SOME CABLE ACCOUNTING PRACTICES SIMILAR TO WORLDCOM, EXPERTS SAY
Long-standing practice by cable MSOs of capitalizing expenses and relying on pro forma results, cash flow and earnings before interest, taxes, depreciation and amortization (EBITDA) to show Wall St. what they're worth has some analysts, investors and experts calling for big changes in way cable does its accounting. Specifically, real earnings matter, experts said, and industry needs to provide more transparency, or cable stocks will continue to be hammered. Capitalizing expenses was one of several questionable practices leading to WorldCom’s downfall, they said. Precursor Group analyst Scott Cleland called cable MSOs “the EBITDA poster children,” saying cable executives constantly focused on EBITDA at expense of debt. “The question people should ask cable is what gray area expenses do they capitalize, because cable investors have been trained to look at EBITDA and not for profit,” Cleland said. He said he believed cable was “on the wrong side of change” and that pristine accounting erred on side of expensing and not capitalizing.
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“Investors are going to want to know where cable draws the line on what’s acceptable and what’s unacceptable,” Cleland said. Certain types of installation expenses, equipment and marketing costs need to be expensed and some cable companies don’t do that adequately, he said. Cleland pointed to SEC Chmn. Harvey Pitt’s recent admonition that top CEOs should personally vouch for their numbers, saying cable investors should hold MSOs to that standard.
But Merrill Lynch analyst Jessica Cohen said accounting worries about cable TV “seem overdone.” She acknowledged EBITDA-based valuations and high capital expenditure nature of cable business had reignited concerns, but said she and her colleagues “believe the accounting concerns seem overblown. While there are slight variances in accounting policies among companies in the cable industry, we believe the differences are slight. It is our understanding that cable operators all follow [generally accepted accounting principles] GAAP practices,” with notable exception of Adelphia. Adelphia filed for bankruptcy this week as news that company had guaranteed $3.1 billion in loans to company’s founding Rigas family sent it spiraling downward (CD June 27 p6). Cohen said cable was subscription-based business leading to “very consistent and highly predictable” revenue and EBITDA. In light of Worldcom’s disclosure that $3.8 billion in expenses was improperly accounted for, Cohen said she and her colleagues had revisited cable operators’ capitalization policies and had conversations with all management teams of companies they tracked. She said AOL Time Warner’s practices were “very much in line” with rest of cable industry, that Cablevision’s fundamentals “remain solid” and that Cox and Comcast had “by far the best balance sheets” in industry. Charter’s fundamentals also are strong, she said, although she believed company could lose basic subscribers in 2nd quarter and have to reduce its publicly stated expectations for subscriber growth for full year.
William Redpath, vp of BIA Financial Network in Chantilly, Va., said he believed set-top boxes should be capitalized because they offered long-terms benefits. But he stressed that cable must disclose any sort of loans or loan guarantees, as well as related party transactions, that had material effects. Because of what happened at Adelphia, Redpath said he wouldn’t be surprised if more boards of directors and audit committees became more involved in putting together financial statements and overseeing how those statements were disclosed. He also said he believes auditing firms were going to be much tougher on cable in mandating disclosures. “There are going to be certain incentives for more disclosure,” Redpath said. Good news is that changes already are being made, analysts said, pointing to recent moves by Insight Communications, Cablevision and Mediacom to be proactive about clarifying to Wall St. how their accounting was done.
Jerry Kent, former CEO of Charter, former certified public accountant (CPA) and now CEO of investment firm Cequel III in St. Louis, agreed some set-top box expenses and labor should be capitalized but said auditors and their techniques needed to be more stringent to assure investors that they could have confidence in numbers published. “I think the market is certainly questioning to what extent cable operators are fully following GAAP, particularly given the Adelphia situation,” Kent said. Although some labor is capitalized similarly to Worldcom, he said, he believes that generally across cable industry it’s done strictly in accordance with GAAP. “Right now, the auditors are so spooked that they are going to be very conservative and I'm sure they're going to scrutinize all the numbers before they're issued.” But Cleland worried about cable companies’ reliance on pro forma results, saying they were company’s best face forward, could easily be manipulated and weren’t standard accepted representation of company’s financial health. Asked whether companies such as Charter and AOL Time Warner should try to buy some of Adelphia’s assets in bankruptcy, Cleland said unequivocally: “No. This is a time to avoid risk. This is a time for caution and not pushing the envelope.”