Cox's Big Bet on Itself
By Steve Rosenbush
The market's view of the cable-TV industry has soured this year. Shares of sector bellwether Comcast (CMCSA ) have dropped to $28.69 from a high of $36.50. The industry already faces intense competition from rivals in satellite TV. And big phone companies, such as Verizon Communications (VZ ), are taking share in the high-speed Internet access market away from cable and even making serious plans to compete in the TV market itself, using upgraded phone wires.
Against that backdrop, privately held Cox Enterprises announced Aug. 2 that it wanted to buy back the 38% of the Cox Communications (COX ) cable-TV business that it doesn't already own. It offered to pay $32 a share, or $7.9 billion, for the publicly held shares. The offer represented a 16% premium on the price before the announcement. But shares of Cox soared 20%, to $33.16 from $27.58, after word of the deal came out. Investors convinced that Cox Enterprises will pay more have already bid the shares 4% over the offering price.
Yet Cox Communications shareholders may be in a tough position. Cox Enterprises said it has no intention of selling its cable assets, which means that there's no possibility of another suitor coming along and offering a higher price. Indeed, Cox Enterprises is pretty much free to set its own price, which is still well below the cable unit's 52-week high of $37. It's a situation that will undoubtedly rankle investors, even though a committee of independent directors is supposed to look out for shareholders' interests. Given the volatile nature of the industry, anyone who's looking for an exit might find this an opportune moment to quietly excuse himself. The next year probably won't be for the faint of heart.
SIGNS OF WAR?
Clearly, Cox Enterprises thinks cable is still a good place to invest its money, at least over the long run. "We like the business. We want to expand our presence in cable," Cox Enterprises spokesman Bob Jimenez said. And the company is willing to pump nearly $8 billion in additional capital into the game to prove its point. "It's a very strong statement," says cable analyst Rob Sanderson of American Technology Research, an independent broker-dealer based in Greenwich, Conn.
Still, despite its years of experience and its managerial skill, Cox may have established quite a challenge for itself. The video-distribution business is in the midst of technological and structural change, in which rivals such as satellite and perhaps even telecom will gain traction. History has shown that it doesn't take many competitors to set off a brutal price war in industries with high-fixed costs. For evidence, look no further than telecom or airlines. And once these price wars begin, they aren't pretty. Plus, they seldom end with any clear winners.
Cox isn't declaring a price war. But it is likely to invest a lot more money in marketing and special offers, so it can lure customers. It will be a lot easier to do that if the company doesn't have to worry about satisfying investor expectations for ever-higher quarterly earnings. While rivals such as Comcast focus on share buybacks and regular dividends, Cox "may be establishing itself as more of a growth company," said Aryeh Bourkoff, cable analyst for UBS. As a privately held company, it's betting that it will be nimbler and have an easier time being aggressive and taking share.
The real question is whether Cox will be taking share in a healthy market or one that's beginning to weaken. Bulls such as Sanderson acknowledge that the cable companies are going to lose TV customers to rivals. But they believe that the opportunities in new fields such as broadband Internet access, Internet phone service, and advertising are larger -- and have better margins, too. Sanderson says video margins are in the 30s, while phone and broadband margins are in the 40s. Even Sanderson admits there are risks, though. He thinks that price reductions in video will be moderate. But if a bloody price war does break out, "all bets are off," he says.
The problem is that any time there's a possibility of a price war in the communications business, it usually happens. And there's another risk: The cable industry has invested $75 billion over the last decade to upgrade its network. If another disruptive technology like fiber-optic lines or wireless comes along, it may be forced to upgrade once again. And Cox is uniquely positioned to make such a gambit. Larger rivals are just too big to take private. Even Comcast couldn't raise $100 billion to take itself off the public market. And smaller rivals such as Charter have too much debt, Bourkoff says. That makes Cox a key player in what could be the beginning of a new media age.
Profit margins in the cable business are falling. Just a few years ago, they were 11 or 12 times earnings before interest, taxes, depreciation or amortization, known as EBITDA. Now they are about 8 times EBITDA, which is getting close to the range of the troubled telecom sector. Cable margins may rise again one day. But that's unlikely to happen any time soon, making the industry a tough place for public investors concerned about quarterly profits.
Rosenbush is a writer for BusinessWeek Online in New York
Edited by Beth Belton