Operating Preview: ’04 Might Be a Big Deal for MSOs

Will 2004 be a big year for consolidation in the cable industry? With Comcast making major headway on integrating the 13 million subscribers it purchased in its 2002 acquisition of AT&T Broadband—the industry’s last major deal—analysts following the industry say further consolidation is inevitable. Several events may dovetail in 2004 to spur that consolidation. Trying to time potential acquisitions is a tricky business, and some industry observers say more time is needed for probable targets to execute and prove their operating strategies. “I’m not convinced there are going to be major domestic deals in 2004,” says Matthew Harrigan, an analyst with Janco Partners. That’s “in part because a number of companies are in show-me postures,” he adds. Harrigan thinks overseas markets such as Europe and Latin America are in more fragmented positions right now and are riper for consolidation. Domestically, however, “next year is going to be more a matter of reinforcing the value of systems,” he says, with companies other than Comcast and Cox attempting to prove that they can generate free cash flow while still growing their customer numbers. Those cash flow numbers will be crucial in determining per-subscriber valuations; right now potential targets like Adelphia and Charter may not fetch particularly attractive prices, he notes. Still, it’s tantalizing to review the events that may push the cable industry toward consolidation and transform it into a mirror image of the telecom industry, with four big Baby Bells, and the satellite industry, with its two dominant players. First, by midyear to late next year, Adelphia could emerge from bankruptcy. “The company continues to target mid-2004 as a target for emergence,” says Adelphia spokesman Paul Jacobson. “I would underscore ‘target’—it’s not a date that is time certain.” If nothing else, one thing is certain about Adelphia’s bankruptcy: Infighting among the company’s various constituencies—secured lenders, unsecured lenders, equity holders and creditors—continues. Not only are the creditors accusing the secured lenders—the banks that set up the infamous “co-borrowing facilities” that eventually led to the company’s downfall—of fraud, due to their role in approving the co-borrowing arrangements among the company and the Rigas family, the different groups are split on whether to proceed with an outright sale of the company once the bankruptcy is over. Despite the challenges facing Adelphia, such as boosting margins squeezed by higher spending on marketing, the company’s systems remain attractive. Fulcrum Global Partners analyst Richard Greenfield argues that the company’s individual assets, such as its cluster in the Pennsylvania-Ohio-New York area, would be more valuable if sold on a stand-alone basis. “The PONY cluster could be very attractive to Comcast or Time Warner given their assets in this area,” he notes. Cox, said to be interested in Adelphia in the past, is a potential acquirer. In addition to taking a stand against higher sports programming costs, Cox is looking to increase its scale, which could give it leverage in its negotiations with big content providers. Cablevision has been intermittently rumored to be for sale throughout the last decade. The anticipated spin-off of VOOM, the company’s new satellite service, would make the cable operations more of a pure play and may bring a sale one step closer. Time Warner, dominant in the New York area, is the logical buyer, but analysts say Comcast shouldn’t be discounted; its East Coast systems stretch from Washington D.C. up to Boston. Cablevision’s systems around New York, Long Island, Connecticut and New Jersey would fit snugly into Comcast’s footprint. If Comcast sees an opportunity, it may pounce, although it would be unlikely to enter a bidding war, even though some observers say that may be just the thing that would finally entice Cablevision founder Chuck Dolan to sell. “I wouldn’t say at all that it’s a foregone conclusion that it’s Time Warner” that would buy Cablevision, says Greenfield. “I think Comcast would be very interested.” Harrigan at Janco Partners argues 2004 will be a year “for Cablevision to further prove itself,” especially with its recently introduced cable telephony product. “Their sentiment would be why sell now,” he adds, referring to the Dolan family, Cablevision’s controlling shareholder. The demographics of Cablevision’s footprint throughout the New York metropolitan area are ideal for selling advanced services. If those services take hold, Cablevision could garner a price well above the $4,000-per-subscriber price analysts think the company could fetch. The IPO of Time Warner Cable is far from a sure bet. The company has been shedding debt, most recently with its $2.6 billion sale of its music unit, but SEC investigations into the Time Warner’s accounting has contributed to the tabling of the IPO. In 2004, smaller MSOs like Insight and Mediacom will need to prove to Wall Street that they can stand up to satellite competition. If customers continue defecting to satellite and margins keep eroding, it will be difficult for them to remain independent.