Good article posted by TokyoMex on the ATHM thread:
To: +TokyoMex (2798 )
From: +TokyoMex
Wednesday, Sep 16 1998 12:49PM ET
Reply # of 2801
The Buysider: Cable Reels 'Em In
By Tom Kerr
Special to TheStreet.com
9/16/98 12:19 PM ET
MARINA DEL RAY, Calif. -- What do you call a company that consistently grows 13%, is resistant to
economic cycles and generates tons of free cash flow? I'd call it a blue-chip growth stock.
This business has been called the greatest business in the world, and not just because it boasts cash flow
margins of 40%-plus.
After all, you bill the customers in advance, you don't have to carry inventory and there is no one significant
customer to lose and ruin your business. In addition, it's not economically sensitive or sensitive to changes in
interest rates, and it has no exposure to Asia or Latin America.
It's the cable business, and here at the Merrill Lynch Fall Media & Entertainment Conference in Marina Del
Rey, Calif., almost everyone seemed to share the rosy outlook for cable companies.
People are excited because cable operators' much-ballyhooed incremental revenue and cash flow opportunities
are finally within reach. Why? Because cable companies are nearing the end of a massive upgrade project in
which old analog cable plant is being turned into high-speed, digital two-way systems.
What are the incremental revenue opportunities? First of all, high-speed data transmission, which means
Internet access at rates never seen before -- hundreds of times faster than a 56K dial-up modem.
The second is digital cable television, a higher-quality version of cable television with twice the channel
selection and a much clearer picture. For example, Time Warner (TWX:NYSE) can go from offering 79 analog
channels to 170 digital channels for an additional monthly charge of only about $10. Watch out, DirecTV.
And the third source of revenues is telephony over the cable plant. We've heard a lot about this recently with
the AT&T (T:NYSE) acquisition of Tele-Communications (TCOMA:Nasdaq), and there is some skepticism
about whether it's a feasible business model -- or if the technology even works.
But it's been working successfully in Europe for some time on a large scale with cable companies like United
International Holdings (UIHIA:Nasdaq), as well as here in the U.S. with Cox Communications (COX:NYSE),
which has more than 13,000 residential telephony subscribers in Orange County, Calif. All that at a monthly
charge about 30% less than the local phone company. Watch out, Baby Bells.
The significance of these developments will really be demonstrated financially. Cable companies' EBITDA
growth rates are set to increase from 7% to 13%, yet at the same time, capital expenditures will decrease as
the upgrade of the systems is completed -- which means most cable companies will start to generate real free
cash flow at an increasing rate. This can be used to reduce debt, buy back stock or invest in new ventures.
Furthermore, a company that can consistently grow 13%, that is resistant to economic cycles and generates
free cash flow can be considered a steady blue-chip growth stock -- and consequently deserves, and will be
awarded, a higher multiple. In the case of cable companies, they should evolve from highly leveraged concerns
selling at 9-12 times EBITDA to investment-grade growth companies selling at 13-15 times EBITDA. A
dramatic and important valuation adjustment.
But is this really feasible? Haven't we been hearing this line for years? Will the market believe it?
Certainly: It already does. Just look at @Home (ATHM:Nasdaq), the market leader in these "incremental
revenue opportunities." The company is creating a high-speed Internet access infrastructure in affiliation with
18 cable companies. The market is awarding it a $4.2 billion market capitalization -- for 147,000 subscribers.
That's $28,000 per sub. Even at the 600,000-subscriber target for the end of 1998, that's $7,000 per
subscriber. (And that's after the stock has fallen 40% from its 52-week high.) That's a remarkable validation of
these type of services.
And @Home is not alone at the forefront of these uncharted waters. Time Warner offers an equivalent service
to @Home on its own cable systems called Road Runner.
Very few people know about this service because it's not a separate publicly traded entity and is consolidated
under TWX's byzantine financials. Road Runner will be available in 8 million homes by the end of 1998 and
currently has 120,000 subscribers, which is actually a higher penetration rate than @Home's.
The "take rates" for this Internet service is about 8%-9% so far, which means that in certain Time Warner
cable markets like Portland, Ore., there are more Road Runner subscribers than AOL subscribers. Road
Runner's partners include MediaOne (UMG:NYSE), Microsoft (MSFT:Nasdaq) and Compaq (CPQ:NYSE).
Watch out America Online (AOL:NYSE).
What if you were to put a market value on the Road Runner service comparable to what @Home is trading at?
Suffice to say, it's in the many billions.
What if you were to combine @Home and Road Runner in a nationwide high-speed Internet service provider
offering access rates hundreds of times faster than dial-up ISPs -- which @Home CEO Tom Jermoluk so
emphatically wants to do?
Watch out AOL. Earthlink (ELNK:Nasdaq). Netcom (NECSY:Nasdaq ADR). The RBOCs. ...
So to answer the first point raised here, is it the greatest business in the world to invest in? With finance
stocks trading like they're headed for bankruptcy, drug stocks facing an inevitable multiple contraction,
small-cap stocks still getting no respect and any company with Asian or Latin American exposure sure to face
an earnings hit -- cable could very well be one of the few good investments left out there. |
