Cablevision Debt Rating Lowered

S&P cites greater uncertainty about the company's ability to grow operating cash flows from its cable services

On Sept. 16, 2002, Standard & Poor's lowered its corporate credit ratings on cable television provider Cablevision Systems (CSC ) and its subsidiary CSC Holdings Inc. to 'BB' from 'BB+' and removed the ratings from CreditWatch. The senior unsecured debt rating on CSC Holdings was also lowered to 'BB-' from 'BB+' and removed from CreditWatch.

The ratings had been placed on CreditWatch on Aug. 8, 2002, due to liquidity concerns regarding the company's ability to fund operating, capital, and financial requirements in 2003. As of June 30, 2002, Bethpage, N.Y.-based Cablevision had $7.5 billion of consolidated debt outstanding (including $1.2 billion of collateralized debt) and $1.5 billion of preferred stock.

The downgrade reflects the higher degree of uncertainty about the company's ability to grow operating cash flows from its cable services, which include analog cable, digital cable, cable modem, and telephony services. Satellite competition has been exacerbated by the company's ongoing dispute with the YES network. Largely as a result of competitive factors, the company has lost 17,000 subscribers since the beginning of 2002, and projects that basic subscriber losses for the full year of 2002 will be roughly between 1.0% and 1.5%.

The company has encountered delays in rolling out its digital cable offering in 2002 and only began to market the service aggressively in May with the introduction of a new customer interface. As a result, only 1.4% of subscribers are digital customers. This is well below the level of digital cable penetration of Cablevision's cable peers, and poses a challenge to company's management, given its strategic goal of significantly ramping up the digital subscriber base in the 2002 to 2003 time frame.

To counteract such disappointing performance and to preserve capital in tight financial markets, the company has announced a major restructuring effort aimed at reducing overall costs and accelerating advanced service capability throughout its network. These cost-cutting initiatives include significant headcount reductions. Such reductions largely reflect the closing of about 26 The Wiz consumer electronics stores and the sale of its 59 Clearview Cinema movie theatres.

The company has also renegotiated its set-top box agreement with Sony to reduce purchasing commitments with this manufacturer, which previously totaled three million units. Even with such initiatives Cablevision is expected to increase its borrowings at least through 2003 primarily from its existing bank facilities at CSC Holdings, Rainbow Media Group, and AMC/Bravo, which collectively provided availability of about $1.3 billion as of July 30, 2002.

Resultant debt to operating cash flow for 2002 is expected to be about 6.2 times (x), excluding $1.5 billion of preferred stock and $1.2 billion of collateralized debt, and including off-balance-sheet debt guarantees. This is comparable with the current 6.1x, based on six months' annualized performance through June 30, 2002. The company's collateralized debt is excluded from this calculation because it is viewed by Standard & Poor's as a forward sale of stock, with no downside risk in the event of a decline in stock price.

While these initiatives hold the promise of reducing overall cash requirements in the 2002 and 2003 time frame, including lower capital expenditures for customer equipment, the company still faces the challenge of increasing overall cash flows from the cable businesses in light of its aggressive use of debt in the capital structure over the past few years. Moreover, the company has undertaken numerous business ventures during the past few years that appear to be inconsistent with its current focus, including its investment in Northcoast PCS and a DBS project. Although management has indicated that Cablevision will not compromise its balance sheet for such ventures, such activities remain distractions that may impair management's ability to improve overall operating results.

In addition, Cablevision faces some near-term contractual overhang issues from its partnership with Fox. Under two separate contractual agreements, Fox can put its interests in several ventures to various entities owned partially by Cablevision, including Rainbow Regional Holdings and Regional Programming Partners Sports venture. These options commence in December, 2002, and are not exercisable again until December, 2005. This obligation could be settled in a number of ways at Cablevision's election, including the issuance of Cablevision equity. Another option that Cablevision has is to settle the obligation with the issuance of a three-year note to Fox. Such an election would place additional pressure on the company's overall financial profile.

The senior unsecured debt rating on CSC Holdings has been lowered to one notch below the corporate credit rating based on two factors. First, it is anticipated that Cablevision's drawdowns under the unsecured bank facility will increase through 2003. This facility carries upstream guarantees from certain restricted subsidiaries, including subsidiaries representing a significant portion of the company's consumer cable subscribers, coupled with a pledge of intercompany loans from other cable subsidiaries. Second, while Cablevision's cable subscribers are still viewed as valuable assets, Standard & Poor's has incorporated more conservative valuations of cable subscribers into its analysis, given industry trends.

One of the underpinnings of the previous 'BB+' rating was the high asset value ascribed to Cablevision's attractive cable subscriber base, which was viewed as providing a significant financial cushion given the attractive demographics of the cable franchise areas. However, the realizable value for these assets has likely declined because of the depressed market for cable properties, thus diminishing the financial flexibility imputed to Cablevision. Despite the fact that cable asset values seem to be under pressure, Cablevision's cable properties are particularly valuable assets. These properties, coupled with the company's programming assets, continue to contribute value to Cablevision's overall asset base.

Cablevision faces the challenge of growing cash flows from new businesses in the 2002 to 2003 time frame, including the addition of Internet telephony in late 2002. If the company is not able to grow cash flows from the cable businesses in 2003, it could require additional funding in the 2003 to 2004 time frame for which no definitive source has been identified.

Programming assets provide some source of potential liquidity, including majority ownership in Rainbow Media Holdings Inc., which, in turn, holds major interests in programming networks such as Bravo, American Movie Classics, and WE: Women's Entertainment. However, the company has not articulated any specific plans for the sale of these investments. The ratings could be lowered if the company is not able to maintain debt to annualized operating cash flow and debt to EBITDA in the area of 7x, excluding collateralized debt and preferred stock and including off-balance-sheet debt guarantees.

From Standard & Poor's CreditWire

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