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The performance of the large cable stocks like Comcast (CMCSA) - Get Comcast Corporation Class A Report, Time Warner (TWX) and Charter Communications (CHTR) - Get Charter Communications, Inc. Class A Report has been dismal over the last 12 months, with the group losing over 4% in value while the S&P 500 has gained 6.7% for the same period.

Judging by the stock performance and the lack of progress in growing EBITDA margins and average revenue per user (ARPU) as a proxy, it would be easy to assume these operators are content with the declining basic cable businesses and don't really care about shareholder value. But the cables have made a concerted effort to keep up with the times, sinking billions of dollars into upgrading networks to bring high-speed, cutting-edge interactive video and data services to the end-users.

This investment will drive higher average selling prices and lead to bigger market share gains, and it is indicative of the cable companies' vision of growth. Given the underperformance of the stocks in this sector, we believe opportunities abound in the stocks of equipment makers and cable operators.

We had the opportunity to sit in on a presentation by Comcast CEO Brian Roberts where the case for video on demand (VOD) was made clear. VOD is light years beyond pay-per-view, both for the user and the operator. VOD applications are geared toward segmenting the television viewing market and that will drive premium advertising dollars. That is why so much money is going into research and development to increase storage capabilities, increase video libraries and create proprietary programming.

Comcast's VOD menu is a screen of channels broken down into a constantly evolving growing list of genres. For instance, Comcast rolled out its on-demand television dating service in September. This service allows users to enter criteria for a possible match and then watch a video, in digital form, of the potential date. In its first month in a small Philadelphia rollout, there were 100,000 streams. And the company's NFL replay allows on-demand users to see archived, 8-to-10-minute highlight reels of each game with audio from the local market's radio broadcast, and comes with digital video recorder (DVR)-like fast-forward and rewind functions. The service has had 3 million streams since the start of the season in early September.

To put that in perspective,



Sunday Ticket, which plays all of the week's games, has only 1.5 million total users. Satellite is unable to offer VOD because it requires a two-way, interactive platform, which is only available from cable. Maybe that is why DirecTV just reported on Tuesday that it is spending more to acquire customers and churn is increasing.

Booking Gains

Every quarter the cable companies release three subscriber metrics: basic, digital and high-speed data. The analyst community and reporters then focus on the declining basic subscriber numbers, ignoring or only mentioning the gains in digital and high-speed adds. The stocks then proceed to trade sideways or lower.

But a closer examination of the cable company model shows that total subscriber numbers are going to be flat to slightly down while average revenue per user and EBITDA margins actually increase. Time Warner is forecast to have flat year-over-year subscriber results in 2004. At the same time, its high-speed data and digital subscribers are forecast to rise a combined 13.6%. The net result is a 9% increase in forecasted EBITDA for this year.

And then there is the once-hyped but now often-ignored telephony business, or Voice-over-Internet-telephony, that is going to aggressively pursue the long-distance market. VoIP currently accounts for less than 1% of sales, but is forecast to grow to 6% of sales by 2007, providing even more upside to the Street's forecasts.

Although these modest financial successes may not seem like such a big deal, potentially explosive growth awaits in the not-so-distant future. The biggest knock on VOD is the lack of programming selections, but that is set to change, thanks to the investments in storage, etc. Bob Benya, Time Warner's Interactive Television vice president, said the company has plans to double its 1,200 hours of on-demand programming next year, and you can start to see the vision that the cable industry is laying out for the next decade of growth.

Substitute some large numbers and the same holds true for Comcast. Comcast says it already has 2,000 hours of on-demand programming; the company participated with


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in the acquisition of the


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film library, adding to this total. And Comcast has penetrated only 60% of its digital subscribers so far with VOD, meaning another 3.3 million digital subscribers are waiting in the wings.

It's not hard to understand why advertisers would be intrigued by the potential take-off of VOD. Advertisers will now get a bigger bang for their buck given the ability to better target its intended demographics.

VOD is going to take on many forms over the next few years as the MSOs work to meet the consumer's increasing needs and cravings for technology. Ideas like Time Warner's Local Teen Idol, Comcast's local dating service or Charter's Sponsored Content will drive interest and attract more basic and digital subscribers to make the move to subscription-based VOD. The cable companies and equipment providers are just now getting an idea as to how to capitalize on high-speed video deployment and streams. When critical mass is met, advertising dollars will likely follow and EBITDA margins will continue to improve.

Now for the hard part. What are these features and add-on services worth to shareholders? The market right now seems to be having a hard time figuring this out.



is being taken private at $3,800 a sub using next year's sales estimates. Most of the larger cable operators, save Charter Communications, which has company-specific financing and leadership issues, are trading in the same range. But these levels aren't much higher than they were 12 months ago and certainly don't seem to reflect what is going on in the cable war rooms.

The two trains of thought go like this. The more popular strategy is to complain that the cable companies are spending too much money to acquire subscribers to protect against market share loss to satellite and telecom companies. With no way to forecast the actual return on investment (ROI), which is already well into the billions of dollars at Comcast alone, it is better to wait on the sidelines for now. The less popular, but potentially more rewarding, strategy is to step in and start buying these stocks here. That is the strategy employed by the founders of Cox, who, in taking the company private two months ago, leveraged their personal fortunes based on their conviction in the value of cable going forward.

We believe greater adoption of higher-margin services is right around the corner and the forecasts could prove conservative, lending credence to the latter train of thought. On the operator side we have



in the

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model portfolio. And just yesterday we added an interactive TV company to the mix. We believe both companies will begin to trade higher once the market wakes up to cable, and we don't want to pass up on the opportunity to own these stocks at current prices.

William Gabrielski is a research associate at and is accredited with a Series 7 license. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback and invites you to send your comments to

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David Peltier is a research associate at In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier welcomes your feedback and invites you to send your comments to

Interested in more writings from David Peltier? Check out his newsletter, The Save Safe Plan. For more information,

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