Yale SCHOOL of MANAGEMENT

Cablevision Initiation Report:

Nowhere to Go but Down
April 21, 2006

Investment Thesis:

Recommendation: Sell
Current Price: $18.14
Target Price: $16.50
Return to Target: -9%

Cablevision has an early competitively advantage compared to

telecom, cable, and satellite peers in the quest to grow
subscribers and increase average revenue per user due to its
early rollout of its VoIP. However, Verizons FIOS looms as a
credible medium term threat to compete for Cablevisions
market share and lower Cablevisions margins.

o Cablevision captured the first mover advantage by

aggressively building out its VoIP capability and
completing the triple play bundle (voice, data, and
video) earlier than peers.

o Demand for HDTV, VOD, and DVRs is accelerating,

driving average revenue per user higher in the near term.

William Pisano
MBA Candidate 2007
[email protected]

o Cablevisions infrastructure is built. As one of the first

cable operators to build out its voice infrastructure,
Cablevision now expects lower capital expenditures and
fewer operational hurdles than peers.

Geoffry Dailey, CFA

MBA Candidate 2007
[email protected]

Cablevisions long term prospects depend on Verizons ability

to penetrate Cablevisions triple play market by pricing below
Cablevision and offering a comparable bundled product.

*Please see the disclaimer at the end of this report before reading. Thank you.

Table of Contents

Basic Business Overview

Recent Cablevision History

Competitive Analysis

12

Key Demand Drivers

14

Concerns

15

Valuation

16

Income Statement Assumptions

16

Balance Sheet Assumptions

18

Adjusted Present Value

19

Sources

20

Business Summary:
Cablevision Systems Corporation operates as the United States sixth largest MSO, serving just
over 3 million basic cable subscribers in the Northeast corridor of the United States. Cablevision
operates in three segments: Telecommunications Services; Rainbow; and Madison Square
Garden. The Telecommunications Services segment operates cable television business, including
basic video, interactive digital video, high-speed data, voice over Internet protocol (VoIP), and
residential telephone services operations, as well as the operations of the commercial telephone
and high-speed data services. Its worth noting that the Cablevision network is home to the
nations second largest individual cable system, based in Hicksville, NY, serving 458,163 basic
cable subscribers.
The Rainbow segment of Cablevision consists principally of interests in national and regional
programming networks, the Madison Square Garden sports and entertainment businesses, as well
as cable television advertising sales companies. Rainbow reaches more than 200 million
customers worldwide through its many popular national, regional and local programming
networks, including AMC, IFC (The Independent Film Channel), WE: Women's Entertainment,
Fuse, MSG Network, News 12 Networks and the MetroChannels. Rainbow used to operate the
recently shut down VOOM HD Originals, a suite of 21 high-definition channels, for distribution
to cable operators and satellite TV providers. The Madison Square Garden segment owns and
operates professional sports teams, principally the New York Knicks of the National Basketball
Association, the New York Rangers of the National Hockey League, the Hartford Wolf Pack of
the American Hockey League, and the New York Liberty of the Womens National Basketball
Association, as well as the MSG Networks sports programming business, and an entertainment
business. It also operates sports and entertainment venues, such as the Madison Square Garden
Arena, Radio City Music Hall, the Hartford Civic Center, and Rentschler Field home of the
University of Connecticut football team.
As mentioned previously, Cablevision has approximately 3 million basic subscribers, 1.7 million
high speed data subscribers, and 700 thousand VoIP customers. The Cable segment of the
business develops, manages, and operates broadband communications networks, including video,
Internet, and phone services, and regional sports and news networks. Its video services include
basic and digital cable, video on demand, high-definition television, digital video recorder,
premium channel programming, and pay-per-view programming.
For the full year 2005, Cablevision generated 70% or $3.6 billion of its revenues from
Telecommunications, 16% or $830 million from Rainbow, and 16% or $800 million from
Madison Square Garden.

