Shuffling of Assets to Follow Comcast’s Acquisition of AT&T Broadband

In the wake of the mid-November completion of Comcast Corp.’s $47.5 billion acquisition of AT&T Broadband, cable operators and dealmakers have been eyeing the other players in the industry to see what efficiencies can be wrung out by further consolidation. Comcast, the nation’s third-largest cable company, combined with AT&T Broadband, the largest cable operator, to form a cable giant with more than 21.4 million subscribers in 41 states. The new Comcast, formerly named AT&T Comcast, will control 29% of the market and have almost twice as many customers as Time Warner Cable, the No. 2 cable company with about 12.9 million subscribers. Asset swaps are projected In order to compete with these two giants, there will be at least some shuffling of assets by the other cable companies, though one industry follower, Robert Nicolson, a principal at Spectrum Equity Partners, believes that deals will be motivated by a new rationale going forward. “Nobody at this state is going to do acquisitions just for the sake of getting customers. Return on capital will be the metric that will influence decisions.” He expects to see acquisitions of cable systems based on a rationalization of footprints, that is, a series of swaps between big operators so that systems can be more closely aligned along geographical lines. It is easier for cable companies to achieve economies of scale when their service areas are adjacent. The cable industry’s prominent role in the blizzard of negative corporate news during 2002 will have a chilling effect on some potential acquirers. Stock values are down across the board for the industry. Indeed, even the marquee industry deal, Comcast/AT&T Broadband, declined in value by about 35% between the December 2001 announcement and its November 2002 completion. Adelphia Communications Corp.’s well-publicized slide into bankruptcy and Charter Communications Inc.’s restatement of financial results has left potential buyers thinking twice about acquisitions, says University of Wisconsin media studies professor Barry Orton. “Somebody will probably buy some of Adelphia’s systems, but there is a lot of questioning of what would have been basic assumptions about their numbers and those of some of the industry’s other larger players,” he states. Patience needed in broadbanding Orton also questions one of the generally assumed driving forces of cable consolidation – the Promised Land of broadband services. “A lot of the talk about the need for cable mergers and acquisitions is based on the need to finance the new magic of broadband implementation, but it’s not clear when that will be profitable,” he says. He notes that there is not yet a “killer app” on the horizon that will enable cable systems to recoup their broadband investments in the short term. It is Nicolson’s view that among the larger companies, both Adelphia and Charter have highly leveraged balance sheets that could lead to divestitures. With Adelphia, these sales could come while the company is under the court’s supervision or after its emergence from Chapter 11. He says that in the case of Charter, CEO Carl Vogel has says that he hasn’t liked the price of the offers he’s seen for systems in his control, terming prices in the range of 10 to 13 times EDIT-DA as too low. Among the potential acquirers out there, according to Orton, are the Baby Bells. “You might see a Verizon or a SBC Communications getting into the cable industry because they want to offset the possibility of cable systems delivering phone service.” Another veteran cable industry watcher, Cable & Broadcasting magazine senior editor John Higgins, expects to see some small-scale spin-offs by Cox Communications Inc. and AOL/Time Warner Inc. Cox, which he calls one of the more stable companies in the industry, might also be in the market for acquisitions. The industry might enter a cycle of “me-too” deals in which competitors’ deals drive activity among rival systems, he adds. Higgins notes that despite the weak balance sheets of many cable companies that could keep them on the dealmaking sidelines, “there is a lot of private equity money sloshing around” that could result in transactions. One private equity deal on the horizon is an offer by Carlyle Group for Dutch cable TV operator NV Casema. Liberty Media Corp. pulled out of a $760 million deal to acquire the Dutch company in November. Growing role for private equity For his part, Nicolson sees opportunities in cable. His firm’s Patriot Media platform was set up to buy cable systems and to assist them in upgrading their technical specifications to handle broadband. The private equity group’s first purchase was the $245 million buyout of RCN Corp.’s South Jersey cable system last summer. “We can come into an undercapitalized cable system, which would be hard pressed to meet Wall Street’s expectations, and finance a system-wide upgrade to carry broadband and take it back into the public markets with a much more viable position,” he notes. Experts are divided about the potential impact on deal activity of the recent collapse of EchoStar Communications Corp.’s proposed acquisition of Hughes Electronics Corp., which was blocked by federal regulators. The proposed $19 billion deal would have combined the nation’s two largest satellite TV operators – Hughes’ DirecTV and EchoStar’s Dish Network. With EchoStar’s bid turned down, it is expected that News Corp. will revive its acquisition proposal for Hughes, and Higgins notes that many cable system operators would rather have competed with an EchoStar/Hughes combination than a News Corp./Hughes combination. “People are concerned about Murdoch’s News Corp. because it also controls programming assets, such as the Fox channel.” In addition, Higgins says that Murdoch has a reputation of being a formidable competitor when he enters a new market. However, Nicholson says that cable only has indirect competition from satellite broadcasters. He mentions a recent Bank of America research report that concluded that satellite and cable can both grow while competing against each other. One advantage of cable is that it can offer broadband services while satellite broadcasters can’t. Orton’s take straddles the fence on whether EchoStar’s loss will affect cable TV industry deal activity. He says that cable owners’ immediate reaction to the death of the EchoStar/Hughes deal was a sigh of relief that they wouldn’t have to contend with “one huge direct broadcasting satellite company that might eat their lunch.” In the longer term, he says they could face a similar or worse situation if News Corp. were to succeed in bidding for Hughes. According to Orton, one of the key strategic assets that cable has in its face-off against satellite broadcasters is the set-top cable box. “There is federal control over the spectrum that satellites use, and if customers are displeased with what they’re being charged, they can complain to the federal authorities.” Price freedom for operators But one reason why cable companies will continue to be attractive targets for some buyers is that the FCC has ruled that the set-top cable box is not a telecommunications device but, rather, an information service. The distinction is important, Orton argues, because that makes cable service a regulation-free zone where operators can set prices and there is no federal body to appeal to. It is this regulatory void and the promise of broadband’s future as a profit center that will continue to have strategic and financial buyers looking for cable properties to buy and sell.