University of Pennsylvania
. Bilotti joined
Morgan Stanley Dean Witter
in 1994 as a senior cable TV industry analyst. Before that, he was a high-yield cable TV analyst at
. In previous positions he followed communications and transportation at
Prudential Bache Securities
Industry Outlook and Style
Note: Bilotti was not available for an interview. The outlook that follows was compiled from five of his industry reports covering cable TV, entertainment, TV advertising and broadband/CATV. The reports are dated July 26, Sept. 19, Oct. 2, Oct. 3 and Oct. 31. Bilotti also declined to name a single top stock pick.
Cable: Competition Speeds New Products
Bilotti's outlook for cable TV has grown steadily brighter through this year: His group raised its investment rating for the sector from underweight in January to neutral in May to overweight in August.
Multiple system operators, or MSOs, are facing competition in the video arena from direct broadcast satellite TV companies and from telephone companies offering high-speed data connections with xDSL lines. But, notes the MSDW analyst, "the players are keenly aware of the dire financial consequences of price reductions."
So as the DBS customer base began to grow at a faster than expected pace earlier this year, cable companies responded by accelerating their rollouts of new programming packages and video-on-demand rather than cutting prices. Similarly, to combat the threat of telco's xDSL, most satellite operators will likely ramp up deployment rates during this quarter and in 2001. "Prices should inevitably come down in later years, but only when economies of scale make this type of competition reasonable," he says.
When evaluating these companies, Bilotti asserts that "total revenue growth is the key near-term metric of success," since it accounts for the effects of competition on both price and unit growth. In addition, he warns investors against using free cash flow as a measure of cable companies' success. "In contrast to consensus opinion, we believe that when the cable television industry begins to produce significant excess free cash flow, it will be a signal that a slowdown in revenue and
EBITDA growth is imminent," he says. Investors, he notes, are best served by a cable company that reinvests all of its cash flow into internal growth.
Believing that industry consolidation has come to an end for the time being, Bilotti predicts these companies will now be able to focus instead on internal growth. But while broadband technologies make scores of services possible, he argues that "broadband operators will need to avoid the temptation to invest in services simply because a technological framework exists. Each new service needs to pass the test that over a reasonable period, such as three to five years, the return on investment on the product line rises above the cost of capital."
Another positive change Bilotti anticipates is the adoption of an open-access policy, whereby cable operators allow multiple Internet service providers to offer high-speed access over their networks. While specific guidelines have yet to be established, Bilotti believes open access is good for the cable companies as well as consumers and large ISPs. In his view, having a choice of ISPs should benefit consumers and increase demand. In addition, open access should improve profitability for both ISPs and cable operators by increasing economies of scale and decreasing redundant costs.
Bilotti and his team choose
as their top picks in the sector, based on each company's fundamental outlook and current trading level. (Morgan Stanley Dean Witter has had investment banking relationships with both companies.)
TV Advertising: Headed for a Soft Landing
On the advertising front, the analyst sees signs that the next two years will be relatively positive. He predicts television advertising, which grew at a robust pace in the first half of 2000, will slow gradually, making a "soft landing."
Whereas broadcast advertising is dominated by traditional sectors of the economy and thus has more cyclical exposure, cable advertising features more high-growth sectors and is more volatile. His group forecasts that the top 50 broadcast and cable advertisers will demonstrate 8% to 10% revenue growth, 15% to 16% operating income growth and 16% to 18% net income growth in 2001 and 2002.
The TV networks have lately been fighting an uphill battle to regain lost viewers: "With the exception of
, all of the major networks have seen their ratings decline during the 1999-2000 season," he notes. The current broadcast season will thus be "pivotal" for the networks, he asserts. At the start of the season, Bilotti believed that ABC was best positioned, while he considered
to be most at risk, thanks to their high percentage of new shows airing in primetime.
At the same time, however, Bilotti believes that Fox is best placed to benefit from a healthy syndication pipeline, which the analyst defines as "one of the most important drivers of long-term growth for an entertainment company."
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Entertainment: It's the Economy, Silly
The entertainment industry is dominated by huge conglomerates, most of which have stakes in all the major entertainment segments. Bilotti and his group analyzed these giants to determine their sensitivity to the economy by identifying each company's sources of cyclical and secular revenues. Cyclical businesses include broadcast networks and stations, cable networks, theme parks and music. Secular growth businesses are comprised of off-network syndication, certain aspects of cable networks such as proprietary content, and lastly, DVDs (Bilotti believes this is an important new format and predicts that if the price point gets to around $10, customers will simply buy them, bypassing video rental stores).
Their conclusions: "In a recession, we believe that worst-case, the overall sector will experience 6% - 8% growth, compared with 14% - 18% growth during peak economic conditions, and it is highly unlikely we will see an overall decline." Hardest hit will be cable and broadcast channels with substantial sports-rights costs. Among the conglomerates,
, where cyclical businesses account for 60% of revenues, will likely suffer most, in his opinion.
Another key to these companies' overall success is investment in new media. "While investing in new media today is unlikely to protect the entertainment conglomerates from near-term cyclicality, it should ensure that the companies' growth rates are sustainable in the long term, " he says. In addition to Fox, his top picks here are the combined
(as well as Fox). He names Disney, NBC and Viacom as conglomerates that have not committed to a new media strategy.
Although the music business has seen solid growth through the first half of the year, lawsuits and mergers have grabbed the headlines. The technologies of
are forcing changes an industry that "has operated under the same fundamental business model for over 100 years," asserts Bilotti. He predicts that the business will shift from selling products (CDs, cassettes, etc.) to providing services (e.g., personalized, on-demand access to music). Copyright law will also need to adapt to this new era, in which high-quality mass-reproduction is possible with the click of a mouse.