Cox: Flying High -- and Solo?


By Jane Black Comcast's $45 billion December, 2001, marriage to AT&T Broadband has set off a frenzy of speculation about just who'll walk down the aisle next. Some analysts see Atlanta-based Cox Communications (COX) clutching the bridal garter.

After the Comcast deal is completed, Cox will be the nation's fourth-largest cable operator, with 6.2 million subscribers. Like Comcast, Cox made an aggressive bid for the largest player in the cable industry, AT&T Broadband (with 14.4 million subscribers), a move that analysts say showed the family-run company is willing to take a minority stake in exchange for entry to the cable big leagues. And like Comcast -- with its 8.4 million subscribers -- Cox is considered one of the best-managed cable operations in the country, capable of digesting a big acquisition.

Cox has done little to dispel rumors that it's on the hunt for a mate. On Jan. 7, CEO Jim Robbins told investors at a Scottsdale (Ariz.) conference that "mergers and acquisitions come in cycles, and I think 2002 will bring another round." Speculation that the bigger players are on the merger prowl, combined with widespread fears that the cable industry will be unable to repeat 2001's gangbuster growth, has caused a mini-sell-off across the sector. Cox shares have tumbled around 8% since the beginning of the year, from about $40 to just under $37 -- a smidgen above their 52-week low.

OUTPACING ITS PEERS. For all the speculation, however, Cox isn't all that likely to merge any time soon. It remains one of the brightest stars in the cable industry. And a pairing as well matched as Comcast and AT&T will be hard to duplicate. Neither Adelphia (ADLAC) nor Charter Communications (CHTR), two rumored partners for Cox, are a good fit, analysts say.

Moreover, many believe that on its own, Cox will continue to see growth this year that outpaces its peers. "Cox will pull ahead of the rest of the industry in 2002 because it is scaling its telephone business," says Lara Warner, a cable analyst at Lehman Bros. "At these prices, it's a great buy."

Just ask Bill Gates. According to a Securities & Exchange Committee filing made public on Jan. 25, the Microsoft chairman personally invested $500 million in Cox for a 2% stake. Speculation abounds that the move was an effort to persuade Cox to bundle Microsoft's MSN service with Cox's high-speed Internet access and to use Microsoft's cable set-top boxes to deliver interactive TV. A Cox spokeswoman says the investment has no "operational implications. Mr. Gates is a long-term investor who believes in the future of Cox."

"TRIED AND TRUE." If Cox keeps doing what it has been, its future is bright indeed. Yes, size is more important than ever in the wake of the AT&T-Comcast deal. The more subscribers a cable operator serves, the more power it has to cut deals with cable programmers, such as HBO. But achieving scale isn't enough of an incentive to push Cox to cut a deal in the near term. "We don't want to get bigger for the sake of getting bigger.... What's tried and true for Cox continues to work for us," CEO Robbins says.

What's working is fiscal prudence. Cox has the lowest debt-to-earnings ratio in the industry. In contrast, Adelphia and Charter, the third- and fifth-largest cable companies, respectively, are both highly leveraged. Adelphia's ratio of debt to 2002 earnings before interest, taxes, depreciation, and amortization (EBITDA) is 6.7, while Charter's debt-to-EBITDA ratio comes in at 7.7. Compare that to Cox's 4.4. "I don't think Cox would want to digest the debt that Charter or Adelphia has on the books," says Robert Martin, a cable analyst at Arlington (Va.)-based investment firm Freidman, Billings & Ramsey.

Other obstacles loom as well. Adelphia already has some of the highest margins in the business. For the three months ended September 30, 2001, it reported operating margins of 39.7%. That's far different than what Comcast got when it bought AT&T Broadband, whose margins stood at 23%, leaving vast potential for improvement.

AN AOL DEAL? With Charter, a potential issue is clashing personalities. Famed hands-on investor Paul Allen, who owns Charter, is actively involved in running the St. Louis-based company, which analysts fear might not sit well with the family-run Cox Enterprises, which retains a 65% economic

stake and 75% voting control in Cox Communications.

On the other side are the rumors that Cox might sell to the second-largest player in cable, AOL's Time Warner Cable (AOL) unit, with 12.7 million subscribers. The media giant, which also bid unsuccessfully for AT&T Broadband, wants scale to compete for programming and, perhaps more important, to distribute its AOL Internet service over cable's high-speed pipes.

AOL also could benefit from Cox's expertise in telephony, which AOL has yet to roll out across its systems. But such a deal wouldn't happen until at least 2003, analysts say. For one thing, AOL stock is trading at around $25 a share, a 52-week low, offering little incentive to use its shares as merger currency. With the ad market in a slump, AOL needs to focus on its core offerings before contemplating new partnerships, analysts say. Cox, AOL, Adelphia, and Charter declined comment on any potential deals.

BUDDING PHONE GIANT. But even without a merger partner, analysts say Cox remains an attractive buy at its current price. In 2002, it's expected to produce more revenue and EBITDA per subscriber than any of its counterparts except for Comcast, according to Lehman Brothers. That's due in large part to its success in rolling out telephony services. At the end of 2001, Cox had 454,000 residential phone customers, making it the 12th-largest phone company in the country. Analysts expect that number to rise 47%, to 667,000, by the end of 2002. "No matter how much people talk about cash flow, this industry, like all industries, is valued on growth. And Cox is way out in front," says Lehman's Warner.

Telephone service is also key to Cox's strategy of bundling, or selling multiple services, to each customer. Bundled services increase margins because, on one pipe into a home, Cox could earn fees for Net access, digital video, and telephone service -- instead of just traditional cable TV.

Fifteen percent of Cox customers now pay for more than one service, an 80% increase over last year. In Cox markets where phone service is available, 23% of customers buy more than one service. Bundling also deters customers from switching providers. Churn among bundled customers is 33% to 55% less than for single-service subscribers.

SMALL BUMPS? The picture isn't all hearts and flowers. Cox is in the midst of transferring its 555,000 high-speed data customers from the soon-to-be defunct @Home network to its own network. Throughout January, Cox customers have complained of scattered service outages -- even though the company has 100 people working almost 24 hours a day to convert them.

Analysts also worry that digital-video subscriber growth could slow in 2002 -- not least because many consumers who try the service opt not to keep it. Digital-video churn rates run from 35% to 45%. Unless Cox this year can roll out new digital services, such as video on demand, it could lose some of those bundled customers it struggled so hard to win.

Cox maintains that these are small bumps on its path to success. Like Bill Gates, it's focused on cable's long-term potential. Patient investors might want to take heed -- especially at this price. Black covers the cable industry for BusinessWeek Online in New York


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