STREET TALK

Cable's bills come due as cash flow dries up, institutional investors unplug

What a difference a few weeks make. Until the start of the fourth quarter, big cable stocks were among the few members of The Hollywood Reporter Showbiz 50 that were up in 2008. After all, cable has long been seen as a sector shielded from the worst economic woes. People always want their MTV, CNN or ESPN, right?

Think again. The recent bloodbath on Wall Street has destroyed cable's success story, pushing shares of Comcast, Time Warner Cable and Cablevision Systems into negative territory for the year-to-date. And a growing chorus of observers warns that the weak economy will limit their financial growth over the near term.

Case in point: At the end of September, Oppenheimer & Co. analyst Timothy Horan downgraded shares of Comcast from "perform" to "underperform," citing "the midst of a cyclical slowdown in consumer communications that reflects the convergence of increased supply with slowing consumer demand." Horan said that Wall Street consensus expectations for the cable giants are too optimistic "as we expect the economy and increased competition to both pressure margins and cause the company to spend more on capital expenditures." He also predicts increased video subscriber losses as consumers look to lower their cable bills.

Larry Haverty, Gamco Investors portfolio manager, whose company is a Comcast shareholder, believes that the same will be a challenge for other cable firms.

"Relative to what Wall Street expected a month ago, cable cash flow will be weaker next year," he says. "This will be a very severe recession." For a generic cable company, operating cash flow next year could fall from 7%-8% to about 4%, he warns.

Sure, Haverty sees cable service on par with electricity in many households' needs pyramid, meaning few will give up their cable connection completely. However, premium services like HBO could be one place where consumers could look to save on their bills. And high-margin advertising revenue will be tougher to come by.

High debt levels at some cable players, including Cablevision and Charter Communications, also have made investors more cautious amid the current credit crunch.

All these clouds overhanging cable's outlook are just part of the story. The biggest drag on cable stocks in the past few weeks has been a broad-based sell-off by big institutional investors, such as hedge funds and mutual funds.

"It's just wholesale dumping by a lot of funds that are getting redemptions," says Dennis Leibowitz, managing general partner at media-focused hedge fund Act II Partners.

Haverty says cable stocks' popularity with key Wall Street players has in this environment turned into an Achilles' heel. "Comcast is on the list of hedge fund favorites, and there has been very significant liquidation there," he notes, adding that Cablevision also has some big hedge funds among its investor base.

There is a ray of hope for bargain hunters, though. Cable stocks haven't fallen as low as quickly this year as other media stocks as represented by the THR Showbiz 50 index. And everyone sees buying opportunities for patient investors at the current levels.

Or as Miller Tabak analyst David Joyce puts it, "There is a plethora of amazing, once-in-a-lifetime, 100-year bargains right now."

That leaves one question that few investors seem to have any time for in the current sell-off rush: Which cable stock to invest in right now?

At an uncertain time like this, it only seems appropriate that analysts would disagree on their favorite cable stock.

Joyce likes little and underappreciated cable provider Knology, which has been under particular selling pressure because little stocks are less liquid. He thinks that stock could run up to $19-$22 within two years once investors refocus on fundamental business trends.

Meanwhile, Sanford Bernstein analyst Craig Moffett rates Comcast and Time Warner Cable "outperform" with price targets of $30 and $42, respectively. He gave an edge to TWC for the near-term as his top pick for the fourth quarter.

He likes TWC's planned separation from Time Warner by year's end, saying it will "leave in its wake for the first time a truly one-share/ one-vote, publicly owned cable company." He also suggested that investors have focused on Comcast so much that they have neglected TWC.

Collins Stewart analyst Thomas Eagan prefers Cablevision, which he rates "buy" with a $35 price target.

Cablevision has been unnecessarily punished because the current credit crunch will push back a possible sale of its content assets that Wall Street had expected, according to Eagan, who thinks it should trade above its peers.

"Cablevision's fundamentals continue to lead the industry, and the prospects for an eventual split-up or sale of its cable networks is high."

Anyone ready to put some money back into cable and the market yet?

Georg Szalai can be reached at georg.szalai@THR.com.
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