Hey Dad, may I have some spending money?
Cable's record of spending wisely means Dad – er, Wall Street –
is a little more lenient when it comes to capex.
Every year from 1999 to 2002, cable kept asking for, and getting, what amounted to one huge advance on its allowance after another. 2002 was when the adults in this equation – financial institutions – figuratively put their wallets back in their pockets.
Total industry capital expenditures were $5.6 billion in 1998. Cable nearly doubled that the following year, and then escalated its spending even more. Much of the money was borrowed.
After cable spent $16 billion in 2001, investors decided enough was enough. In 2002, in response to intense pressure applied by Wall Street, MSO after MSO promised to rein in capital expenditures.
The conventional wisdom has been that cable has been operating under severe spending restraints ever since. And maybe that’s the case, if the free-wheeling spending of 1999-2002 is the measure.
During that entire period, the cable industry as a whole was spending about one-third of revenue on capex, give or take a few percentage points.
It’s not like MSOs were staging hunting parties in Europe for their executives – they were spending on critical infrastructure. But spending one-third of revenue on capex is an unsustainable rate for any industry.
So it’s notable that in 2007, the cable industry as a whole spent $14.6 billion on capital expenditures, as much as it did in the presumably profligate years of 2000 ($14.6 billion) and 2002 ($14.5 billion). And if projections for this year hold, the cable industry is likely to spend nearly as much on capex in 2008 as it did in 2001 – nearly $16 billion.
And there’s been barely a complaint, for several reasons.
First and foremost, the industry as a whole is bringing in significantly more revenue. As a consequence, total capex spending is a lower percentage of total revenue. True, through the last three years, cable capex spending has been inching up, from 17 percent to 18 percent to 19 percent. But in comparison, the last time cable spent $14 billion, in 2002, capex as a percentage of revenue was 29 percent.
“The MSOs have done an effective job of reframing the capex discussion away from how much they are spending relative to previous years and toward how much they are spending as a percentage of revenue going forward,” said SNL Kagan Senior Analyst Ian Olgeirson. “That way, they can increase spending (or more likely just not produce a decrease in spending), as long as it’s in proportion to revenue increases.”
Meanwhile, cable has proven its competitive mettle. With DirecTV and Dish Network throwing everything they have into direct assaults on cable’s bread-and-butter video business, and now Verizon and AT&T taking aim at video, too, cable is thriving.
Capex as percentage of revenue.
Not only is the cable industry doing better at holding on to video and data subscribers than anyone had anticipated a few years ago, but MSOs have also gone on offense, expanding successfully into telephony and business services (drawing some blood from the phone companies in both instances), and preparing to get into wireless, while executing on a cross-platform advertising strategy.
Six years later, after putting the brakes on the cable industry, Wall Street seems to believe that cable is now spending its money wisely and responsibly.
The question about capex spending still comes up, of course. For example, Goldman Sachs recently hosted one of its occasional Communicopia Webcasts with Comcast CFO Michael Angelakis.
When the interviewer asked Angelakis about spending, he responded, “We have to be reasonable about returns on capex,” and added, “we have more focus on analytics on profitable growth.”
The exchange was perfunctory, sort of like asking Democratic candidates if they’re going to raise taxes on the middle class. It doesn’t matter how many times the question’s been asked and answered before, you have to ask again anyway. Question posed and answered – now let’s move on.
So yes, analysts still make an issue of spending, but capex spending now tends to be one concern among many, rather than the one thing that sets off alarm bells.
Attitudes about capex tend to be expressed in terms of stock valuations. Starting in 2006 (even before the recent economic crisis during which nearly every single company in the world has taken a hit to its stock price), MSO stock values were slipping, a phenomenon typically ascribed to fears of competition, worries about disintermediation, concern about the economy and an aversion to excessive spending.
(Cable, of course, believes a lack of understanding of cash flow businesses is another factor, no small part of the reason that Cox went private, Suddenlink is staying private and Cablevision is trying to go private.)
As mentioned, the cable industry’s aggregate spending has been going up, and many expect it to increase again in 2009. There’s a lot to buy: set-tops (with requirements for HD, DVR, CableCards), DOCSIS 3.0 equipment upgrades, switched digital equipment, HD equipment, etc.
Given everything that’s happening, including the market meltdown, Angelakis told the Goldman Sachs audience that Comcast has no intention of altering its plan to spend with return on investment in mind. Cable is not only not backing off, but it can’t. Cable still has to compete, he observed.
Wall Street has some tolerance for the argument; after all, it’s tolerating immense expenditures from AT&T and Verizon to install advanced networks capable of supporting video services.
And despite all, the phone companies are not backing off. At the end of November, Verizon CEO Ivan Seidenberg issued a statement with the company’s financial report in which he said: “The strategic investments we made over the past few years continue to drive growth in wireless, enterprise, broadband and video. Although the capital markets and economy may present challenges, we will continue to execute on our business plan and invest for future growth.”
Verizon said it is on track to deliver lower overall capital spending in 2008, compared with 2007; through nine months, it has spent $200 million less than it had at the same point last year.
On the other hand, Verizon is on pace to spend $16 billion in capex in 2008 – more all by itself than the entire cable industry together. Verizon reported capital expenditures of $4.1 billion in its third quarter, or about 16 percent of revenue.
That’s just a few percentage points lower than the aggregate rates for the cable industry the last few years.
In other words, everybody in telecom is playing by approximately the same rules when it comes to capex. Verizon and AT&T are just playing in a much, much bigger sandbox, so to speak.
By way of comparison, other branches of the electronics industry are already getting crushed. The semiconductor industry, for example, is contending with a diminishing number of customers, some overcapacity and the economy. Gartner expects semiconductor industry capital spending to decline 25.7 percent in 2008, and another 12.8 percent in 2009, before recovering to grow 16.7 percent in 2010.
Telecom stock prices are down. That said, there hasn’t been that much of a change in fundamentals. Subscription to services is generally up, revenue is fairly steady, ARPU is trending up and cash flow is good.
Plus, service companies tend to hold their own in a down economy – in general, customers getting squeezed by prices elsewhere tend to entertain themselves more at home.
Cable is also benefiting by accomplishing a major expansion that won’t appear anywhere near the capex budget line.
Cable needs a wireless play. Cox actually purchased spectrum, for $550 million, and at the end of October said it plans to build its own 3G network in its markets by the end of 2009, and then upgrade to 4G. Being private, Cox is clear with that spending.
Three of the remaining five biggest MSOs are making their wireless play through the Sprint Nextel/Clearwire joint venture. Clearwire plans to create a national WiMAX network, by nature already a 4G technology.