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Analyst Downgrade Piles Onto Stocks

6/11/2000 8:00 PM Eastern

Donaldson, Lufkin & Jenrette Inc. cable analyst Karim Zia lowered his outlook on the cable sector from "outperform" to "market performance," citing increased competition from direct-broadcast satellite, digital-subscriber-line providers and overbuilds.

Cable stocks, already down about 40 percent so far this year, dipped somewhat when Zia's report was released June 6. But losses that day weren't all that heavy.

DLJ removed a "Top Pick" rating from Comcast Corp., but it maintained a "buy" rating on the stock. DLJ also maintained a "market performance" rating on Cox Communications Inc. and maintained "buy" ratings on Charter Communications Inc., Adelphia Communications Corp., Cablevision Systems Corp., Insight Communications Co. Inc., Mediacom Communications Corp. and Classic Communications Inc.

And Zia lowered price targets on Charter, Adelphia, Cablevision, Insight, Mediacom and Classic.

At market close June 6, Comcast was down $1.50 to $35.75 per share; Adelphia was down 25 cents to $46.44; Cox was down $1.71 to $46.38; Charter was down 88 cents to $12.94; Insight was down 50 cents to $15.63; and Classic was down 34 cents to $8.47.

Cablevision ticked up 62 cents, to $66.75 per share, and Mediacom was unchanged at $8.94.

While Zia was downgrading based on competition, SG Cowen Securities Corp. analyst Gary Farber was restating strong-buy ratings on Comcast and Cablevision-making them his top picks-because he believes the flip side is that competition has forced cable operators to roll out new services more quickly than expected.

Those new services, coupled with benefits from further consolidation and new strategic alliances, will drive near-term stock performance, Farber wrote in a separate report.

Farber wrote that his outlook for cable was still bright, and he continued to "raise near- and long-term expectations concerning the size of the market, particularly for digital TV."

In his report, Zia said that despite cable's average subscriber-growth rate of between 1.5 percent and 2 percent annually-in the face of substantial DBS growth-he believed that as DBS continues to grow and as DSL and overbuilds gain credibility, "conditions for cable stocks are likely to remain difficult in the near term."

Zia also adjusted valuations for cable stocks-previously at 18 times to 20 times cash flow-to 15 times to 18 times, reflecting rising interest rates and the growing competitive environment.

Zia remains bullish on cable for the long-term, adding that fundamental prospects for new revenue streams look better than ever. Dgital video was bringing in $15 to $20 per month incrementally from about 5 million subscribers, he wrote, and gross margins for the service were between 60 percent and 70 percent.

The outlook for digital cable appears even better, as more advanced digital set-top boxes are slated for deployment next year, he said.

On the high-speed-data front, take rates in markets where the service has been available the longest are above 10 percent, and they should get even better as retail availability of cable modems increases. Residential telephony penetration in some markets has hit 20 percent, he added.

Despite that rosy outlook, the competitive threat from DBS, DSL and overbuilders is too great to ignore.

According to the report, DLJ maintained a long-term forecast calling for digital-video penetration of 66 percent of basic-cable subscribers, along with an assumption that cable would capture 30 percent of the online market by 2006.

But DBS is gaining ground, especially now that the addition of some local television stations has enhanced already-rapid subscriber growth.

DBS has a further advantage because it derives only a small fraction of cash-flow growth from rate increases. Rate hikes make up at least one-half of cable's cash-flow growth. That fact, Zia wrote, gives DBS greater leverage in future pricing competition.

DSL-which has been hampered by slow rollouts and technology restrictions in the past-is gaining ground on cable modems, Zia wrote. Although there are only about 400,000 DSL customers, compared with 1.3 million cable-modem users, that gap could close quickly.

Because DSL can be transmitted over existing copper lines, upgrade costs aren't as high as what cable companies face, Zia wrote. He estimated that DSL-qualified households number about 35 percent of the country, versus 45 percent of households that can receive cable-modem service.

"That has already led to a narrowing of the relative growth of the two technologies, as in the first quarter of this year, DSL net-subscriber additions of nearly 230,000 reached one-half that of cable-modem-subscriber net additions of 440,000, despite having one-third of cable's base," Zia wrote.

Internal telephone-company projections see them adding nearly 2 million DSL subscribers this year, compared with DLJ's estimate of 2.3 million net subscriber additions for cable-modem services.

Despite their historically spotty record, overbuilds are also being taken more seriously, mainly because of the addition of new revenue streams and an abundance of available capital.

Overbuilds are likely to create a sense of urgency for cable operators to speed up their upgrade schedules and rollout of new services, Zia wrote.

He added that the recent downturn in cable stocks implied that previous estimates of penetration and pricing were too optimistic, and that cable's window of competitive advantage may be smaller than originally expected.


Off-Target

Company Previous Target New Target Actual Price 6/5 Actual Price 6/6


Adelphia


$100


$72.50


$46.69


$46.44


Cablevision


98


86


66.13


66.75


Charter


28


19.25


13.81


12.94


Classic


37.50


19


8.81


8.47


Comcast


46


46


37.25


35.75


Cox


50


50


48.09


46.38


Insight


37


25.50


16.13


15.63


Mediacom


24


16


8.94


8.94


Sources: Donaldson, Lufkin & Jenrette Inc. estimates, NASDAQ.com

September