortization. Before WorldCom, the claim was rarely challenged. Thursday, investors swung back with a vengeance.
Shares of media stocks in the cable and satellite sectors continued their downward slide from Wednesday.
Cablevision(CVC Quote - Cramer on CVC - Stock Picks) topped the list of heavy losers, down $1.45, or 15.26%, to $8.05, after losing nearly 30% Wednesday.
Charter Communications(CHTR Quote - Cramer on CHTR - Stock Picks) lost 27 cents, or 7.74%, to $3.22.
Insight Communications(ICCI Quote - Cramer on ICCI - Stock Picks) lost $1.71, or 14.58%, to $10.02.
Cable bellwethers
Cox Communications(COX Quote - Cramer on COX - Stock Picks) shares rallied a penny, or 0.04%, to $26.91, after spending much of the day in negative territory.
Comcast(CMCSK Quote - Cramer on CMCSK - Stock Picks) shares lost 39 cents, or 1.72%, to $22.33.
Viacom(VIA Quote - Cramer on VIA - Stock Picks) lost $1.12, or 2.62%, to $41.67.
News Corp.(NWS Quote - Cramer on NWS - Stock Picks) shaved 62 cents, or 2.74%, to $21.99.
Overblown
Market watchers were quick with the fire extinguishers. "As yet another accounting scandal makes the headlines, cable operators are taking another hit, as EBITDA-based valuations and the high-capex nature of the cable business reignited concerns that cable companies could also be overcapitalizing expenses and overstating EBITDA," wrote Merrill Lynch's Jessica Reif Cohen in a note to clients. "We believe the accounting concerns seem overblown." Cohen explained that cable companies rely on a steady stream of subscriber revenues that lead to "very consistent and highly predictable revenue and EBITDA results," implying that Worldcom-like gaming is just not feasible in the industry.
Put simply, said Ryon Acey, cable industry analyst at BB&T Capital Markets, "There's no other way to value these guys."
Particular concern erupted yesterday over
AOL Time Warner's(AOL Quote - Cramer on AOL - Stock Picks) complicated accounting structure, fueling rumors the company planned to issue a warning ahead of its quarterly earnings on July 24. AOL shot down the speculation Thursday and the shares rallied back from midday losses, ending down 5 cents, or 0.37%, to $13.68.
"I think that it's the fact that the WorldCom situation brought to light the realization that fraud can exist anywhere," said BB&T Capital Markets' Acey. "Both cable and telecom companies have capital intensity in common with one another, which causes investors to sell off on stocks similar in nature."
Syllogism
Analysts cautioned investors from drawing a straight line of correlation between flagrant impropriety and companies that rely on this metric as the only credible measure of value. "We have to remember what we're talking about here. We're talking about illegal activities," said Acey. "We're not talking about aggressive accounting tactics. We think investors have to be careful when they assume that because there's a criminal at WorldCom that the same conditions exist in other cable companies."
EBITDA concerns also helped drag down the wireless sector, though to a far lesser extent than Wednesday's initial panic. In a note to investors titled "WCOM Impact. Not the End of Wireless, but End of EBITDA," J.P. Morgan wireless services analyst Thomas Lee called for an overhaul in the valuation of wireless shares, which have the same capex-intensive, over-levered nature of many telecom and cable stocks.
Wireless investors dumped shares Wednesday and "whether this was justified or not, in this current market environment, it is almost besides the point," Lee wrote. "The downward spiral in the credit cycle for wireless seems to be the primary driver for wireless equities today." Above all, the credit cycle "overshadows" any incremental improvements on fundamentals, he said.
"EBITDA is not going away anytime soon, as bank covenants, credit analysis and even private-market analysis rely on EBITDA as a measure," Lee wrote. "Still, the fact is, that it is proving to be an even less reliable a measure of the performance or value of a company in our view."
Kenneth Li
RSS
