Despite Skeptics, Stocks Appear Winners

This “multimedia” thing is supposed to be a full-fledged investment craze: In theory, everyone wants a stake in the linkage of Americans’ TVs, personal computers and telephones. Hundreds of billions of dollars in future information/entertainment revenue are up for grabs.

Yet the excitement level on Wall Street is rather subdued. Tuesday, for example, there was little follow-through in cable TV stocks, one day after phone giant US West said it will buy a 25% stake in Time Warner’s cable unit.

Time Warner, up $1.50 on Monday, added just 37.5 cents to $35.375 on Tuesday. Cable king Tele-Communications Inc.’s “A” shares gained 75 cents Tuesday to $19.50 after rising 50 cents Monday, but the stock remains well below its peak of $25.50 earlier this year.

What US West did, in essence, is validate cable technology as the platform for the coming multimedia explosion, argues David Shell, senior research analyst at $5.5-billion Eagle Asset Management in St. Petersburg, Fla.

“It comes down to buy it or build it,” Shell says, and US West decided it is far more efficient to buy into, and upgrade, the existing cable TV network for the coming interactive-media revolution.

The last time the “don’t build it, buy it” issue dominated trading in cable stocks was in 1989, when merger mania was at its peak and investors began to view the sky as the limit for cable franchise values. The 1990 recession soon corrected that euphoria, and cable stocks have had a relatively tough time attracting investors ever since.

It’s unlikely that the US West deal will inflate cable stock values overnight. There are a host of regulatory barriers to phone companies simply stepping up and swallowing cable franchises whole. And many of the phone giants may not be convinced that US West’s partnership is the way to go anyway.

What’s more, the federal government’s recent decision to force cable companies to roll back certain user rates has cast a pall over the stocks, reminding investors that this is still a regulated industry and probably always will be.

Nonetheless, Shell and other pros hunting for a payoff in multimedia believe that leading cable stocks remain among the most intriguing long-term investment plays.

Think of it this way, Shell says: What cable companies increasingly will be positioned to do is siphon business away from local phone companies, local video stores and other, more limited providers of information services. The wider the cable “highway” becomes through better technology such as fiber optics, the greater the cable companies’ ability to usurp competitors’ markets.

What US West knows, and what other phone companies fear, Shell says, is that “it takes no space whatsoever to carry a voice back and forth” over existing cable.

Meanwhile, consider the potential for pay-per-view TV, which is a relatively small--and unregulated--business for cable firms today. The incentive for Hollywood to supply more pay-per-view to cable is gigantic: By most accounts, the studios take back about 25% of the dollars that video stores collect for movie rentals. On pay-per-view, the studios are more likely to share 50-50 with cable companies in the long run, analysts say. Good for the studios, good for cable.

What’s also important to understand is that many cable companies own not only the highway that will carry new information and entertainment into the home, but also the programming that will run on that highway as it is expanded.

“No matter what the technology is, what’s really important is what’s traveling over the technology,” says Mark Berniker, analyst at media consulting firm Jupiter Communications in New York.

Time Warner, of course, is a cable company, and also a software producer through its studios. Viacom has 1 million cable subscribers and also owns MTV, The Movie Channel and Nickelodeon.

And the biggest name of all, Tele-Communications, has stakes in Discovery Channel, Turner Broadcasting and Liberty Media (which in turn has stakes in many other popular channels).

As with any investment, the key question for cable-stock investors is whether they’re paying a fair price. In 1989, prices were clearly over inflated. What about now?

These aren’t income stocks. They’re valued based on cash flow, because the firms’ continued high investment in new technology leads to heavy depreciation costs that depress reported earnings.

Shell figures that US West is paying about 12 times cash flow for its stake in Time Warner. By contrast, Tele-Communications “A” shares, at $19.50 today, are valued at just nine times this year’s expected cash flow. Either US West overpaid, or Tele-Communications is relatively cheap.

Ralph Wanger, whose Chicago-based Acorn Fund is a major investor in cable franchises, says he has no illusions about expanded multimedia uses for cable developing overnight. In fact, he says, “I suspect all of these new things will be very minor contributors to either revenue or the (industry’s) eyeball count over the next five years.”

But if you’re looking for growth industries to the year 2000 and beyond, he says, don’t ignore the obvious--including the TV sitting in your living room.