From St. Louis Post-Dispatch 11/23/02
Charter's swift growth fueled current woes
By Jerri Stroud
Of the Post-Dispatch
11/23/2002 03:14 PM
For its first six years, Charter Communications Inc. seemed to be living a charmed life.
From April 1994 to February 1997, the cable company grew from no subscribers to more than a million by acquiring 15 companies, raising $2 billion in equity financing along the way. Over the next three years, the Town and Country-based company added nearly 20 more companies, becoming the nation's fourth-largest cable company, with more than 6 million subscribers.
But the company's swift growth held the seed of its current troubles - $18.5 billion in debt to finance acquisitions and cable system upgrades. Adding to Charter's woes are a quantum shift in financial markets, a decline in basic subscribers and a grand jury investigation into Charter's accounting for subscribers and certain installation costs.
Industry observers don't expect Charter to go out of business. Even if the company goes through a restructuring - with or without a bankruptcy proceeding - it would continue to provide service. The company has promised to hold rates constant until 2004 in virtually all of the St. Louis area.
Charter executives say their focus hasn't shifted, though they're making the transition from an acquisition mode to one focused on making the most of the systems they've acquired and refurbished.
"Our numbers aren't dramatically different from what they were when we went public," said Kent Kalkwarf, Charter's chief financial officer. Financial markets have changed their tolerance for risk, he continued. "They don't like debt, and we've got a lot of debt."
Charter's beginnings
Charter's story starts in 1993, with three former executives of Cencom Cable Associates: Jerald L. Kent, Howard Wood and Barry Babcock. The three were pursuing their dream of recreating a cable company that had been sold out from under them only a few years earlier. Cencom, the dominant cable company in St. Louis County in the 1980s and early 1990s, was sold to Hallmark Inc. in 1991.
Kent, a master deal-maker, often asked the people who were selling him cable companies to take a stake in the deals. He also got backing from foreign banks and several venture capital funds.
In 1998, Paul Allen, a Microsoft Corp. co-founder and one of the nation's richest men, bought a controlling interest in Charter for $4.5 billion in a deal that merged Charter with another large cable company. Charter continued to seek out deals, but at a slower pace. The company went public late in 1999.
As it was growing, Charter also was borrowing - through banks, private debt placements and finally with publicly traded bonds. The borrowing financed its growth and the rebuilding of its cable systems to support advanced services like high-speed Internet service, digital cable, video-on-demand, and, in a few systems, telephone service. It didn't stop until early this year, when Charter sold $900 million in notes to pay off some of its revolving credit.
When AT&T Broadband and Comcast merged last week, Charter moved up to third among the nation's cable companies, behind the merged company and Time-Warner Cable, a subsidiary of AOL Time-Warner Inc. But the new standing comes as Charter's luster has tarnished, at least in the eyes of some observers.
Facing challenges
The growth engine that seemed unstoppable just two years ago has sputtered. The debt that financed Charter's growth has become an albatross, and the government has raised questions about Charter's accounting practices and its handling of deadbeat subscribers.
Charter's stock price has fallen from around $13.83 a share a year ago to $1.22 a share on Friday. Charter's founders have been replaced with Allen's hand-picked chief executive, Carl E. Vogel.
Vogel's task of turning the company around is a formidable one, especially given the sea change in financial markets over the last 18 months.
"The fundamental problem is that it's a company built on acquisition," said Todd Bernier, an analyst with Morningstar Inc.
Said Ted Henderson, a cable analyst with Stifel Nicolaus & Co.: "They overbought, then they overbuilt, and then the bottom of the market fell out." Charter's outstanding stock is worth about $600 million, an amount dwarfed by its debt.
Kalkwarf, Charter's chief financial officer, isn't happy about the stock price, but he doesn't see Charter as having its back against the wall. Charter's growth has lagged because it is no longer making acquisitions and because the benefits of upgrading its systems haven't yet kicked in, he says. In an interview, he said Charter remains on track to achieve "free cash flow" - enough revenue to cover cash expenses, capital spending and cash interest payments - late next year. After that, Charter will have less need to borrow money and should begin to pay off some of the debt.
But the debt issue is dominating the investors' views of Charter.
The company owes more than $2,700 for each of its 6.7 million subscribers. That was OK when cable properties were rising in value, topping out above $4,000 per subscriber in the priciest neighborhoods, Bernier said.
But values have receded in the face of Adelphia Communications Corp.'s bankruptcy and the investment community's wariness of businesses like cable that rarely turn a profit. Sellers are asking $3,000 or less per subscriber, and few systems are selling at that price.
"There's very little equity left for the shareholders," Bernier said.
Bernier says that Charter's debt load is so heavy that the company could be forced to take drastic action. He stops short of saying he expects Charter to file for bankruptcy, but says he wouldn't be surprised if it did.
A pre-packaged bankruptcy would allow Charter to shed some its debt and reduce its interest costs, Bernier said. The company would likely continue to operate and provide service while in bankruptcy.
