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Cable Revives
by Jim Surowiecki (Surowiecki)

NEW YORK, NY (July 10, 1997) -- In the heady and hype-ridden days when the information superhighway was everyone's favorite metaphor, it was the cable industry that analysts and investors looked to as the standard-bearer to lead us all into the brave new world of 500 channels and PC-TVs. Though by the mid-1990s, some of that boundless optimism had succumbed to reality. When Congress passed the Telecommunications Act of 1996, many still believed that cable companies would be the big winners. Using their existing wires to offer high-speed Internet access and long-distance telephone service, cable companies would be the force that would make telecommunications deregulation work.

Those hopes faded, though, with astonishing speed, and cable stock prices fell precipitously. Companies that once seemed far-sighted now looked worn-out, and a business that had once seemed like a sure thing now looked surprisingly vulnerable. Vulnerable, that is, until a combination of factors turned prevailing assumptions on their heads and sent cable stock prices soaring. These factors include some internal, including a decision by industry giant TELE-COMMUNICATIONS, INC. (Nasdaq: TCOMA), known as TCI, to refocus itself around its core business, and some external, including most notably a sharp rise in interest in cable from other media and information companies. Over the last three months, the way investors value cable companies has undergone a dramatic change. The only question is whether the new valuations are any more sensible than the old ones were.

The rapid-fire shift in Wall Street's attitude toward cable hardly comes as a surprise, of course. In no industry, after all, is the conventional wisdom as subject to change as in the business of distributing information and entertainment. In the early 1990s, the rapid advance of cable television and the proliferation of channel options it offered led analysts to proclaim that the three major TV networks were dead, monoliths doomed in a world of niche programming. That conclusion was eventually overturned by the success of the Fox network and the explosion of interest in the networks -- an explosion that culminated in the merger between Cap Cities/ABC and WALT DISNEY (NYSE: DIS) and the purchase of CBS by WESTINGHOUSE (NYSE: WX) to bolster its Group W unit.

The general perception of the cable industry has been subject to similar, if even more sudden, alterations in the conventional wisdom. In late 1996, cable's core business was viewed by analysts with increasing skepticism as they saw cable companies trimming their capital expansion budgets. While the prospect of 500-channel systems brightened the imaginations of many in the early days of the info superhighway, in 1996 two harsh realities intruded. First, in spite of all this promise, most cable systems still delivered between 35 and 50 channels and it wasn't entirely clear that anyone wanted the 500 channels enough to make them profitable, stunting cable's ability to grow revenues from its existing subscriber base. Additionally, in late 1996 some realized digital broadcast satellite (DBS) was growing fast enough to become a threat to the cable companies. Cable, it appeared, risked going the way of the dinosaurs.

In January of this year, for instance, with TCI's stock trading at $13 1/8, Fortune wrote: "In the past 18 months, the cable industry has watched its monopoly, and the pricing power that tags along with it, begin to fade... All of a sudden there really are at least two 'cable' systems in every town, with the second and third and fourth brought to you by the magic of [DBS] -- a technology that can reach everyone and offer every cable channel under the sun." Around the same time, The Motley Fool's Randy Befumo (TMF Templr) suggested that "doubts have accumulated over whether or not satellite premium channels would take the bloom off of cable's rose."

At their lowest point -- generally between October and December of 1996 -- cable stocks were trading at around 6.5 times expected 1997 cash flow, or somewhere between 3 and 4 times sales. Both COMCAST (Nasdaq: CMCSA) and CABLEVISION (AMEX: CVC), two of TCI's largest competitors, were trading at what now look to be significant discounts, though neither of those companies had TCI's overwhelming debt load -- $15 billion in September 1996 -- or a CEO who, in Fortune's words, "denounced profits... [as] damning evidence that a company has stopped growing." (Of course, neither Comcast nor Cablevision appeared to have any recipe for a dramatic turnaround, either.) Pessimism continued to mount and many of the stocks traded at multi-year lows.

Today, cable is once again the darling of the entertainment and information industries. All it took was a little investment by Bill Gates and a change in operating strategy by TCI. In fact, it's safe to say that Gates really helped kick off the new love affair with cable when, in early June, MICROSOFT (Nasdaq: MSFT) agreed to invest more than $1 billion in Comcast. Microsoft took this 11.5% stake in the company in order to speed the eventual meeting of the PC and the television.

"What we're looking at here is a vision where not only can the PC experience be better with the high-speed connection, but also there can be a new generation of TV experience," Gates said.

In other words, Microsoft was expressing its confidence that cable networks can become the vehicle for high-speed access to the Internet and, presumably, to other forms of information and entertainment distribution. That, in turn, has made others feel confident in cable as well.

In the weeks leading up to the Microsoft announcement, TCI had begun divesting itself of many of its holdings, spinning off some operations and trading or selling many of its cable systems. After buying everything in sight, TCI had apparently decided that it cannot manage it all, and that it is better off investing in those that can. In early June, the company exchanged systems in the Mid-Atlantic States for an equity stake in Adelphia Communications. On the same day that the Microsoft investment in Comcast was announced, TCI traded 820,000 subscribers in the counties surrounding New York City for a 33% stake in Cablevision and Cablevision's assumption of $669 million in TCI debt -- a deal that sent Cablevision's shares soaring from $34 5/8 to $42 5/8, while TCI's stock rose a point. Analysts were universal in their acclaim for the move. Two weeks later, TCI continued the trend by trading 300,000 subscribers in five states for a minority stake in a partnership run by cable operator Falcon Operating Group.

Soon, it appears, TCI may no longer be the nation's largest cable company. After years of thriving on appetite alone, the company is trying to find out how to live within its means. Next on the list is almost certainly the sale of TCI's 50% stake in Fox Sports to media mogul Rupert Murdoch.

Ironically, although TCI is moving out of many of its cable systems, its restructuring has to be seen as part of a renaissance of the industry as a whole. At the same time, Microsoft's interest has reminded investors that while sales growth may not be large, the cable industry's single largest asset is the infrastructure it already has in the cable going into millions of subscriber homes. The newly focused strategy of TCI, in addition to Comcast's evident intention to move its subscribers into the world of high-speed access, bode well for the industry as a whole. Of course, six months from now everything will probably be different, if past history is any indicator of future hysteria. But for the first time in a long time, cable companies appear to have their houses in order, and investors are certainly paying attention.


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