Will Declining Stock Prices Short-Circuit Cable Deals?

The plummeting price of entertainment stock prices is unnerving Hollywood, but Wall Street's meltdown could have particularly serious consequences for the much-maligned cable industry.

After being beaten down for the better part of three years, the stocks of cable operators are so low they threaten to blow up two pending acquisitions and make expansion in the fast-consolidating and newly competitive industry more costly.

At risk are two acquisitions that are supposed to close in the next five months and that use stock as currency: Comcast Corp.'s $1.58-billion purchase of E.W. Scripps Co.'s cable operations and US West Media Group's $10.8-billion acquisition of Continental Cablevision Inc.

Under the terms, both deals must be renegotiated--and can be legally scuttled--if the buyer's stock price falls through a specified floor. Both stocks are now well below those so-called collars, meaning the sellers might have to issue more shares to meet the agreed-upon price, making the purchases more costly.

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At current prices, Comcast could be on the hook for an additional $240 million in shares, and US West could be forced to issue shares worth more than twice that amount.

"The tension is beginning to build," said John Tinker, an analyst at Montgomery Securities.

Certainly, the deadlines for each deal are still a ways off, giving the stocks time to recover. Comcast, the nation's fourth-largest cable company, is aiming to complete its purchase by the end of September at a strike price of $20.075 a share. The stock closed Thursday at $14--$3 less than the collar.

US West, the regional phone company whose acquisition would make it the third-largest cable operator, had targeted year's end, at which time shares were expected to be trading at above $24.50. US West Media, the cable and new-media subsidiary that is making the purchase, closed Thursday at $16.50 a share--about $4 less than the collar.

"Despite the bludgeoning they have taken for the last three years, cable stocks were creamed in the mini-crash of last week and did not recover with the general market," said Sharon Armbrust, a senior analyst at Paul Kagan Associates in Carmel.

The dozen cable stocks in Kagan's cable index have fallen 25% since March 6, compared with the Dow's drop of about 10% through July 16, when it began to recover.

The relevant question now is: What will propel these stocks back into the safety zone?

Cable stocks were supposed to rally this year, propelled by telecommunications reform that lifted rate restrictions, the introduction of high-speed cable modems for the Internet, digital cable boxes and revenues from entering the telephone business. But many investors have grown tired of waiting for the results to roll in.

"The saving grace for cable is in moving data via modems at high speed," said one investor who bailed out of Comcast several weeks ago. "But significant revenues from that business are a ways off, so where are the earnings going to come from to increase the stock? There is no longer confidence in what the cable companies are saying because they have promised so much for so long."

Adding to the crisis of confidence are new worries about the impact of possible higher interest rates and a recession, which fueled the stock market drop. Cable companies are particularly vulnerable to interest rate increases because they borrow heavily to upgrade their systems and invest in new technologies to compete against telephone rivals and digital TV services. Their high debt levels is one reason for financing acquisitions using stock.

Competitors such as AT&T;, which holds an interest in satellite service DirecTV, have deeper pockets.

Many cable companies are still counting on a stock jump later in the year, after the first cable modems are due to be shipped and new services kick in.

Although the modems can connect users to the Internet a thousand times faster than telephone wires, some analysts believe retail prices will have to drop significantly below the $300 level before consumers reach into their pocketbooks in great numbers.

And many on Wall Street are already talking as if the stocks will not recover.

"These deals are victims of the rising and falling tides of the cable market and show the risks of using stock as currency," said Christopher Dixon, an analyst at PaineWebber Inc. who expects the deals to be renegotiated in some fashion before going through.

The deals were driven by competition-induced consolidation that analysts and industry executives say could eliminate all but the top three or four cable companies in the next few years. Cable companies need economies of scale to justify investments, allowing them to sell a bundle of telephone, digital TV and Internet services.

To stay in the game, Comcast was counting on Scripps' 800,000 subscribers to use as trading chips to build its base of 3.5 million households. The company is still in cable's second tier, far behind the two leaders, Tele-Communications Inc. and Time Warner Inc., which, counting pending acquisitions, would reach an estimated 18 million and 11 million subscribers, respectively.

If Comcast is forced to issue more stock to make the purchase, shareholders could be aggravated by the dilution. Comcast agreed to issue Scripps shareholders 78.5 million shares of its Class A stock, at a value of $20.075 each, and additional shares if the stock falls to less than the $17.06 collar.

But analysts say Comcast could have the upper hand in negotiating a compromise because Scripps is unlikely to find a better offer. There are few cable buyers and most share Comcast's double bind of having little cash and a weak stock price. Most cable companies are now trading at less than seven times cash flow.

"There is plenty of time for the Comcast stock to rebound and there are options available if it doesn't," said Tim King, a Scripps spokesman.

Continental and US West are of similar mind. US West says new services delivered later this year should drive up the stock. "We are demonstrating to the market that we are fulfilling our promises," said Bruce Amundson, director of financial and international communications at US West Media.

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He said the company will start delivering phone service to a few thousand of its cable subscribers in Atlanta by year's end and to all of its total 497,000 subscribers by 1998. The Continental acquisition is key to its strategy of growing revenue outside its core phone service area in 14 Western states, where rural neighborhoods make it costly to compete.

Analysts, however, say Continental is in a better negotiating position than Scripps because its systems are among the best in the country. It might make a nice fit with sixth-ranked Cablevision Industries, which is clustered in Long Island and could create an Eastern Seaboard stronghold by buying Continental.

"The stock collar is an issue, but we retain confidence that investors will drive up the value of the stock and the merger will close on schedule," said Rob Stoddard, a Continental spokesman.

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