Recent Cablevision History:

One of our primary concerns with the current business model has little to do with the assets or
cash flows, but instead with Cablevision owners and management team, the Dolans. James
Dolan, President & CEO of Cablevision and Chairman of the Board and father Charles Dolan
have spearheaded some of the more curious management decisions Wall Street has seen in the
past five years, and never cease to amaze the investing public. We have included a brief timeline
of recent events to give you a sense of the some of how the Dolans like to run their business.
January 2005: A father-son showdown in the family that controls Cablevision ended with the
son outmaneuvering the father and persuading directors to vote to sell the companys troubled
VOOM satellite business to Echostar Communications for $200 million in cash. The directors
sided with James L. Dolan, the 49-year-old chief executive and the heir apparent, against his
father, Charles F. Dolan, the 78-year-old founder and controlling shareholder of Cablevision.
The father, who founded HBO, wanted to keep Voom. The son wanted to sell. The meeting
appeared to have been prompted by outside directors who were concerned about the satellite
company. Several independent directors were concerned about the possible legal implications of
supporting VOOM despite its losses and criticism on Wall Street. Problems at the company had
become so noticeable that even longtime family supporters had started to oppose the project.
The service has 26,000 subscribers and has about $76 million. When Cablevision recently
canceled plans to spin off VOOM and its Rainbow Media group, it said it would pursue
strategic alternatives instead.
Under the terms of the deal, EchoStar will pay $200 million in cash for Cablevisions satellite,
called Rainbow 1, as well as federal licenses to construct, introduce and operate satellite services
over 11 frequency channels. In addition, EchoStar will buy the companys ground facility in
Black Hawk, SD, and related assets.1
June 2005: Cablevision confirms an offer to take the company private for about $7.9 billion.
The bid includes $21 a share in cash plus shares of a spun-off company comprising various cable
networks worth an additional $12.50 a share. Cablevision's board will form an independent
committee to evaluate the offer. The Dolan family owns about 20% of the company's common
stock and controls 71% of the company via a special class of stock.
Under the transaction outlined in a letter to the board, Cablevision would spin off a company that
includes cable networks such as AMC and IFC as well as its regional sports networks, Madison
Square Garden, the New York Knicks and Rangers and various other properties. Existing
shareholders would get a proportional interest in the content and sports unit.2
October 2005: The Dolans cemented their reputation for unpredictability by withdrawing a
$7.9bn offer to take private Cablevision, their family-controlled cable operator. Charles Dolan,
the company's founder, and his son James, chief executive, said they had been "unable to reach
1
2

Cablevision family showdown leads to VOOM satellite sale to EchoStar, BroadcastEngineering, January 2005
Dolans Offer $7.9 Billion for Cablevision, TheStreet.com, June 20 2005

agreement" with the directors negotiating on behalf of shareholders. Instead, the Dolans, who
own 20 per cent of shares but control 71 per cent of votes, have suggested that Cablevision's
board pay a $3 billion special dividend in cash to shareholders.3
December 2005: Cablevision announces that it has to cancel a planned $3 billion dividend and a
$1 billion financing deal after finding it had breached a promise to bankers. Cablevision
executives attributed the violation to a "technical" error and said it wasn't related to "any
underlying financial weakness." To show how minor the violation was, the company pointed to a
misstatement of an $18 million loan from a supplier.
"It doesn't make any sense," said one New York hedge fund manager. "You don't cancel a $3
billion dividend over an $18 million accounting error."4 We tend to agree, and yet the story
would continue to get more and more interesting.
February 2006: Cablevision obtains $2.4 billion of secured credit facilities. The cable TV
system operator said the line consists of a $1 billion revolving credit facility and $1.4 billion of
term loans. The company said its CSC Holdings arm has used $1.3 billion of the proceeds from
the new credit facilities to repay the amounts outstanding under its current $2.4 billion revolving
credit facility and accrued interest and fees, and intends to use the remainder of the proceeds for
general corporate purposes.
The existing facility was scheduled to expire in June 2006. The terms of the new credit facilities
allow the company to access up to $3.1 billion of additional funds from an uncommitted
incremental credit facility. Cablevision said in December that it had to cancel a planned $3
billion dividend and a $1 billion financing deal after finding it had breached covenants of an
earlier credit line. They now feel as though the distribution of this dividend is now possible.
April 2006: Cablevision declares a special dividend of $3 billion, or $10 per share. The
company had announced plans for the dividend earlier but put them on hold after finding it
would have created problems for its borrowing agreements, which were apparently later
resolved.
To be clear, a company that has $9 billion of debt and capital expenditures that show no signs of
decreasing in the near future is borrowing money to pay out a dividend. The on-again, off-again
distribution has not received a warm welcome from Wall Street analysts, several of whom would
have preferred to see the company buy back its own shares rather than taking on debt to pay a
dividend. Its worth noting that the combined payout to the company's controlling shareholders,
the Dolan family, would amount to about $650 million.5

