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December 21, 2005

Cable Stocks Still Require Patience

I still like Comcast (CMCSA/K) and as I pointed out in the previous post the key to getting Time Warner (TWX) to close its valuation gap is an improved multiple for its cable division. This week has seen a few new developments on the cable scene but nothing that seems likely to boost multiples in the immediate future. I am beginning to think that approval of the Adelphia takeover and any conditions placed on the approval are the next significant catalyst for the group....

On Monday, Texas Utilities (TXU) announced it was teaming with leading broadband over power lines (BPL) player CURRENT Communications to roll out broadband services across 2 million homes in TXU's Dallas-Ft. Worth service area. BPL works and has tens of thousands of subscribers around the country. CURRENT has had success in Cincinnati. I question the potential for success of a standalone broadband product when bundles are being offered by the cable and telephony industries but BPL is real and this news just serves as a further depressant to cable multiples.

Also on Monday, TWX announced it would offer a family friendly tier to its subscribers. The tier would include 15 channels and would be offered on top of the basic cable package required by law with about a dozen channels including broadcast stations, public access, and a very limited cable number of traditional cable networks. Among channels to be included in the family tier are the Disney Channel, Discovery Kids, the Food Network, and Headline News. ESPN and Nickelodeon would not be included and neither would CNN or Fox News. According to a spokesman, TWX basically is going with true G-rated channels.

The family tier is to be priced at $13 per month which would be in addition to $12 per month for basic cable and $5 to $8 to rent a digital cable box that is required to make tiering possible. Thus, a household desiring the family tier would receive about 27 channels at a cost of a little over $30 per month. Presently, expanded basic includes 60 or more channels for about $45 per month. Digital tiers can bring the channel offerings to well over 100 for another $10 to $20 per month before considering Pay TV networks like HBO.

While TWX's offering was immediately criticized by the indecency lobby, I think it will be enough to sway the FCC and Congress and avoid true a la carte via legislation. Approval of the Adelphia transaction with the family tier concept explicitly cited should end this issue for the cable industry for the at least the next several years.

Despite my optimism, the cable industry is still fighting the public relations battle against a la carte. The latest salvo is a study by media consulting firm < a href="http://adage.com/news.cms?newsId=47231>"Kagan Research that concludes a la carte will hurt consumers though less choice and higher prices. Kagan does some excellent work but I would not consider them an objective party in this dispute. Nevertheless, I agree with their conclusion that current analysis suggesting a la carte would save consumers money is flawed as it largely ignores the economics of the cable networks business. Specifically, the analysis ignores the dramatic increase in expenses that channels would incur to market themselves and fails to consider how per subscriber prices charged to cable companies would have to rise massively to offset lost affiliate fees and advertising revenue. Kagan concludes that consumers might have to opt for as few as nine channels to save money. I don’t know if that is true but I would again point out that HBO charges on average over $10 per month. To me, this implies that quality networks currently offered on expanded basic would have to charge at least several dollars per month and ESPN with all of its exclusive live sports programming would be as expensive as HBO.

So this week sees one win and one loss for cable. Adelphia could be wrapped up in six months or less and 4Q results for the cable industry should be solid. I think that is a recipe that means investors should show patience with cable stocks.

Posted by Steve Birenberg at December 21, 2005 09:05 AM in Comcast/Cable TV