May 21, 2008

Investment Analysts See Upside for Cable Shares

Report from the Cable Show: Market sentiment turning positive, tentatively.

By Peter D. Shapiro

NEW ORLEANS—At an NCTA panel at the Cable Show called “Street Smarts: Investment Analysts on Cable’s Competitive Crusade,” financial analysts from UBS Securities, Goldman Sachs, Wachovia Capital Markets and Deutsche Bank Securities explained why cable shares are undervalued by today’s stock market.

According to the analysts, market expectations became overinflated in 2006 but then painfully overcorrected in 2007 when FiOS gained traction, MSOs reported higher-than-expected capex along with basic sub losses and the economy slowed. As a result, cable share values dropped to telco-level multiples of EBITDA (earnings before interest, depreciation and amortization), despite cable’s better growth story. Now market sentiment has turned positive again due to surprisingly good 1Q ’08 numbers reported by most pay TV suppliers. Maybe too positive in the manic world of cable investors, given that operators’ upcoming 2Q ’08 numbers are expected to be seasonally disappointing.

MSO Investment Seen Through Analysts’ Eyes
How would the analysts invest if they were put in MSO shoes and given a pot of cash? They said they would bet with their convictions that cable is undervalued and would buy their own (MSO) stock and adjacent cable systems, and invest in their own (cable) networks, including converting to all-digital and deploying DOCSIS 3.0.

Their main worry about cable is not competitive inroads from Verizon FiOS or DBS or online TV, or the slowdown in the economy, but that the MSOs might commit too much capex to buy something big or overpay for an investment.

While they recognize a strategic need for a cable play in mobile wireless, the analysts on the panel were relieved that the MSOs have not allocated capex to build or buy a competitive mobile wireless network. In this respect, MSOs are apparently in tune with Wall Street in taking what the analysts called “baby steps” with “cautious bets” in wireless. About wireless, the analysts are perched resolutely on the fence: Something should be done, they say, but not right away.

New Metrics for a New Era
On metrics to evaluate cable shares, the panelists expect investors to focus increasingly on free cash flow, along with growth in EBITDA and RGUs (revenue generating units) and gains or losses of basic video subscribers. On this topic, the last word at the session came from the audience. Julian Brodsky, the retired (but not retiring) financial wizard on the remarkable team that founded and built Comcast, said it would be better to use traditional financial metrics rather than concentrate on basic subscribers and RGUs. Such metrics might include revenue growth, margin expansion and free and operating cash flow growth. Now that operators are moving toward generating most of their revenue from non-video products, Brodsky said a metric reflecting nominal changes in numbers of basic subs doesn’t mean much anymore. In short, he advised the analysts, “Forget about it!”

Peter D. Shapiro is founder and principal at PDS Consulting, a cable & telecoms consultancy (www.pdsconsulting.net). He can be reached at: peter@pdsconsulting.net.