Cable Stocks Hurt by Reregulation, Satellite Threats

In a fine example of Wall Street’s terrifying mood swings, cable television stocks have gone from market darlings to virtual pariahs in just a few months’ time.

Industry leader Tele-Communications Inc., for example, has plunged from an all-time high of $21.625 last year to $14 now--a drop of 35%. The decline began last fall and accelerated in January as the broad market slumped.

Though the stocks have bounced up a bit this week, they remain severely depressed. And although the beating may appear overdone, some experts say a bet on cable stocks is a risky proposition now, despite their stellar gains in the ‘80s.

What’s happened to cable is that a list of new worries has emerged at the same time that old concerns have come back to haunt the industry. In fact, one can argue that cable firms now display almost all of the attributes that make investors queasiest these days: There are no earnings, debt is high, the threat of pricing problems looms as Congress zeros in on cable rates and new technologies threaten cable’s growth.

Together, these worries come down to a single question: Has there been a sea change in the way investors perceive the worth of cable companies’ assets--which is the only way these stocks have ever been valued? If that perception has shifted, there may be little hope of seeing a dramatic recovery in the stocks.

Sharon Armbrust, senior analyst at communications research firm Paul Kagan Associates in Carmel, said it isn’t yet clear if investors have permanently altered their views of cable. “We’re in the middle of trying to see if that’s true,” she said, referring to the action in the stocks.

The problem with cable isn’t in the fundamentals. An estimated 45 million households subscribe to cable, and the number continues to rise. Cable companies are generating plenty of cash from their operations and have no trouble paying interest on the debt they took on in the 1980s to build their systems. The cost of the companies’ debt, and their depreciation expenses, mean they’re always officially showing red ink on the bottom line. Yet investors accept that--it’s cash flow that counts.

But the driving force behind the stocks in the ‘80s was the belief that the takeover value of the companies was ever rising: that the price someone would be willing to pay for a cable franchise would always be higher next month than this month.

Now, in an era when takeover financing is far more difficult to arrange, investors have been forced to rethink the values that should be ascribed to cable assets. What’s made a reassessment more urgent are two threats: First, that Congress will reregulate cable, after deregulating it in 1987. Second, that new technology may supplant cable.

The threat of reregulation seems real. Many in Congress are angry about cable monopolies and what they perceive as high prices for shoddy cable service. A House hearing Thursday in Washington provided a forum for consumer advocates arguing for federal control of cable rates.

Paul Napper, analyst at Crowell, Weedon & Co. in Los Angeles, believes that “we will see a reregulation of basic cable rates.” (The average monthly rate for basic cable is about $16 to $17 now, he said.) But Napper argues that an indexing of cable rates to inflation, perhaps the most likely outcome, “is something that the industry could live with quite well” without jeopardizing cash flow.

A greater worry longer term is that direct broadcast satellite technology will begin to take away cable subscribers by the mid-’90s. Two weeks ago, a consortium of companies--including cable giant Cablevision Systems--announced plans for Sky Cable, a system that would provide homeowners with direct satellite-to-home TV transmissions via a satellite dish the size of a dinner napkin. The advantages, in theory, would be more channels and better signals.

It sounds great, but whether Sky Cable ever amounts to anything is anyone’s guess. In big cities with tall buildings, getting clear reception could be a problem. The threat to cable from such technology is overblown, many experts believe.

Still, Sky Cable adds another perceived worry to the list. And talks with money managers about cable suggest that perceptions may be far more important than reality, if you’re trying to predict whether the stocks can rebound soon, or at all.

Listen to Chris Boyd, an investment analyst for Kansas City-based Twentieth Century Investors, which owned 3.5 million Tele-Communications shares as of last October. He won’t say if his firm has been selling the stock. Yet he sounds like a concerned man. “We’re growth investors,” he said. “That’s what attracted us to cable in the first place.” But he now perceives a slowing of industry growth. “So my personal view is, it’s time to take a more wait-and-see attitude toward the stocks.”

What Are They Worth? Boyd’s concerns ultimately get back to the central issue: For a host of reasons, have cable franchise values been permanently reduced?

Armbrust’s firm calculates the estimated market value of cable franchises based on annual cash flow. In essence, that yardstick figures the price that a firm should fetch in a takeover.

Right now, Armbrust’s calculations are based on 13 times a company’s cash flow. She has cut that from 13.5 times last year as fears about the industry have risen. Even so, at 13 times cash flow, Cablevision Systems has a potential asset value of $86 a share, while the stock has plunged to $29.

Does that make the stock cheap? Perhaps, Armbrust said. But what if concerns increase about cable’s future growth? Then, a potential acquirer is unlikely to be willing to pay 13 times cash flow. And the “fair” multiple doesn’t have to fall much--perhaps just to 10 times cash flow--before the stocks look overpriced even at current levels, she said. The reason: In a market perceived to be declining, it becomes unlikely that anyone would be willing to pay a decent price for assets.

At that point, some cable firms could find creditors unwilling to extend new loans, because of worries about the underlying assets. A downward spiral could ensue. If that vicious cycle sounds familiar, it should: That’s what happened with the junk bond market in recent months.

Crowell Weedon’s Napper, however, believes that such concerns are misplaced. Even if some of the industry’s worst fears come true, he said, the stocks are at such a low point now that they are unlikely to go lower. “The worst case is that the stocks do nothing” from here, he said.

Still, it’s worth remembering that many big investors now are re-evaluating cable. The headlines this year on reregulation may be bad news. The companies can’t escape the debt stigma, even if cash flow is dandy. All of that may make it very tough to make money in cable stocks soon.

Briefly: January mutual fund sales figures confirm that investors continued to exit junk bond funds. Redemptions totaled $703 million, the Investment Company Institute said. Yet even while the junk market was crumbling, some investors couldn’t resist chasing those high yields: New sales of fund shares, not counting reinvested dividends, totaled $393 million.

HOW CABLE STOCKS HAVE TUMBLED

Most cable TV stocks have plunged 20% to 40% from their 1989 highs. How prices have fallen, and the estimated per-share value of each company’s assets:

Est. 1989 Dec. 31 Thurs. takeover Stock high close close price/share Amer. TV & Commun. $55 1/4 $44 3/4 $34 3/4 $65 Cablevision Sys. A 47 1/4 37 1/8 29 86 Comcast 19 7/8 16 3/4 13 3/4 26 3/4 Jones Intercable 20 7/8 15 1/2 11 1/4 36 Multimedia 108 94 1/4 75 1/2 154 Tele-Commun. A 21 5/8 17 7/8 14 38 Viacom 65 1/4 57 1/2 49 3/4 77

Source: Paul Kagan Associates

(for estimated takeover price per share)