Federal rate regulation and the threat of competition from telephone companies may have soured the stock market on cable TV until recently. But even in the dark days, all Jerry Kent and his two partners at St. Louis-based Charter Communications Inc. saw was opportunity.
Armed with $300 million in equity capital from New York merchant banks Kelso & Co. and Charterhouse Group International, Kent began buying depressed cable assets in 1993, concentrating on St. Louis, Los Angeles, Connecticut, and the Southeast. In the process, he has built a healthy midsize cable company with more than 900,000 subscribers. Kent is so bullish on cable, in fact, that Charter is currently teamed with Kelso and Ellis Communications Inc. to bid against the likes of Tele-Communications Inc. (TCI) and NBC in the $2 billion auction for Multimedia Inc. "We didn't buy into the conventional wisdom" that cable had become something to run from, says Kent. His eye is trained on Multimedia's 450,000 cable customers.
SATELLITE SLOWDOWN. Now, Wall Street has come around to Kent's way of thinking. After stewing about the cable industry ever since the collapse of the TCI-Bell Atlantic Corp. deal, investors have bid up cable stocks 24% since April, outpacing the Standard & Poor's 500-stock index (chart). The market is following savvy private investors, including Kelso, Hicks Muse, and Goldman Sachs, who have pumped more than $1 billion into the industry since last year. Says investment banker John Waller, head of New York's Waller Capital Corp.: "There's more outside capital coming in than there has been in years."
The new optimism is creating opportunity for everyone. Viacom Inc. last year saw the $2.3 billion sale of its cable systems to a group including TCI fall apart because Republicans killed a minority tax break crucial to the deal. A new transaction, without the tax break, will likely close soon at only about $2 billion. But that's more than Viacom would have gotten before the surge in cable values.
Meantime, Continental Cablevision Inc., the nation's fourth-largest cable operator, may soon make its first public offering, says President William T. Schleyer. Jones Intercable Inc. also plans a big offering, this one to fund acquisitions, says Chairman Glen Jones. Falcon Cable Systems Co. in Los Angeles says it is raising private money for expansion. And J.P. Morgan & Co.--one of several merchant banks scouting out small acquisitions--is hoping to finish raising $125 million by August.
What's driving the upsurge in prices is both the promise of cable deregulation and the realization that re-regulation hasn't been as dark a nightmare as was first perceived. Moreover, hot satellite competitor DirecTV has slowed its pace lately, and the telephone companies have acknowledged in various ways that their move into television will take longer than they had hoped. Cable companies will face competition someday, and they still need many billions in capital to upgrade their sprawling systems with broadband fiber-optic technology. But the job looks increasingly manageable. "I think we've really worked through a lot of the clouds," says Merrill Lynch & Co. analyst Jessica Reif.
Regulation, which forced cable systems to roll back rates by 17% over two years, has been the biggest bugaboo. By the second round of rate cuts--instituted a year ago--systems that once had the steady cash-flow characteristics of a utility were tagged risky and unpredictable. How would they ever pay down their heavy debt, let alone finance the upgrades needed to add competitive offerings such as telephone service and video-on-demand? As capital dried up, investor worry threatened to become a self-fulfilling prophesy.
SENATE VICTORY. Many in the private markets saw this as an overreaction and believed that last November's Republican victory in Congress would eventually counter the regulatory zeal led by Vice-President Al Gore and Federal Communications Commission Chairman Reed E. Hundt. Most investors, however, wanted evidence that the vast deregulatory telecommunications bill wending its way through the House and the Senate had legs. June's decisive victory in the Senate gave proof the Republicans were serious. Many Washington experts believe a cable-friendly bill is likely to pass this fall.
Even without congressional action, however, the future looks brighter than it has for some time. Having absorbed the rate reductions, industry revenue is now picking up steam. According to the National Cable Television Assn., annual subscriber growth through this past May was running at about 4%, vs. 3.5% the year before. Several companies, including Time Warner, Continental Cable-vision, and Comcast, report growth rates faster than the trade association's numbers. Innovative packaging of pay channels has increased subscriber buy rates. And advertising sales--although less than 5% of most systems' revenues--have been growing in the double-digit range.
At the same time, despite the fact the FCC has received 15,000 rate complaints and has forced companies to repay $28 million in overcharges since 1993, it has gotten more lenient about allowing cable systems to pass along upgrade costs. Rules expected to be decided on in a July 28 vote would facilitate such pass-throughs, as long as a company can make the case that its upgrades benefit subscribers.
All told, most analysts are predicting increases in cash flow for 1995 topping 10%. "Cash flow is up, cable subs are up, the industry is getting itself in shape for real growth," says investment banker Brian Deevy, president of Denver's Daniels Associates.
With such good news in hand, cable executives feel less need to crow these days about the unlimited potential of the ephemeral Information Superhighway. Ironically, some of thmse services suddenly appear very much within reach. Digital set-top boxes that will allow for hundreds more channels should be affordable by early next year, analysts say. Ditto for "cable modems" that will allow customers to hook their PCs to the Internet via broadband cable. More channels will mean more opportunities to raise revenue from the same customers, be it from home shopping or a more competitive menu of movies. And cable modems--if they can be made affordable, say $200 to $300--will allow lightning-quick access to the World Wide Web. As anyone who has tried it can attest, current Web access over telephone lines is akin to sipping molasses through a straw.
TIME TO BUY. Comcast finance chief John R. Alchin is high on the future, but he isn't counting on new services in the short term. "None of our budgets anticipates any new services that depend on delivery of those boxes," he says, ruefully recounting the deadlines the technology has missed already. While Continental's Schleyer is more sanguine about starting to offer more channels, high-speed data services, and even telephone service sometime next year, he insists that his company's capital spending is justified through regular cable cash flow alone.
New services or no, investors are definitely heated up right now. Says Falcon Cable Chairman Marc B. Nathanson, recently returned from seeking capital in New York: "I haven't seen this kind of enthusiasm in 18 months." One executive at a major New York merchant bank is even fearful the moment to buy low may already have passed. "I'm reluctant to say anything positive about the industry," he says, "because we're still buying." For a business with as many bruises as cable, such a sentiment is positive enough.