By Jane Black
In recent months, investors searching for refuge from market volatility have taken shelter in cable stocks. Strong and dependable, the big cable operators consistently report cash-flow growth of about 10% to 12% a quarter. As subscription-based services, cable companies are less susceptible to downturns in ad spending. They're also seen as recession-proof: Let's face it, no matter how bad things get, most people aren't going to stop watching TV.
All true. But the same can be said for satellite stocks, which, along with the Nasdaq, have plummeted since the autumn of 2000. Like cable, satellite is a subscription service, which means providers can count on a steady stream of revenues. And like cable, satellite companies also can bundle new services -- such as high-speed Internet access or interactive television -- over existing infrastructure.
But in the rush from high-tech growth to defensive plays, investors have abandoned satellite stocks -- leaving good opportunities for the savvy. Leader DirecTV (GMH ) is hovering around $21 a share, from about $38 in October, 2000. No. 2 EchoStar (DISH ) plummeted from its 52-week high of $65 to about $31. Hardest hit is Pegasus Communications (PGTV ), which is trading at about $22 a share, from a year high of $57.50.
Why did satellite stocks get hit so hard? It's a matter of perception. Although their business is similar to cable, the companies have been tarred with the high-tech brush. UBS Warburg's satellite index reports that the sector's stocks are highly correlated to the volatile Nasdaq, while cable stocks are virtually unaffected by the composite's movement.
So the Nasdaq's plunge slashed the values attributed to satellite subscribers. The so-called enterprise value per satellite subscriber fell from $4,750 on Oct. 1, 2000, to $2,500 at the end of March, 2001. In contrast, cable subscribers gained value, as investors escaped high-tech stocks -- rising from $3,300 on Oct. 1, 2000, to $3,800 at the end of March.
Satellite stocks have also been hurt because the companies are still growing. The satellite industry adds subscribers at rates of 10% to 15% annually, while the mature cable industry adds only slightly more than 1% a year. Subscriber-acquisition costs, such as marketing and installation fees, are hiding the cash flow of satellite companies, making them appear less profitable than the stodgy cable operators. "Like cable, satellite companies are consistent cash-flow generators. The fact that they are growing obscures the cash-flow opportunity," says Eric Green, a portfolio manager at Penn Capital in Cherry Hill, N.J.
LESS OF A LOAD.
Ironically, while investors are punishing the sector for growth, they also fear that it isn't growing as quickly as it had. Satellite operators saw the number of subscribers zoom from next to nothing in 1996 to almost 15 million today. But that growth is leveling off. Solomon Smith Barney forecasts that the industry will add about 3 million new subscribers in 2001, down from an estimated 3.36 million in 2000. "The market is not in the mood to reward growth. It sees a decline in net additions, not a continued growth in subscribers," says Jeff Wlodarczak, a cable and satellite analyst at CIBC World Markets.
In short, satellite stocks are down, not because of an inherent weakness, but because the companies are entering a more mature phase where they can maximize profits. And that means they could be a good deal for investors in the long term. Another plus: All three major satellite companies are relatively underleveraged compared to the multichannel industry. They run at about half to a quarter of the same type of debt load when compared to cable, analysts say.
Pegasus, in particular, could be a good buy (see, BW Online, 5/3/01, "Pegasus Spreads Its Wings"). The company, which is expected to reach $1 billion in revenues this year, has a 12-month target share price of $49, according to First Call. Its stock was knocked down as investors worried that the rural market had reached its saturation point. But a closer look shows that there's still a lot more room for growth.
It's not economically viable for rural cable systems serving fewer than 1,000 subscribers to upgrade their network for digital services such as broadband, interactive TV, and the much-hyped 500-channel capabilities. Since cable-TV service costs about the same as satellite, customers have no reason to stick with a cable provider that offers fewer and less sophisticated entertainment options. By 2006, Pegasus predicts that 50% of 33 million rural customers will get video service from satellite, shrinking cable's overall market share from 185 million to about 115 million.
EchoStar will also see a huge upside as the market adjusts. Its stock is predicted to hit $50 a share by the end of the year, thanks to CEO Charlie Ergen's iron-fisted business strategy. In markets where EchoStar competes with DirecTV, it grabs more than 6 of every 10 subscribers. Only DirecTV's future is uncertain. Though it's the market leader, mum's the word from most analysts on the stock's future until there's some resolution on Rupert Murdoch's aggressive bid for the company.
Still, cable stocks are safer than satellite plays. Cable companies are stockpiling cash since they aren't spending as much on acquiring new customers. And satellite stocks are not quite as recession-proof as cable. The satellite story to date has been one of high growth. But, though it's unlikely anyone would switch off their cable or satellite services during a downturn, new subscribers might be deterred from signing up if the country were to enter a sustained recession.
"Should cable stocks be at a premium? Yes. Are satellite stocks being traded at too much of a discount? Definitely," says Thomas Eagan, UBS Warburg's cable and satellite analyst. Satellite stocks offer a unique proposition for investors: a perceived risky investment today that could translate into a defensive one down the road.
Black covers the cable and satellite industries for BusinessWeek Online from New York
Edited by Beth Belton