A Different Yardstick for Cable

In scandal's wake, many say EBITDA is too lenient--and fuzzy

Cable companies have almost never made money the old-fashioned way. Outfits such as $4.1 billion Charter Communications Inc. (CHTR ) have lost millions each year on a net-income basis. But the industry convinced investors long ago that it should be measured by a different yardstick. They substituted earnings before interest, taxes, depreciation, and amortization (EBITDA), which magically portrayed cable companies, overburdened with capital investment, as moneymakers.

When it first came into widespread use back in the 1970s, EBITDA was meant to be a temporary measure, something to look at while a young industry built the infrastructure it would need to thrive long-term. By excluding the interest due on the money borrowed to build and the depreciation of the assets, investors could get to a number from which to better gauge future performance. That was the thinking anyway. Three decades later, EBITDA is still in place, sheltering companies from the harsh judgment a net-income calculation brings. And in an industry that sometimes traded assets like baseball cards, resulting in a lot of one-time gains, EBITDA had a smoothing effect. As time passed, investors became so comfortable with EBITDA that it was sometimes talked of as a proxy for cash flow, even though it expressly excludes many cash costs. Investors came to believe that, like cash flow, EBITDA was somehow safe from manipulation.

But then came WorldCom Inc. (WCOEQ ). The company has owned up to a staggering $7 billion in operating expenses that had been incorrectly categorized as capital investments,--thus inflating EBITDA--and there could be more to come. The question now is "whether Worldcom is just an aberration or whether everyone is playing with capitalizing expenses," says Lehman Brothers Inc. accounting and tax analyst Robert Willens.

That has sent investors searching for a more reliable measure for cable outfits. Some are adding capital expenditures to EBITDA to take into account the high cost of infrastructure. Others are starting with cash flow from operations and making the calculation, which adds in the effect of real cash outlays that EBITDA excludes, such as taxes and interest payments.

Analysts and money managers say that in a more cautious period, companies that want access to the capital markets will have to use these more conservative measures and abandon EBITDA. "Any company that chooses to still use this as eyewash, as a sleight of hand, is going to meet with investors who are just not going to accept it," predicts Harold Vogel, a longtime media analyst and critic of EBITDA who now heads Vogel Capital Management, a media investing firm.

And make no mistake, the new measures are tough. Take St. Louis-based cable operator Charter, which made $1.8 billion by EBITDA measures in 2001. Add in capital expenditures, and the number falls to a $1.2 billion loss.

So why haven't the new measures become standard? Inertia is partly to blame. EBITDA has become the default measure in a variety of companies, from airlines to media. Companies rarely put out full cash-flow statements at the time of their earnings announcements, so investors have to wait weeks until quarterly results are filed with the Securities & Exchange Commission to get the detail they need to calculate the more revealing numbers.

And some believe EBITDA is being unfairly lambasted. The backlash against EBITDA "is a fad," says Lawrence H. Haverty Jr., senior vice-president at State Street Research and one of the biggest media investors on Wall Street. Haverty still uses EBITDA, although he looks at other measures of value as well, including free cash flow, which can be used to make acquisitions or buy back stock.

Still, the concern about EBITDA is building. Viacom Inc.'s (VIA ) Chief Financial Officer Richard J. Bressler says that his company, which currently highlights EBITDA in press releases, may place more emphasis on earnings per share instead. A move like that could force the rest of the EBITDA pack to follow.

By Nanette Byrnes and Tom Lowry in New York

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