But its shares - including Allen's 51 percent stake - would be worthless.
Henderson agrees that Charter needs to address its debt load, but he doesn't think it's headed for bankruptcy. He thinks a debt-for-equity swap is more likely, and he thinks Allen might buy some of the debt to protect his stake in the company.
"You don't file bankruptcy because your stock is trading at a low price and your bonds are trading at a low price. You file because you need protection from creditors," Henderson said.
Executing a strategy
Charter has enough money to get through the end of next year or into early 2004 without taking on more debt. Charter could face a funding gap in 2005, when it has to start paying back some of the principal on its bonds, Henderson said. But that's a long way off.
In the meantime, Charter has to focus on operating efficiently, hitting its targets for revenue and cash flow growth, Henderson said. "They have to execute, execute, execute."
Kalkwarf declined to comment directly on any restructuring plans Charter may have, saying only that the company will consider all of its options. Financial markets' concerns about Charter's debt level is more a reflection of investors' "change of perception" about the cable business rather than a change in Charter's outlook.
Kalkwarf said he believes investors' concerns about its debts will disappear as Charter carries out its business plan - a plan built on the belief that customers will buy into the products made possible by the company's network upgrades, which will be completed by the end of next year.
But before that can happen, Kalkwarf admitted, the company has to improve its customer service and do a better job of communicating the advantages of cable systems over satellite.
The company has almost completed one of Vogel's first initiatives as chief executive - stopping discount promotions Charter previously had used to boost growth in basic cable subscribers and tightening credit policies to weed out nonpaying subscribers. No one blames Vogel for the tighter credit policies, which were probably overdue. But the timing couldn't have been worse. The new policy coincided with a direct assault on Charter's subscribers from satellite television companies. Their offers included free equipment, installation and one or more months of free service.
"It's hard to compete with free," Kalkwarf said.
Largely as a result of the tight-credit policy, Charter's subscriber list shrank in the first quarter for the first time in its history. In February, Charter said it expected to remove 120,000 subscribers from its rolls, mostly due to the new policy.
The losses continued in the second and third quarters, and Charter identified satellite companies as the culprit. The company's most recent financial report put the number of subscribers at 6.7 million, down about 280,000 from a year earlier. The company expects to lose another 30,000 to 40,000 subscribers in the fourth quarter.
Charter's loss of subscribers is hardly unique, said James R. Smith, associate professor of communications and media at the State University of New York at New Paltz. But Charter has lost more than other companies, and it hasn't been able to turn the trend around.
Cable subscribers nationwide have balked at paying for digital cable, which can push cable bills to $70 a month or more from about $45 for expanded basic cable, Smith said. Satellite companies have developed discounted packages that undercut both digital and basic cable offerings.
Charter's response to the satellite barrage includes talking to customers about their options when they call to disconnect their cable service, said Diane Schneiderjohn, senior vice president of marketing and programming. A special "save desk" of customer service representatives has been trained to work with customers to address their concerns.
Sometimes, the customer has a service problem that can be fixed. In other cases, the customer can switch to a less expensive plan and stay with Charter. Save desk employees can offer customers coupons or free trials if that's what it takes to get them to give cable another chance.
Since starting the save desk, Charter has been able to keep 44 percent of the customers who call to disconnect, Schneiderjohn said.
Charter also is developing a discounted plan that will be priced below its current expanded basic analog service. Details weren't available Friday, but Vogel has suggested that it would be priced at $30 to $35 a month and contain some of the most popular cable channels.
Smith said there is some evidence that cable companies are losing young subscribers, the group advertisers most want to reach. These tech-savvy customers are sometimes buying cable modem service without cable television. Some buy satellite, but others aren't buying pay television at all. It's a customer group no media company can afford to lose.
As of Sept. 30, Charter had 50,300 cable modem customers who didn't take regular cable service, up from 16,800 a year earlier.
Kalkwarf said Charter sees data products like cable modem service as the company's future. For customers who don't want the entertainment service, cable modems represent an entree into those customers' homes. For Charter's entertainment customers, the data products will open up an increasing array of possibilities - all of them chances for Charter to increase its revenue.
"The growth driver for this business is data," Kalkwarf said. "Part of the cultural change of our industry and our people is that we are as much a data company as a video company."
A final issue for Charter is resolving the grand jury and Securities and Exchange Commission inquiries into its accounting for subscribers. The company and authorities haven't elaborated on the investigation, but Stifel's Henderson says he doesn't expect investigators to find anything seriously wrong or financially significant.
"If there had been material fraud there, something would have been uncovered by now," Henderson said.
Charter's latest quarterly report indicates that neither Vogel nor any of its directors is expected to face criminal charges in the grand jury inquiry. Charter officials are continuing to cooperate, but they have no indication of when the investigation will end, said David Andersen, a Charter spokesman.
Reporter Jerri Stroud:
E-mail: jerristroud@post-dispatch.com
Phone: 314-340-8384 |
