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Cable's Outlook: Fuzzy Around the Edges

By Tuna Amobi, CPA Standard & Poor's maintains a cautious stance on cable-TV operators in the wake of Verizon's (VZ) announcement in early May of aggressive price cuts for its digital subscriber line (DSL) Internet-access service. Our overall outlook for the S&P Cable & Broadcasting index, which also includes shares of over-the-air TV and radio broadcasters, is neutral to modestly positive. Cable operators have so far ruled out an overt price war on broadband services. However, expect to see near-term responses like increased bundling of services, extended free months, more aggressive marketing and promotions, even modest price cuts from cable outfits that offer multiple services such as broadband as they defend their high-growth Internet-access business.

Continued rapid growth in digital cable and high-speed data services helped support the industry's ongoing revenue growth. We at S&P are wary of price pressures on the long-term and short-term economics of cable's broadband business. That's especially true as another Baby Bell, SBC Communications (SBC), is also undercutting cable-service providers in many core markets. Nonetheless, the impact on cable broadband providers should vary by region, depending on factors such as market penetration, bundled services offered, user concentration (homes passed), and competition within markets.

CASH ADVANTAGE. In their traditional business segment, U.S. cable operators continue to benefit from a modest rebound in advertising spending, following a significant downturn during the economic slump that started in 2001. The industry has actually increased its share of total U.S. ad spending. The cable sector posted uninterrupted revenue growth during the recent downturn, as its greater reliance on subscriber revenues gives it a more defensive posture than broadcasters. Subscriptions remain the industry's primary revenue source, accounting for roughly 65% of the total, with advertising makes up the rest.

Despite these successes, cable-industry equity valuations were hurt in the last two years by accounting scandals and subscriber losses at Adelphia Communications and Charter Communications (CHTR), two of the larger operators. Nonetheless, cable outfits are winding down their long-running capital-investment programs, and those that emerge with healthy cash flows will have the wherewithal to pay down debt.

Our near-term outlook for cable remains tempered by heightened levels of geopolitical anxieties, though the Iraq war's end has has alleviated their impact on advertising demand. Meanwhile, core subscription growth continues to be driven by robust rates of high-speed data sign-ups and by improved prospects for digital-video ancillary offerings like video-on-demand and high-definition TV. Despite continued near-term challenges and relatively depressed equity valuations, we expect to see additional consolidation, driven by the industry's dominant theme: the convergence of content and distribution.

RESHAPED LANDSCAPE. One other factor that could have far-reaching effects: The April, 2003, agreement by media conglomerate News Corp. (NWS) to acquire a 34% controlling stake in Hughes Electronics. A subsidiary of General Motors (GM), Hughes owns DirecTV, the nation's largest satellite-TV operator and second-largest pay-TV provider. In the long term, we expect this transaction to further reshape the industry's competitive landscape.

We believe that successful media operators will continue to anticipate, rather than react to, the ever-changing dynamics of an increasingly competitive media environment. Even with increased regulatory surveillance, vertically and horizontally integrated media operators should begin to wield increasing competitive advantages as they leverage operating efficiencies and realize synergies across multiple delivery platforms.

Our top selection in the cable group remains Comcast (CMCSA), which is ranked 5 STARS, or buy (See BW Online, 03/10/03, "A Stronger Signal at Comcast"). On May 8, it reported 36% higher pro forma first-quarter earnings before interest, taxes, depreciation, and amortization (EBITDA), and raised its outlook for new-customer growth in basic cable and high-speed Internet businesses for 2003. Overall, early gains from the company's AT&T Broadband integration are exceeding expectations -- and its aggressive de-leveraging plan is on track.

As for other members of the group, we maintain a 4-STAR (accumulate) rating on Cablevision (CVC), while Cox Communications (COX) and Charter Communications are each ranked 3 STARS (hold). Analyst Amobi follows cable-TV stocks for Standard & Poor's

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