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Cable: Wired for Growth

By James A. Anderson Big names and big dreams both got cut down to size in the communications business in 2000. AT&T (T) and WorldCom (WCOM) ran smack into a shrinking long-distance market. The Baby Bells found themselves mired in a mudslide of lower prices and thinner margins. Some scrappy startups, like telecom carrier ICG Communications (ICGX), found themselves gasping for air as both cash and capital seemed to evaporate before their eyes.

The commotion last year obscured a bright spot in the sector: Big strides in the cable industry. Thanks to massive network overhauls by the industry's major players, cable operators seem poised for hefty boosts in revenue and profits. Such prospects have piqued Wall Street's interest. For the period ending Mar. 12, a Standard & Poor's index of eight stocks in broadcasting, television, and cable was up 9.8% year-to-date and 13% in the past 13 weeks. Compare that to a 6.6% drop for the S&P 500 year-to-date and a 10% drop over the past 13 weeks.

TIGHTER SHIPS. The industry has done more than upgrade its technology. The sector's members have overhauled their images, too. As recently as the mid-90s, cable companies were maligned as debt-ridden, uninspired monopolies, all too often owned by unambitious families or cavalier corporate giants. Confident that premium TV was snug in their laps, they felt they could overlook slipshod customer service.

And Wall Street's overly generous terms didn't help: Share prices were measured by an operator's cash flow, not profits, the assumption being that cable companies merely needed to keep monthly subscriptions rolling in to earn investors' attention.

But over the last few years, cable companies, bracing for new competition in more open telecommunications markets and from satellite TV, have become more disciplined. Starting in 1998, the industry began funneling about $45 billion into installing the latest gear to be able to offer high-speed Internet access, digital video, and even telephony as basic TV-program delivery.

SUBSCRIBER BOOST. The investment has paid off. Cable operators such as Cox (COX) and Comcast (CMCSK) offer existing and future customers one-stop shopping for everything from high-speed Internet access and interactive TV to phone service. They've also beat their competition to the punch. At the end of 2000, the cable industry had completed about 75% of its upgrade and was on track to have 84% finished by the end of 2001, estimates Lehman Brothers analyst Laura Werner. "That's a vastly different case from the Baby Bells, which had maybe 40% of their networks upgraded [for high-speed Net access] at the end of 2000," she points out.

She looks for Comcast, the nation's No. 3 cable provider, to increase the number of subscribers for its new upgraded services, from 1.75 million at the end of 2000 to 8.3 million in 2005. Such figures would boost the company's average revenue from each home outlet 10% annually, from $48 to $79.20 during the same period. S&P analyst Howard Choe is more optimistic: He says a 15.4% average annual increase in sales through 2004 isn't out of the question.

And now that the big capital-spending push is largely completed, cable operators can focus their attention on paring down debt like never before. Back in 1995, it wasn't uncommon to find companies like Comcast, Tele-Communications Inc., and Cablevision carrying debt burdens of 50%, 80%, or even 100% or more to long-term capital. Those figures are down to a more manageable 20% to 40% load in many cases.

OLD STANDBY. New revenue streams and less debt service have combined to help the cable group become more shareholder-friendly. "We've seen Comcast and Cox announce pretty aggressive share buybacks, and now that the bulk of [the] upgrade push is behind them, shareholders will be able to reap the reward of the industry's modernized systems," says Jefferies & Co. analyst Fred Moran. Better yet, says Lehman's Warner, the industry can expect cash flows, the measure the Street uses to gauge how well business is going for cable operators, to leap 15% a year over the next five years.

Yes, the economic slowdown might delay the plans a bit. So far, the market penetration of new services has been small -- 7% of the country's nearly 70 million hooked-up households. Still, high-grade services have lured wealthier customers, those with an average annual income of $70,000, says Lehman's Warner.

Plus, cable operators have their old standby -- programming delivery -- to fall back on as a source of cash flow. Best of all, it's an income source that has historically been downturn-proof. "When things get tight and consumers have to pull back their spending, they're more likely to stop going out to dinner or the movies," says Jefferies & Co.'s Moran. "At that point, they'll start looking for entertainment closer to home and rely on cable."

CHOICE PICKS. Perhaps the two best pure plays in cable are Comcast and Cox, say the analysts. Both companies should have completed the lion's share -- 90% -- of their network upgrades by yearend, says Warner, who thinks Comcast should see cash flow increase at a 13.6% average annual clip.

"They're the fastest-growing operator in the business," says Moran. "And still, they've managed to balance new services with profitability, performance, and consistent double-digit cash-flow growth, even in the face of a slowing economy." All 18 analysts who cover Comcast rate the stock a strong buy or buy, according to Zacks Investment Research. Warner holds a $55 12-month price target for the shares, which closed Mar. 19 at $43.50 a share.

Cox, too, has been hard at work sprucing up its systems to serve lucrative Sunbelt regions, such as San Diego and Phoenix, as well as markets in the Midwest and East. The fifth-largest cable operator in the U.S., Cox's menu of advanced services should lift average monthly revenues per household from a current $31 to $56 in five years and help Cox push cash flow up 15.3% a year over the same period, says Warner. All 15 analysts tracking Cox rate the company a strong buy or buy, according to Zacks. Warner believes Cox, which closed Mar. 19 at $44.80, could hit $56 a share in the next 12 months.

MIXED LOT. Mutual-fund investors will find that the market doesn't really have a pure cable fund. The list of pure-play cable stocks isn't very long -- maybe a half-dozen. The two largest operators -- AT&T and AOL Time Warner -- are in a vast number of other businesses.

If you're looking for a fund portfolio with its sights on cable stocks, you might check out Invesco's Leisure Fund (FLISX), an offering on BusinessWeek's A-List of high-return, low-risk funds (see BW Online's Mutual Fund Scoreboard, February update). As of Dec. 31, the Invesco fund counted Comcast and Time Warner among its 25-largest holdings. It has logged a 25.4% average annual total return over the past three years, although it went through a rough patch in 2000, losing 8% that year. As of market close on Mar. 16, the fund was up 4.2% year-to-date.

Such bright prospects and promising numbers all serve to make cable worth watching, especially in this volatile market. Anderson teaches journalism at the City University of New York. Follow his twice-monthly Sector Scope column, only on BW Online

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