Dolans pull $7.9bn Cablevision offer, FT.com, October 25, 2005

Cablevisions Credibility Gap Closes, TheStreet.com, December 20, 2005
5
Cablevision Declares Special Dividend, Associated Press, April 10, 2006
4

Business Segment Overview:

Cable TV & VOD:
With just over 3 million basic subscribers, Cablevision operates the sixth largest cable system in
the United States. Their video offering generates the highest margins, and will soon generate a
great deal of competition from not only the DBS operators, but also the telecom operator Verizon
(see exhibit one for a geographic map of the impending Verizon threat). As of now, 22% of all
Cablevision subscribers overlap with Verizons geographic footprint. This is an important
consideration when forecasting subscriber growth and ARPU figures. Of all the major cable
service providers, Cablevision benefits from extraordinary demographics. Levels of expendable
income are unmatched when it comparing Cablevisions average subscriber to those of Comcast
or any other major MSO.
A quick note on how Cablevision is able to offer the end user cable TV. Cablevision uses digital
technology to compress video signals, allowing more than one program service to be carried in
the bandwidth space normally required for one analog program service. Typically, the signal is
sent through the head-end and to the home and decompressed in the set-top box for display on
the television. Digital cable can provide a host of services, such as video-on-demand, interactive
television and commercial-free CD-quality music. Digital television also allows Cablevision to
offer high-definition television (HDTV), which offers a movie theater-like viewing experience,
complete with Dolby Digital sound and a resolution of either 1,280 or 1,920 active horizontal
pixels by 720 or 1,080 active scanning lines respectively.

Exhibit One: Cablevision vs. Verizon

Source: Company Website

High-Definition Television or HDTV is a digital television format delivering theater-quality

pictures and Dolby Digital 5.1 surround sound. Cablevision began delivering HD service in
earnest to customers in 2002, and deployment has been steady. Currently, Cablevision offers a
channel line-up of exclusive HDTV content that includes channels such as ESPN, HBO,
Showtime, TNT, all the major broadcasting networks, as well as other smaller cable channels. In
early 2005, Cablevision sold off its VOOM satellite business for $200 million to EchoStar. Up
to this point, Cablevision was able to compete with an HDTV package that was effectively
unmatched in the industry, though considered by industry insiders as being cost prohibitive to
even Cablevisions attractive demographics.
Cablevisions video subscriber numbers have remained relatively flat over the past three years,
achieving growth rates of -0.7%, 0.7%, and 2.2% respectively. Churn rates have seriously
impacted subscriber growth, as DBS operators have driven pricing down in overlapping markets.
Our forecasts reflect the DBS pricing pressure, as well as the Verizon FiOS threat going forward.
While there are very few major markets that actually have two competing cable operators
competing against each other, the versatility and cost effectiveness of the satellite operators have
created a very tough environment to increase subscriber count. As we see in exhibit two, basic
subscriber penetration is higher than all other competitors, which can be both a positive and a
negative for Cablevision. Going forward it will mean that Cablevision will need to generate
higher ARPU numbers to counteract a potential increase in customer churn due to a saturation of
potential subscriber base.
Exhibit Two: Basic Subscriber Penetration
70.0%

66.9%

66.9%

60.8%

60.0%

58.5%

66.8%

59.9%
57.1%

53.9%

52.0%

59.6%
56.1%

52.8%

52.1%
49.6%

50.0%

48.6%

40.0%

30.0%
2003A
Time Warner

2004A
Comcast

Cablevision

2005A
Cox

Charter

Source: Lazard Frere & Company Reports

Taking a closer look at Cablevisions ARPU numbers, we again revisit our thesis, CVC has
nowhere to go but down. They are head and shoulders above competition, much of which has to
do with their accelerated VoIP roll-out strategy, which we will discuss later.

