Why Cox Is Leading Cable's Comeback


By Jane Black A few years back, most people thought the cable companies couldn't survive in the Digital Age. Best known for terrible customer service and high prices, they began losing ground in the late '90s to satellite competitors such as DirecTV and EchoStar, which delivered far more channels via digital video than cable could supply over its analog lines. Since 1999, the satellite companies have won four out of every five new video subscribers, according to the National Cable Television Assn. (NCTA).

But there are signs now that some cable companies are getting it together. With their networks newly upgraded for high-speed digital traffic, cable companies are beating out phone and satellite providers by offering consumers packages of services, including digital video, high-speed Internet access, and local-phone service.

At the forefront of the comeback is Atlanta-based Cox Communications (COX). The stock had a 17% runup in December as investors abandoned satellite companies because of fears they may be hitting the saturation point. But since then, Cox's share price has remained flat, hovering around $45. With analysts' 12-month target prices ranging from $43 to $59, Cox is again becoming more attractive for long-term investors.

SOLID GROWTH. "Cox is one of the blue-chip names in the cable industry," says Jeffrey Wlodarczak, an analyst with investment firm CIBC World Markets. The nation's fifth-largest cable service, Cox has one of the country's most advanced networks, having spent $2.2 billion on upgrades last year.

Cox also has a reputation as a successful marketer of new services. According to Wlodarczak, potential competitors -- including satellite providers and local-phone companies -- aren't nearly as aggressive in Cox's markets as they are elsewhere. Satellite penetration is 8% in Cox's service areas, vs. 14% to 15% in other cable companies' markets. Phone companies, too, seem reticent about rolling out new offerings in Cox territory. Both BellSouth and SBC are bailing out of earlier forays into video services.

Cox also saw its subscriber rates in new services grow steadily in 2000. In total, Cox won 910,000 new customers for Internet access, phone service, and digital video last year. These new services will be crucial to cable companies' future growth since the market for regular analog video is almost saturated. About 80% of U.S. homes that pay for TV service get it through cable. Cox conservatively estimates it can add 1.1 million or so more new customers in 2001, despite the economic slowdown.

MONEY IN THE BANK. But the biggest reason analysts are content with Cox is its impressive growth in operating cash flow (OCF) -- the cable industry's vital measure. Cox, which reported earnings last week, saw 10% pro forma OCF growth for 2001 and expects that figure to rise to 13% or 14% in 2001.

Cable companies are valued based on OCF growth rather than earnings per share because of the industry's high depreciation costs. Since 1996, the cable industry has spent $42 billion to build out its networks, according to the NCTA. True, those depreciation charges reduce net income -- but because growth forecasts are strong for cable's new markets, OCF growth is the key. Cox expects to report OCF above and beyond its expenses -- free and clear money in the bank -- in 2003.

Almost as important is the general state of the cable industry. Today, cable companies not only have digital service in most of their markets but they can offer something satellites can't: high-speed two-way Internet access. Satellites are one-way transmitters, meaning they can send data to a consumer, who cannot send any back.

To offer high-speed Internet access, digital broadcast companies will need to launch a new generation of satellites that allow two-way communication. That's not likely to happen anytime soon. In the past year, high-profile satellite companies Iridium and ICO have gone under, and GlobalStar is flailing. "Investors have been burned, and pumping more money in is not without risks," says one industry source, who adds: "It will take a while for the satellite industry to launch new satellites and come up with a good product."

BULK SAVINGS. At the same time, Cox and other cable companies are the first to offer truly bundled services -- packages that allow customers to buy more than one service from the same company. For example, you might get your video and high-speed Net access from your cable company instead of obtaining TV from one source and Internet access from another. The advantage is in the potential discounts. "Bundled services are great for customers because the more you buy, the more you save. It's the same reason you go to CostCo or Walmart: People love to get a deal," says Merrill Lynch analyst Stuart Rossmiller.

Bundled services are central to Cox's competitive strategy. Starting midyear, the company will offer "aggressive" discounts for customers who buy more than one service. Even without the price incentive, the concept of bundled services seems to be catching on. In 2000, Cox reported that the number of customers ordering more than one service doubled, up from 6% to 12%. In California's Orange County, one of Cox's key markets, 35% of customers subscribe to more than one Cox service. In Omaha, 30% take advantage of bundled services.

With the one pipe running into the home, Cox earns fees for Net access, video, even telephone -- instead of just traditional video. Bundled services also help reduce customer churn. "It's always easier to retain a customer than steal one because customer inertia is a powerful force," says Rossmiller. Although reliable statistics are lacking, Frank Loomans, Cox's vice-president for finance, says: "There is clear evidence that bundled services provide stickiness."

STATIC AHEAD? Still, the picture isn't all golden. While cable has been historically recession-proof -- the last thing consumers cut back on is TV watching -- the new services may not prove as stalwart. Cox management is being particularly cautious about tooting its own horn. Loomans says while the company has seen no slowdown in data services -- "the Internet is almost a necessity now" -- digital-cable services could be a weakness. "Digital is just more video, and a slowdown in at-home entertainment is pretty regular in a recession," he warns.

Analysts are more sanguine. True, the stock might see a slight drop for the first and second quarters if digital-cable numbers don't meet expectations. But the first quarter is traditionally slow in the cable business because, after the Christmas spending blowout, consumers are usually less keen to purchase new subscription services. Betting on a gain of 10% to 20% in Cox's stock over one year might not be a great return in boom times, but it's pretty respectable in a downturn.

With cable companies poised to be the first to deliver and cash in on bundled services, there's room for a lot more growth over the next 24 months to 36 months. As the economy falters, a solid stock like Cox's may be just what investors have in mind. Black writes about technology for BW Online in New York


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