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Analysts Point Trend Lines Downward

4/07/2002 8:00 PM Eastern

Cable valuations — now significantly lower than in the heady days of the late 1990s — will likely continue their downward trend for the next 12 to 18 months, as investors grapple with issues regarding the high leverage and complicated structures of most publicly traded MSOs, some investment analysts said last week.

But valuations should rise in the future, especially after some of the industry's larger mergers — mainly the AT&T Broadband-Comcast Corp. deal — are approved, and begin to show results, panelists said during the Kagan Broadband Summit here.

Despite cable's consistent revenue and cash-flow growth, investors are turning their attention elsewhere, said Goldman Sachs & Co. cable and media analyst Richard Greenfield.

Though the cable industry has reported cash-flow growth of 12 percent to 14 percent for the last two years — and is forecasting similar growth for 2002 and 2003 — that has "totally become beside the point."

"What everyone is focused on now is the actual structure and balance sheet nature of these companies," Greenfield added. "These companies are leveraged. They clearly do not look like a Viacom [Inc.] or a Fox [Entertainment] Group.

"You have significant debt ranging from three times to eight times cash flow, and none of these companies are throwing off free cash flow. In this environment, the central question investors are trying to get their hands around is, 'What are these companies worth?' "

Adding to the confusion are cable's varied historic valuations — seven to eight times cash flow in 1997; 19 to 20 times in 1998 and 1999; and 11 to 13 times this year.

WATCHING BIG GUYS

But with one major merger done (America Online Inc.-Time Warner Inc.) and another expected to wrap up by year-end (AT&T Broadband-Comcast), the industry has the opportunity to move further up the media value chain of distribution, programming packaging and content, Greenfield added.

Aside from the obvious scale advantages of AT&T Comcast Corp. — which, once combined, will have 22 million subscribers — the merger could bring more confidence into the sector if it can show other advantages, Greenfield said.

"Comcast is getting to a size in the distribution end of the equation where they can leverage that distribution very opportunistically up the value chain, creating cable networks, creating new types of programming entities to even further leverage the ability to control content," Greenfield said. "To me, that's what you're seeing now, and that's what may affect valuations over the next 12 to 18 months."

CIBC World Markets cable and satellite analyst Jeff Wlodarczak agreed that the AT&T-Comcast merger would be critical to the rest of the industry. Although the consolidation wave that most industry pundits predicted in the wake of that deal hasn't materialized, he added, it could after AT&T Comcast starts showing quantifiable results.

"For more consolidation to happen, Comcast is going to have to demonstrate that size matters," Wlodarczak said.

Though there has been some speculation regarding Adelphia Communications Corp. — under fire since it revealed $2.3 billion in off-balance sheet debt — may be a takeover target, Wlodarczak said he does not expect deals to be made prior to the AT&T-Comcast closing.

STOCKS OFF 30%

Even with another wave of consolidation, shares in the nine publicly traded MSOs are down about 30 percent this year, mainly over slowing digital and data subscriber growth.

For instance, Wlodarczak said that Comcast provided guidance earlier this year that data additions would be flat-to-down.

"What you saw from growth-fund managers is, 'Comcast is 80 percent data-penetrated, how in the world could you have a slowdown?' " he said.

Exacerbating the situation was the overall malaise in the market and concerns about accounting issues that have forced cable operators to provide more detailed information about off-balance-sheet entities and supplier relationships.

"The stocks are getting absolutely killed," Wlodarczak said. "I don't see the stocks doing much for the next two quarters."

It would take at least two consecutive quarters of digital and data subscriber growth to lift cable stocks out of the doldrums, he added.

Steamer Capital Corp. partner John Tinker put the current situation for cable stocks in more blunt terms.

"It was a huge party, it was a great party," Tinker said. "Now we're going through the hangover."

Problems in the industry have yet to affect the entire sector, he added. "Wall Street is shooting companies as problems come up."

Tinker believes added concerns stem from a slowdown in basic subscriber growth. Unlike past 1 percent to 1.5 percent growth rates, most MSOs now forecast basic-growth rates below 1 percent.

That raises questions about the overall health of the cable business, Tinker said.

"Satellite is picking up nine out of 10 new subscribers, a lot of them in larger markets," Tinker said. "They are still taking away subscribers from spaces where the cable guys should be strong. That begs the question of, 'How strong is the core business?' "

But Greenfield said basic-subscriber growth was not as important as it once was because of the new, higher-margin services that cable operators are able to sell to their existing base.

"Pricing for new services can make up the difference, as long as basic-subscriber growth is at a certain level," Greenfield said.

September