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Cable turns the tables on broadcast TV

Consider this factoid: ESPN, the once-struggling sports cable network, is now worth almost as much as the venerable ABC TV network, according to Wall Street crunchers.

Sound surprising? Perhaps so, but it’s indicative of the fact that cable is no longer a dirty word on Wall Street. Investors have discovered that wired networks have now become cash powerhouses to rival the broadcast biggies.

That changed perspective was dramatized by Walt Disney’s $19 billion deal to buy Capital Cities/ABC Inc. – which owns both ESPN and the ABC network – and Time Warner’s proposed $8 billion buyout of Turner Broadcasting System Inc. The two mega deals are motivated largely by the extraordinary appreciation of cable networks over the past decade.

By consolidating ownership of cable networks into the hands of a few big entertainment groups, these two deals could prompt other takeovers of smaller cable networks, Wall Streeters say. Likely takeover targets include Gaylord Entertainment, which owns two country-music cable networks, and International Family Entertainment, which owns the Family Channel.

The new attitude toward cable even extends to cable systems, which act as pipelines carrying the networks to subscribers. Earlier this year, hopes for deregulation of this sector sent stocks of cable system operators soaring.

But while the optimism about cable systems depends on the passage of the telecom bill through Congress, cable networks are in favor simply because investors have awoken to their rising profitability and value.

As a group, the basic cable networks – which include such well-known brand names as MTV, Nickelodeon, Lifetime and CNN – present a “more compelling” business case than broadcast networks, says a new report by analyst Paul Kagan Associates.

Cable is king

Kagan estimated that based on forecast 1996 cash flows, the cable sector is worth $27 billion, more than double the combined values of the four major broadcast webs.

Kagan analyst Larry Gerbrandt, who wrote the report, estimated that in Disney’s acquisition of CapCities, the ABC network was valued at $4 billion compared to $3.6 billion for CapCities’ 80% share of the ESPN network. (ABC’s valuation doesn’t include ABC’s owned stations.)

Optimism about cable networks is focused on their growth potential compared with that of broadcast webs. While the broadcast webs have 100% audience penetration and profit cycles tied to the economy, the cable universe is still growing.

Kagan estimated in its report that revenues for basic cable networks had grown from $701 million to $6 billion between 1985 and 1995 and were expected to grow 11% next year; meanwhile, cash flow had risen from $72 million to $1.7 billion over the same time period and is expected to rise to $2.1 billion in 1996.

That cash flow growth could accelerate over the next five years if cable networks succeed in lifting their coverage of the national audience from the present levels of just under 70% to closer to 90% through growth of direct broadcast satellite distributors and new program services run by telephone companies.

Larry Haverty – a senior vice president with Boston money manager State Street Research who is a recent convert to the case for cable networks – says that as audience coverage grows, the difference between cable advertising rates and broadcast advertising rates “will continue to narrow.” He said this would make cable network franchises ultimately as valuable as broadcast networks.

While some investors had cottoned onto cable networks’ potential some time ago, most only woke up after the launch of direct broadcast satellite services over the past year. Disney’s move to acquire CapCities/ABC confirmed the trend. At the time of that deal, most attention focused on the acquisition of the ABC network, but analysts note that Disney chairman Michael Eisner highlighted the value of acquiring CapCities’ ESPN cable network as much as its ABC network.

Interest piqued

Time Warner’s proposed acquisition of TBS has stirred investors’ interest even more. That deal is driven solely by the value of the cable networks built by Turner, including CNN, TNT, TBS, Cartoon Network and TCM, which are expected to grow rapidly in coming years.

Tim Pettee, an analyst with big money manager Alliance Capital, who was an early supporter of cable networks, says many people on Wall Street had been distracted by the personality of Ted Turner rather than the “juggernaut” of CNN.

But the two deals have also highlighted the growing concentration of ownership. If both are consummated, most cable networks will be owned by just four companies: Viacom Inc. (which owns MTV), Tele- Communications Inc. (which through its Liberty Media affiliate owns big pieces of networks like Discovery Channel), Disney and Time Warner (which aside from TBS owns pieces of networks like Court TV). That emphasizes the strategic value of remaining independent cable network companies like Gaylord Entertainment, which owns the Nashville Network and Country Music Television; International Family Entertainment, which owns the Family Channel; and BET Holdings, which owns Black Entertainment Television.

IFE’s stock price has jumped 16% over the past 10 days and 38% since the start of the year. Gaylord has been trading on takeover speculation for several months and its stock is up almost 17% on the year. The stock of BET Holdings, owner of Black Entertainment Television, is up 6.25% in the past week.

So, are they for sale?

Whether Gaylord, IFE or BET is available for sale is another question. Gaylord, which is controlled by the family of chairman Ed Gaylord, has long been rumored to be a target and has been looked over by everyone from Disney to Turner, Wall Streeters say.

Liberty Media owns 18% each in both IFE and BET, although IFE is controlled by religious evangelist Pat Robertson and BET is controlled by its CEO, Bob Johnson. But TBS is controlled by one individual (Ted Turner, with a big position held by Liberty) and yet it is likely to be taken over by Time Warner.

Turner’s motivation for selling out is different from the likely scenarios for smaller companies like Gaylord, IFE or BET since the consolidation in the rest of the entertainment industry may make prospects of life as an independent tougher.

Launching is hard

The biggest problem smaller companies face is the cost of launching new networks. Lehman Bros, analyst Larry Petrella says companies that own an array of networks more easily cross-promote new networks on their existing channels, as well as persuade cable systems to carry new networks, because of the value of their existing networks to cable customers.

In addition, Petrella says, “There are operating efficiencies of being combined with other cable networks. You can group together when leasing transponders (on a satellite), and you can have a bigger sales force.”

Gaylord already has taken steps to cut costs in its sales through putting its sales and marketing in the hands of Westinghouse Electric Corp.’s Group W broadcasting division, which also owns one-third of CMT. Gaylord spokesman Alan Hall also downplays problems of launching future networks, arguing that Gaylord’s expertise in its niche of country music “opens the door to the cable operator.”

Ironically, Gaylord’s status as a perennial takeover target reduces its attraction to some, bankers say. “It’s always traded at a fancy price,” said one.

BET is more attractive, says Lazard analyst Sal Muoio. He says Black Entertainment doesn’t have high programming costs, using a lot of music, for example. IFE’s Family Channel, in contrast, uses lot of original programming.

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