Balance Sheets Matter, and Adelphia's Is on the Mend

The cable outfit's stock is the cheapest in its sector, and it looks like a winner.
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Editor's Note: Brett Messing's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published Nov. 19 on RealMoney.

There is nothing worse than riding a stock down to zero. It is mathematically difficult for even a diversified portfolio of stocks to absorb the debilitating effect of the total loss of capital from an individual holding.

Fortunately, no one ever owned, or owns up to having owned,

Exodus

(EXDSQ)

,

Teligent

(TGNTQ)

,

Winstar

or

Polaroid

(PRD)

. It reminds me of a 1964 Gallup poll that asked people whom they voted for in the excruciatingly close 1960 election between Kennedy and Nixon. According to the poll, 78% of the country's electorate voted for Kennedy. Don't be a liar. Learn from your mistakes. The bottom line is that balance sheets matter.

While I am on a roll, I would like to offer up another ludicrously obvious observation. Stocks with weakening balance sheets tend to go down, while stocks with strengthening balance sheets tend to go up. Some of our biggest winners have come from investing in companies right after significant -- and apparently dilutive -- financings that strengthened balance sheets. As an example, we were big buyers of

Lucent

(LU)

this summer after it executed a billion-dollar convertible preferred offering. The stock has appreciated approximately 30% since then.

Opportunity might be once again knocking at our door.

Adelphia Communications

(ADLAC)

is a great balance-sheet improvement play. The company owns and operates cable systems. In fact, Adelphia is my cable provider in Los Angeles. On Nov. 9, the company raised $1.1 billion through an equity and convertible financing. Importantly, Adelphia's founders, the Rigas family, bought 7.5 million shares and $50 million in convertible preferred stock.

The company is also spinning off

Adelphia Business Solutions

(ABIZ)

, its underfinanced competitive local exchange (CLEC) unit, which will further remove $1.4 billion of debt and $300 million of preferred stock from its balance sheet. During the last year Adelphia Communications stock has underperformed the cable sector because of concerns about its balance sheet and its association with Adelphia Business. Now in one fell swoop, both concerns have been addressed. As a point of interest, the stock peaked at $70 in March 2000, and its 52-week low is $18.76.

Held Up With Cable
Adelphia Communications is looking up

We are bullish on the cable business, and Adelphia Communications is the cheapest stock in the sector at 11.3 times 2002 estimated earnings before interest, taxes, depreciation and amortization, or EBITDA. We expect the company's revenue growth rate to accelerate from 11% and 12.5% and its EBITDA growth rate to accelerate from 10.5% to 13%.

Moreover, digital and data subscriber additions continue to come in ahead of plan. Anecdotally, high-speed cable access seems to be crushing digital subscribe lines, or DSL, in Los Angeles. As an earlier adopter (my parents had a Betamax VCR), I have DSL with

Verizon

(VZ) - Get Report

. The quality of the service is good, but the installation process was abysmal. With high-speed access still in its infancy, this product represents a great growth opportunity for Adelphia Communications.

From a trading standpoint, the secondary equity offering on Nov. 9 was priced at a discount of $1.87 from the last sale. The offering price of $21.50 did not hold because of short-selling pressure from convertible arbitragers who purchased the preferred stock. The shorting selling pressure seems to be abating, and we expect a couple of points run from the stock in the short term. Longer term, we think that Adelphia Communications will be a big winner for us.

Get into the improving-balance-sheet game. It will treat you well.

Brett Messing is partner of Oscar Capital Management LLC, an investment adviser that is based in New York and Los Angeles, registered with the SEC and has approximately $1 billion in assets. At the time of publication, Oscar Capital and its clients were long Lucent, Verizon and Adelphia Communications though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Messing appreciates your feedback and invites you to

send it along.