News

Analyst Views: Stocks Are a Buy, DBS Ails

5/14/2000 8:00 PM Eastern

New Orleans-Cable-stock analysts were in full force at the National Show here last week, with most predicting a reversal in the downturn in cable shares and one predicting the death of cable's main competitor, direct-broadcast satellite.

Cable stocks, once the darling of Wall Street, are down 25 percent to 30 percent since the beginning of the year, but they may be turning into buying opportunities, according to Donaldson, Lufkin & Jenrette Inc. senior vice president Dennis Leibowitz.

Competition from DBS, regional Bell operating companies and overbuilders, as well as economic factors like rising interest rates, have hit the cable sector hard, Leibowitz said. But with the continued deployment of new services such as digital cable, high-speed data and telephony, along with the promise of interactive services, cable stocks could be on the rise.

Leibowitz said cable-stock multiples have fallen since the beginning of the year from between 18 and 19 times cash flow to about 13 times.

"Cable stocks went from no discount to a 35 percent discount this year and 45 percent next year," Liebowitz said. "It could be a strong buying opportunity."

In yet another panel discussion, Goldman, Sachs & Co. analyst Barry Kaplan predicted cash-flow multiples of up to 20 times year-2000 cash flow based on the potential of new services.

Kaplan said that while high-speed data, digital cable and telephony are beginning to be deployed, the real potential will come after operators deploy the next generation of digital set-tops, which make a host of interactive services available to the consumer.

"There's a lot of broadband capacity out there, and [cable companies] are converting their whole network to digital," Kaplan said. "The digital box is an incredible Trojan Horse."

Morgan Stanley Dean Witter & Co. managing director Richard Bilotti said another factor in the decline of cable stocks is the absence of free cash flow, or cash flow minus capital expenditures and interest.

"Cable needs to better explain to Wall Street why free cash flow is delayed," Bilotti said.

Leibowitz said the most important factor will be cable's response to competition and, in particular, competition from DBS companies. "Cable has got to act a lot quicker," he added.

Bilotti said DBS poses a real threat, but one that cable can overcome. He added that DBS took cable by surprise in the early years of its development, adding millions of subscribers mainly by spending between $1.6 billion and $1.7 billion on marketing and capital-acquisition expenditures.

"This was the first time the industry faced competition-competition from a nationally backed competitor with national-scale economics," Bilotti said. "It's a competitor people know."

DBS also gained subscribers by offering a service similar to cable at a lower monthly price. And now that DBS can offer local broadcast channels to its subscribers, the threat becomes even more formidable.

"What that caused is an erosion of pricing power," Bilotti said. "It may be a good idea [for cable companies] to hold down basic rates."

Bilotti added that he expects DBS to add about 4 million subscribers this year and another 4 million in 2001.

One analyst who refused to see DBS as a threat was Credit Suisse First Boston's Laura Martin.

No stranger to making pro-vocative statements, Martin said explosive DBS-subscriber growth was not due to cannibalization of cable subscribers, but to upselling subscribers from C-band satellite and PrimeStar Inc. to DirecTV Inc. and EchoStar Communications Corp.'s Dish Network.

"I'm actually here to predict the death of the DBS industry," Martin said in response to a question.

She added that despite subscriber growth of 50 percent at DirecTV and 75 percent at Dish, cable added 1.5 million multichannel homes in the same period, indicating greater usage of the cable product.

A key point, Martin said, is that of those subscribers who have moved over to DBS, many have at least kept basic-cable service for local broadcast channels. "[Cable has] kept the client name," she added. "The future is about new services."

While that broadcast-basic subscriber may be spending substantially less, Martin said, that subscriber is likely to return to cable for telephony, high-speed data and interactive services.

Those services also have substantial returns. The profit margin on interactive services is between 50 percent and 70 percent, she added.

"As the cable industry rolls out new services, they have the ability to package and recapture," Martin said. "Cox [Communications Inc.] found that as they rolled out their data modems, the consumer viewed them as a technology company. Bundling, packaging and executing is a way to recapture growth."

Consolidation in the cable industry is likely to continue, she added, stating that in the not-too-distant future, cable subscribers will purchase service from just three cable companies-AOL Time Warner Inc., AT & T Corp. and one other large cable company. She declined to identify No. 3.

While not predicting the outright demise of the DBS industry, Bear Stearns & Co. Inc. senior managing director Raymond Katz said that as digital cable is more widely deployed, DBS will feel the pinch.

"Come the Christmas selling season, some of the bloom will come off the DBS rose," Katz said. "Time Warner [Cable] will have digital in their whole market [by then]. Now, that is not the case-maybe 80 percent of their customers are not able to get digital. By this Christmas, they will."

Although there is a threat from competition, cable still has the upper hand because it has access to so many homes, Bilotti added.

September