Charter: No. 4 -- and Not Gaining


By Jane Black In April, 1998, billionaire Paul Allen paid $2.8 billion for Dallas-based Marcus Cable. A month later, he forked over $4.5 billion more for St. Louis-based Charter Communications. It was typical of Allen's style: Buy second-tier companies with a view to turning them into powerhouses to compete with giants -- in this case Time Warner and AT&T. Since those acquisitions, more than a dozen additional deals have turned the combined entity, still called Charter Communications (CHTR), into the country's fourth-largest cable operator, with 6.9 million subscribers.

After an impressive buildup, the strategy of pushing Charter into cable's big league -- now dominated by Comcast (CMCSK) and Cox (COX) -- appears to have stalled. In its Nov. 1 third-quarter earnings report, Charter saw its basic video subscriber growth -- the cable industry's bread and butter -- tumble from 1.9% in the previous quarter to 1.1%, slightly ahead of the industry average.

Although the company continues to show notable growth in add-on digital services, Charter lowered its revenue growth forecast for the fourth quarter to between 12.5% and 13.5%, down from its earlier estimate of 14% to 16%. Cash-flow projections, a key metric in gauging cable companies' success, were also slashed -- from 12% to 14% down to 10% to 11%. The stock is hovering around $14 a share, down from July's 52-week high of $24.40.

ANXIOUS SHAREHOLDERS. Charter has, by and large, attributed its dreary outlook to the "difficult economic environment." But cable has remained traditionally resilient during recessions, since even in the worst economic times, few people stop watching TV. The tragic events of September 11 also have encouraged Americans to stay home.

Relatively new CEO Carl Vogel, unproven at a major cable company, doesn't appear to be soothing shareholder anxiety, either. In short, while Charter's performance is still in line with the overall industry, it's failing to live up to its own aggressive targets. "It's hard to make an argument that they should be in the blue-chip tier," says Jeff Wlodarczak, a cable analyst with CIBC World Markets. "It's not that they can't get there. But it's a hard road ahead."

Analysts' biggest concern is the subscriber slowdown. "Basic subscriber growth still drives the engine. It provides, at some level, a backstop for cash-flow growth," says Robert Martin, a cable analyst with Friedman, Billings & Ramsey, an Arlington (Va.) investment firm. Staking its future on add-on services is risky, since more than a quarter of Charter's systems still require an upgrade. By the end of 2001, 72% of the company's pipes will have a capacity of 550 megahertz or higher and be able to handle two-way interaction, which is needed for high-speed Internet access. Rivals Comcast and Cox have 95% of their pipes upgraded, according to CIBC World Markets.

CABLE CATCH-UP. In fact, although Charter is focusing on digital services, the company is still playing catch-up to Cox and Comcast. In high-speed Internet access, Charter falls far short of those two -- and of the industry average. Only 7.8% of Charter customers have signed up for broadband, vs. Cox's 12.6% and Comcast's 9.4%. The industry average is 10.2%. Charter does better in digital video, with 28% penetration among subscribers -- a 7% lead over Cox and Comcast. But it still lags behind Comcast in total number of digital subscribers.

Beyond competitive pressures, Charter may have balance-sheet problems. The company spent a fortune building up its systems, a move that made it one of the most highly leveraged cable companies. It has over $15 billion in debt -- more than half of its total enterprise value. At the end of the third quarter, debt totaled 8.3 times cash flow.

"They have to see cash-flow growth at rates they initially projected." says Martin. "If they don't, it will extend the time until they see free operating cash flow" -- the industry's holy grail, because it means the business is finally paying for itself. Martin doesn't expect Charter to reach that point until 2004, although the company contends that it can do it by second-half 2003. This is a long time to expect shareholders to be patient -- especially when Comcast estimates it will hit the target by the middle of 2002, and Cox by first-half 2003.

LEADERSHIP SHUFFLE. Finally, Charter's new CEO, appointed in October, leaves some investors cold, analysts say. Vogel replaced the popular and proven Jerry Kent, the veteran cable executive who led Charter through its three-year expansion. Although Vogel has some cable experience from his days at Jones Cable, which was later sold to TCI and AT&T Broadband, his most recent experience is in the satellite business.

Before Charter, Vogel headed Liberty Satellite & Technology, a unit of John Malone's Liberty Media. Vogel also was CEO of satellite provider Primestar until 1999 and president of then-troubled satellite TV company EchoStar Communications from 1994 to 1997. Kent's reasons for leaving haven't been publicly discussed, but sources close to the company say his relationship with Allen was strained. Allen, Kent, and Vogel couldn't be reached for comment.

Some analysts believe Vogel's experience will help cable against a stronger satellite play in the form of a united EchoStar-DirecTV. "It's a benefit to have noncable guy. Vogel

knows satellite promotions. He knows what customers want from cable and satellite service," says Tom Eagan, cable and satellite analyst with UBS Warburg.

Still, Allen may have pushed Kent to expand too quickly and, in some cases, to help support Allen's other investments, including his $8 billion stake in Microsoft. Recent company presentations, including one at Goldman Sachs' October investor conference, focused heavily on a co-branded portal with MSN for high-speed Charter customers.

MICROSOFT TIES. Analysts weren't surprised when Charter announced on Nov. 8 that it would deploy Microsoft's interactive-TV software in a million homes. "Is Carl the one to hold Allen at bay?" says CIBC's Wlodarczak. "Cable is becoming an incredibly complicated business. I don't know how anyone can say that Vogel is a home run yet."

That said, Charter's decision to cut back on basic subscriber growth could pan out in the long run. After all, luring subscribers is easy if a company is willing to cut its prices enough. EchoStar saw 35% year-over-year subscriber growth in its third quarter, thanks in part to aggressive promotions such as the "I like 9" program, giving subscribers 100 channels for $9 per month, plus equipment.

Charter, though, believes that gaining subscribers by cutting prices just doesn't pay. "The low-end customers that we were working hard to recruit with discounting were not paying off in terms of generating revenue. Continued aggressive growth for the sake of leading the industry didn't make sense to us," says Dave Anderson, Charter's senior vice-president for communications.

REGULATORY WINDOW. Focusing on additional services could prove smart over the long haul because it differentiates cable operators from the increasingly powerful satellite industry. "Cable's biggest advantage over satellite is their technical ability to offer two-way services. Therefore, it makes sense to focus on services that competitors can't deliver," explains John Martin, a cable analyst with ABN Amro.

Analysts are bullish about Charter's long-term potential, but that's largely because of investors' warm-and-fuzzy feelings about cable. The EchoStar-DirecTV deal won't clear regulatory hurdles for 9 to 12 months -- if ever, giving Charter a solid window of opportunity to chalk up some major gains. If it succeeds, Charter could finally join the blue chips and fulfill Allen's -- and investors' -- dreams. Black covers technology markets for BusinessWeek Online in New York


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