Fitch: U.S. Cable Industry Positioned to Manage Slowdown of Subscriber Growth in 2008

CHICAGO — Fitch Ratings believes that a combination of increased competition from local exchange companies, high penetration levels of cable modem and digital television services and a difficult housing market will lead to slowing overall revenue and, to a lesser extent, cash flow growth for U.S. cable multiple system operators (MSOs) in 2008. This will be partially offset by strong growth in telephony services and advertising. Continued strong generation of cash flow and free cash flow along with manageable leverage should lead to a stable rating outlook for cable MSOs in 2008.

Fitch believes that the cable MSOs will add over 11.5 million new revenue generating units (RGUs) in 2007, which represents a growth of approximately 12% compared to the prior year. However, Fitch forecasts that new RGU additions in 2008 will fall below 11 million. Fitch anticipates that the growth in telephony subscribers, which should grow from approximately 40% of total new RGUs in 2007 to 45% in 2008, will not offset slowing growth from cable modem and digital television services or basic subscriber losses. Fitch also believes that the cable industry will lose nearly 1.5% of its basic subscribers to increased local exchange carrier and satellite competition. The impact of competition on basic subscribers will be more pronounced in 2008, in part due to continued weak new home growth and more effective product offerings from competitors.

While digital television subscribers are expected to grow in 2008 due to higher penetration rates of high definition (HD) television and digital video recorders (DVRs), the pace will slow compared to 2007. Fitch expects digital television to reach a penetration rate of approximately 60% by year-end 2007 representing an annual increase of approximately 600 basis points compared to 2006.

Additionally, Fitch anticipates that digital television penetration will increase to approximately 64% in 2008. Fitch believes that cable modem service growth will continue in the near-term, but capturing incremental penetration amounts will be increasingly difficult and will require refining product positioning and pricing going forward into the future. Cable MSOs have begun to tailor new low price, low speed cable modem tiers to target specific market segments. Fitch notes that this strategy has the potential to negatively impact cable modem average revenue per user (ARPU) and margin. Fitch believes that the total of new cable modem subscribers will fall modestly in 2008 compared to 2007.

As a result of slowing new RGU additions, Fitch expects that revenue growth for the cable MSO industry will slow to a high single digit rate in 2008. Beyond slowing new RGU levels impacting revenue growth, Fitch believes that annual price increases will be more tempered than in the past due to competition. Although Fitch does not expect cable operators to compete with price in 2008 and as a result expects that ARPU should still grow in the low double digit range, Fitch does believe that cable operators will spend more heavily on advertising and marketing to differentiate their services and could increase promotional offerings, which will put negative pressure on EBITDA growth. One offset to competitive pressure on EBITDA is the expectation that high margin advertising revenue should grow in the low-to-mid teen range reflecting the impact of the 2008 election year. With that in mind, Fitch believes that cable MSO operators will generate high single digit EBITDA growth in 2008.

Capital spending in 2007 was approximately 20% higher than 2006, but Fitch believes it will be flat in 2008 compared with 2007. Since capital spending is largely success-based, slowing RGU growth should lead to lower customer premise equipment (CPE) spending. However, continued plant investment to support new revenue opportunities — such as commercial services — will likely offset any CPE capital spending savings. Subsequently, Fitch believes that free cash flow generation in 2008 will be flat with 2007.

Fitch also expects that cable MSOs will continue to return nearly all of their free cash flow to equity shareholders in 2008, primarily through share repurchases. Fitch believes that acquisition risk in 2008 will be low with activity most likely focused on trades to improve subscriber clustering.

Generally, Fitch believes that credit ratings for cable MSOs should be stable in 2008, although there could be some modest weakening within some ratings with the changing competitive landscape. Recovery ratings, which apply to speculative grade operators, should remain relatively stable as the value of underlying assets should remain solid as they continue to be supported by strong operational metrics and continued system investment. Fitch notes that speculative grade cable MSOs increased the proportion of secured debt within their capital structures in 2007 by a material amount, but Fitch expects this mix of secured and unsecured debt to be stable in 2008 as bank and bond lending becomes more balanced.

–Cablevision Systems Corp. (‘B+’, Negative Outlook)
–Charter Communications, Inc. (‘CCC’, Stable Outlook)
–Comcast Corp. (‘BBB+’, Stable Outlook)
–Cox Communications, Inc. (‘BBB-‘, Positive Outlook)
–DIRECTV Holdings, LLC (‘BB’, Stable Outlook)
–Echostar Communications Corp. (‘BB-‘, Stable Outlook)
–Insight Communications Company, Inc. (‘B+’, Rating Watch Negative)
–Intelsat, Ltd. (‘B’, Rating Watch Negative)
–Mediacom Communications Corp. (‘B’, Stable Outlook)
–Rogers Communications, Inc. (‘BBB-‘, Positive Outlook)
–Time Warner Cable (‘BBB’, Stable Outlook)

Fitch’s Recovery Ratings (RR) are a relative indicator of creditor recovery prospects on a given obligation within an issuers’ capital structure in the event of a default.

Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct’ section of this site.