If you listen to the parade of CEOs blaming the economy for their companies' lackluster performance, you'd never know there are actually companies out there that are not only having a good year but a great year. Let me use one industry, the cable business, to show how this economy is working to separate the winners from the whiners. We all know how terrible the cable business has been lately, right? Selling consumers on getting their phone service over their cable TV has been a tougher-than-expected sell. Upgrading systems to sell the new digital services has been incredibly expensive -- and demand for digital cable TV has been tepid in many service areas. Satellite services have been stealing market share. In this environment, AT&T's ( T) cable division lost 432,000 basic subscribers in the first nine months of 2002 -- and showed an almost 4% drop in subscribers in the third quarter alone. The question seems to be not why AT&T decided to get out of the cable business but why Comcast ( CMCSK) wanted to buy these systems in a deal that finally closed on Nov. 18.
In Charter's case, debt is now at overwhelming levels. According to UBS Warburg, the company could finish 2003 with $20 billion in debt -- or about $3,050 for each basic subscriber. Growth is slowing, interest expenses are climbing as the company's credit quality slips, and Charter is unable to sell assets at attractive prices, because that's what every other debt-laden cable company is trying to do right now. So Charter can't easily de-leverage its balance sheet. The company has, under the circumstances, promised Wall Street a target that is almost impossible to reach: growth in EBITDA (earnings before interest expenses, taxes, depreciation and amortization) at double-digit rates in 2003, while cutting capital spending by 50% from the year-earlier levels. No wonder the stock is down 90% this year. ( Securities and Exchange Commission investigations into the company's bookkeeping haven't helped, of course. Nor have fears that the company will be forced into a financial restructuring that wipes out the remaining stake in the company held by owners of Charter's equity.)
Why the huge difference between Cox and other cable companies? Merrill Lynch recently took a look at Cox's Orange County, Calif., operation to see. Part is luck -- or foresight. Cox started its Orange County unit in 1968. It was one of the first cable operators to upgrade its systems to include digital video and telephone over cable, available in Orange County since 1997. That gave the company time to work out the kinks in its infrastructure and make the necessary investments before the Internet-over-cable boom really took off. That partly accounts for the company's extremely high market share in the country; 85% of high-speed Internet customers in Orange County are Cox subscribers.
Cox shapes its capital budget to promote this bundling strategy. Relatively little goes to adding new digital cable subscribers; at $17 a month, the service is not that lucrative. More goes to building out Internet access -- $40 a month for a cable modem and high-speed service -- and telephone over cable, where the average monthly bill is $46. A cable system built out and managed, such as Cox's Orange County operation, is also extremely resistant to competition. Direct broadcast satellite has about 18% market penetration on average nationally. In Orange County, it's just 10%. The market isn't ignoring the Cox story -- the stock trades at a premium (based on EBITDA) to the average for the cable group. And at a recent $29 a share it is within 20% of a conservative one-year target price of $35.50. Certainly not a bad potential return considering the low risk in the stock.
And that's not the only challenge. AT&T's unit overcommitted to telephone over cable -- perhaps only natural given the company's roots -- and neglected its video and data offerings. This means reorganizing marketing and pricing plans to beat back competition from direct broadcast satellite. AT&T's cable systems have seen huge losses to that competing technology. All this means there's a big risk that Comcast could take its eye off the ball, flub the execution of the acquisition and wind up needing to spend more over a longer period of time to generate a lower return. A purchase of Comcast at this point is a vote of confidence in management. If you think it's up to the job, buy the stock for the potential that the AT&T systems will eventually operate as well as the rest of Comcast did before the deal. If you think this deal will end up as just another case of overestimated synergies, then take a pass. I'm adding the shares to Jubak's Picks with a target price of $34 a share by December 2003.