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SECTOR SCOPE by James A. Anderson February 4, 1999

The Street Isn't Laughing at Cable Guys Now
So how many smart buys are left for investors?

Until recently, cable TV was a business long on promises and short on results. Industry bigwigs would spout on about a future filled with video phones and 500 channels of couch potato nirvana, but the only thing they delivered with any regularity was rate hikes. In fact, even as the brains behind the business gushed about the day it would challenge the Baby Bells for local-phone customers, satellite video sneaked up on them. The industry's image may have hit a low point when comic Jim Carrey starred in a silver-screen spoof of cable TV's spotty customer-service record.

Suddenly, though, the cable guys arent laughingstocks anymore. AT&T (TWX) have formed a joint venture -- to be majority-owned by AT&T -- that will let AT&T provide local-phone service to Time Warner cable subscribers. That comes even as AT&T is about to complete its purchase of the nation's largest cable operator, Tele-Communications Inc., for $48 billion.

As a matter of fact, cable has had more than its share of noteworthy callers recently. Microsoft (CMCSA) two years ago. And Microsoft co-founder and former Bill Gates partner Paul Allen has snagged a couple of cable companies himself. "Theres no doubt that folks like Microsoft and AT&T have helped renew interest in the sector," says Franklin Templeton portfolio manager and analyst Fred Fromm. "These stocks were stuck in a narrow trading range before, but weve seen them move when those names came calling."

PHONE SPEEDWAY. Why all the fuss over wired TV? Because the networks that Time Warner, Cox (COX), and others use to whisk reruns or pay-per-view to your living room are now being touted as the communications speedway of the future. By mixing fiber optic lines with coaxial cable, cable TV, in fact, has found the perfect way to zap not only video signals but data and telephone calls from coast to coast. And that should give the Baby Bells a run for their money.

Investors have taken notice. A Standard & Poors industry index that lumps cable companies with other broadcasting stocks in television and radio rose 61% in 1997, and an additional 53% last year. Individual companies have done even better. Time Warner, the industrys No. 2 in terms of households wired, rocketed 105% in 1998. Comcast rose 81%, and Cox Communications rose 73%.

Without question, weighty investments by AT&T and Microsoft have gone a long way toward boosting investor confidence. And cable companies such as Cox and Comcast have helped change perceptions, too. Long criticized for slow, inconsistent upgrades, the cable industry has sped things up. This year, it is expected to spend $7.74 billion on improvements. One major move will be to upgrade existing cable to 750-megahertz capacity in order to accommodate the two-way communications that phone, data, or Internet service requires. By yearend, according to industry experts, about 70% of the cable network should be spruced up and ready for the industrys next generation of services.

AT&T's latest moves will give it entre to around 40% of the U.S. homes that are wired for cable. And now analysts expect to see alliances between AT&T and other cable operators -- giving AT&T coast-to-coast reach. With that might come the power to mint money. "Monthly revenue per [cable] subscriber is in the $40 range," says Merrill Lynch analyst Jessica Reif. "Add onto that $40 per telephone subscriber, and its a big deal."

PRICEY STOCKS. It doesnt hurt that cable revenues are strong, too. Rigging America for cable TV may be a mature business, with subscriber growth rising just 2% a year, but cable companies have made the most of their installed based by hiking prices an average 6.5% annually over the past three years. Standard & Poors analyst William Donald says that rate increases should continue at a 7% to 8% annual clip. And keep in mind that cable companies rake in 60% to 70% of their sales from subscriptions. Its little wonder, then, that the industry can keep up 14% annual revenue growth, says Donald.

Meanwhile, satellite dish TV, while still a threat, has experienced slower growth over the past year. Chances are that DBS, or direct broadcast satellite, will continue to make cable operators sweat. But now cable can counter with digital video signals that can rival DBSs clear reception.

The conundrum for investors is that cable stocks are so pricey. Wall Street tracks cable stocks by cash flow per share and measures how costly cable shares are using price-to-cash flow multiples. In the past, cable shares have fetched price-to-cash flow multiples from the high single digits to the low teens, says Franklin Templeton's Fromm.

Not anymore. On the wings of a 11% rally since Jan. 1, Comcast now fetches a price-to-cash flow ratio of close to 18, according to Theodore W. Anderson, portfolio analyst for the Ford Foundation. Cox's multiple is a fully priced 20, Anderson adds. "With new services coming on, the group could soon be growing cash flow nearly 20% annually," says Fromm, vs. 13% to 15% this year. "But with the stocks so pricey, I suspect the Street is going to hold off a bit until the additional income starts rolling in."

Even so, says S&Ps Donald, investors might find a bargain in the No. 5 industry player, Cablevision (CVC). AT&T, which already has taken over TCIs 30% stake in the company, might long for Cablevision's markets in New York Citys outlying boroughs and suburbs. Cablevisions revenues should rise 13% this year, and its cash flow should rise by 12% to 15% over the next few years, according to S&Ps Donald, who estimates that the stock is trading at just six times his cash flow estimate for 1999.

FUNDS FOR CABLE FANS. If you want to invest in a bigger players, Comcast might be a good choice. The No. 3 cable operator has a solid record of double-digit earnings growth, and its cash flow could grow by 12% a year over the next five years, estimates Merrills Reif. Cash flow in the companys QVC programming unit, meanwhile, is growing by 20% a year. And there's betting on the Street that its probably just a matter of time before AT&T comes knocking with a proposal to offer local service on Comcasts network.

In an industry where cross-ownership is commonplace, another way to fashion a Comcast play is through its 30% stake in Jones Intercable (JOINA). Glenn Primack, an analyst for the FMI Fund, says Jones's cash flow is growing roughly 10% a year. Yet the company trades at a price-to-cash flow multiple of just 12. Some analysts think Comcast might soon look to absorb Jones. And Primack says that could propel Comcast's stock to the mid-40s from about $38 currently.

A screen of Morningstars database turns up two funds for cable fans. The FMI Focus fund (JASSX) fund, meanwhile has focused on cables biggest names, such as Time Warner, Tele-Communications, and Comcast. Special Situations had total returns of 46% and 25% in 1997 and 1998, respectively.

For this year, cables outlook is upbeat. But a lot hinges on market perception. Put the stocks on the Internet hit list, and they could soar. Hold them up to historical valuations, and they might slow a bit in the next 12 months.

James Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week

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