Cable's Costly Road to Profits


By David Shook If one business has kept the faith in perilous economic times, it's cable. For the past decade, operators have spent billions to rebuild networks to deliver the premium digital services that industry players and observers all agree are the future. Result: Cable providers have amassed more than $92 billion in debt -- without a whiff of profits to show for all the new infrastructure.

The absence of profits has never fazed cable execs, however. Their vision is that, sooner or later, the nation's cable monopolies will solidify their grip on home-entertainment and communication services. In addition to digital cable, which allows for hundreds of channels rather than dozens, the industry is rolling out high-speed Internet service, Internet telephony, and the technology to handle high-definition TV signals. And a few providers have already begun reporting positive free cash flow -- a precursor to real earnings, which some companies could achieve as soon as later this year.

ERASING THE RED. Smart investors will be wary, however. Last year's bankruptcy of Adelphia Communications, the fifth-largest cable operator, and the woes of Charter Communications (CHTR), the third-largest, have raised concerns that the industry may be spending too much too fast. The stocks of the six publicly traded cable providers are down 51% on average from one-year highs. And subscription growth for basic cable-TV service has leveled off. "Cable companies have really fallen under pressure to produce results," says Mike Paxton, senior analyst for Cahners In-Stat Group.

An imminent windfall for the cable companies isn't in the cards. Although the major players have completed more than 80% of the buildout necessary to equip most U.S. cities for the newest digital services, consumer demand for many of these costly add-ons remains latent. With cable companies so deeply in debt, it will be several more years before the industry hits its stride on profit growth, analysts say.

So the eight companies that make up the industry are striving to trim debt. Comcast (CMCSA) has pledged to reduce its overall burden from $30 billion to $25 billion by yearend. Other providers have made similar vows. And the industry also has ratcheted back on capital spending, according to Cahners' Paxton. Spending fell from $15.3 billion in 2001 to $13.3 billion last year -- and will most likely decline 12% this year, he says. Points out Mark Kersey, broadband analyst for ARS: "The industry's need to upgrade is largely behind us."

CHARTER'S BURDEN. While that's encouraging, the wind-down in spending isn't happening fast enough, many analysts caution. Take Comcast, the nation's largest cable company. The remaining costs associated with completing its network upgrades will most likely erase any chance for profits this year. And it still needs to spend as much as $2.5 billion over two years to outfit its newly acquired AT&T cable systems. AT&T networks in many cities, including Denver and San Francisco, must be overhauled, Kersey notes.

With the rebuilding of the old AT&T systems incomplete, Comcast is reluctant to estimate when it can reach profitability. "We're at the point where we're seeing tremendous consumer response to the applications we're rolling out, but net profits are not part of the guidance at this point," says John Alchin, executive vice-president of Comcast, which has 21 million subscribers. The stock is down 27% from a one-year high, to $26 a share.

Other cable providers' debt loads pose a more dire challenge. Charter Communications, part-owned by Microsoft co-founder Paul Allen, carries $18 billion in debt -- a staggering sum considering that Charter is less than a quarter of Comcast's size. Charter is now mired in questions about its accounting, too. It's re-auditing financial statements for 2000 and 2001, and, since last year, has seen its stock plummet from $13.80 to around $1. Investors seem worried that Charter might follow Adelphia into bankruptcy if it can't begin generating free cash flow soon.

Says Charter spokesman David Anderson: "When we went public in 1999, debt was looked upon by Wall Street with a smile. Now it's suddenly out of favor." Anderson adds that Charter isn't in breach of any debt covenants, but he says the company has given no indication when it might be profitable.

UPGRADED SYSTEMS. For the rest of the industry, the profit picture isn't so fuzzy. No. 2 provider Time Warner Cable, a division of AOL Time Warner (AOL), and Cox Communications (COX), the fourth-largest operator, could reach profitability late this year or early next, assuming they continue to see growth in high-speed Internet services and other digital applications, says Alan Bezoza, cable analyst for CIBC World Markets. But neither Time Warner nor Cox is offering guidance on profits.

Cox already has actually reported a profitable quarter -- $179 million (28 cents a share) in the fourth-quarter of 2002, vs. a net loss of $105.2 million for the same period of 2001. But the profit was due to one-time investment gains rather than operations. "We expect to have positive free cash flow this year," says Lacey Lewis, Cox's chief of investor relations. "We've pretty much upgraded all of our cable systems for premium services and high-speed Internet."

Cablevision (CVC), the No. 6 operator, also reported a one-time profit in the fourth quarter -- $517 million ($1.62 a share), vs. a loss of $281 million a year ago. But the profit followed three quarters of losses, and analysts expect Cablevision to report losses in all four quarters of 2003.

GRADUAL SHIFT. Two smaller cable companies are better positioned. Both Insight Communications (ICCI) and MediaCom (MCCC), the No. 7 and No. 8 cable providers, respectively, are the most likely candidates to report profitable quarters in the latter half of 2003, Bezoza says. Each carries less than $2 billion in debt -- and both are attracting paying customers for such premium services as high-speed Internet and movies-on-demand.

With profits for some companies now in sight, many investors might figure this is the right time to buy. But the industry is still fraught with risk. The high debt carried by all providers means the gradual shift to profitability isn't likely to result in major stock gains. Yes, the glimpse of black ink ahead is encouraging, but cable still has a long way to go before reaching its pot of gold. Shook writes about the markets for BusinessWeek Online in New York


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