Exhibit Three: Average Revenue Per Subscriber

$96

$100
$90
$80
$70

$84
$69 $68

$76 $75

$73 $72

$85

$80

$88
$82
$74

$67

$62

$60
$50
$40
$30
$20
$10
$0
2003A
Time Warner

2004A
Comcast

Cablevision

2005A
Cox

Charter

Source: Lazard Frere & Company Reports

So what of the impending telecom invasion? Cablevision will be the first to be tested, as
Verizons FioS cable service has recently begun service in areas already serviced by Cablevision.
Although a very small sample size, it has been closely watched by industry insiders across the
board. Fourth quarter numbers provided by Cablevision indicate that there has been no effect on
net additions for the quarter, and in fact their subscriber numbers have increased on a net basis
compared to previous quarters. While hardly a telling sample, this does indicate that cable
operators can withstand the telecom invasion. Looking at the overall competitive environment,
we have to realize that the telecom threat comes with a number of disclaimers. Unlike the DBS
operators, they cannot compete with exclusive content, i.e. the NFL package. They are already
entering into a highly competitive pricing environment, and their market share has to be carved
out with overly aggressive pricing structures which may not support the capital expenditures
needed to build out the fiber to the home network. These build-out costs have been highlighted
in recent press as being not nearly as cost effective as the telecom carriers would have helped.

High Speed Data:

The data aspect of the business will be not only sensitive to pricing pressure from an enhanced
FiOS data offering, but also to subscriber saturation. Just as with the video subscribers,
Cablevision holds a considerable advantage to its peers when comparing high speed data
penetration rates. See exhibit four for a breakdown of the leading MSOs and their current high
speed internet penetration rates.

Exhibit Four: High Speed Internet Subscriber Penetration

60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
2003A
Time Warner

2004A
Comcast

Cablevision

2005A
Cox

Charter

Source: Lazard Frere & Company Reports

As of the end of 4Q05, Cablevision had a total of 1.7 million high speed internet customers,
representing a 25.3% annual growth rate over the 2004 year end figure. Going forward we are
projecting a CAGR of 14%, which is line with company guidance, again a figure we found to be
accurate historically. These growth estimates are also in line with Wall Street estimates, which
we often found to be close to managements guidance as well.
As mentioned in our industry report All Bundled Up and Ready to go Wall Street analysts and
industry insiders believe that there will be two data pricing models that will potentially emerge.
First of which is the utility model where consumers pay for bandwidth consumed. The second
would be the pay twice model where Internet users would have to pay for enhancing
performance of their website/services. Both of these models will enable operators such as

Cablevision to increase their data profitability.6 The real question remains, can Cablevision
maintain data ARPUs that already show signs of slipping. Furthermore, can they maintain a
seemingly unsustainable growth rate for their high speed internet subscriber base?
Our main concerns with the Cablevision data business are aggressive DSL pricing, the advent of
the new telecom technology which could be significantly faster than Cablevisions offering, and
what the need for increased Mbps (megabits per second) will cost Cablevision in terms of
additional capital expenditures. Aggressive DSL pricing is a going concern, but alleviated by the
fact that DSL customer satisfaction is much lower than that of a cable modem customer. The
service is slower, less reliable, and by all accounts less convenient than the bundled offering
Cablevision puts out. That being said, with DSL prices creeping around and below $19.99, there
the threat of increased customer churn becomes increasingly real. If in fact the Verizon FiOS
data offering is as fast as speculated, Cablevision could face the very expensive need of
upgrading existing networks. In the end, it really amounts to customer preference. If the
consumer wants blinding speed, Verizon may very well eventually hold the advantage. If the
consumer wants the convenience of the bundled package as well a reduced pricing structure
(which Cablevision will eventually be able to offer in comparison to more expensive FiOS
pricing), than Cablevision should win the day.

Voice over Internet Protocol (VoIP):

In the past two years, Cablevision has begun to compete successfully with the Regional Bell
Operating Companies (RBOCs) with the third aspect of their triple play bundle. They are
launching Voice over Internet Protocol (VoIP) service throughout their geographic footprint, and
doing so with unprecedented success in the cable industry.
As a quick primer on how the technology works: through the use of software, VoIP provides all
of the functionality of the public switched telephone network (PSTN), while making possible
new features not available through traditional circuit-switched telephony. Calls are placed over
an IP-based data network and voice is transmitted with data "packets." The IP data packets used
by services from some of the Internet telephony providers travels over the public Internet.
Facilities-based cable offerings, in contrast, transport IP data packets over their private managed
IP networks with end-to-end quality of service monitoring (while still interconnecting with the
PSTN as necessary).
The roll-out of the VoIP product line is one of the few instances where the Dolans treatment of
CVC as a private company actually helped them in the long run. In 2002, prior to this roll-out,
the cable industry was being heavily criticized for their excessive capital expenditures. The
expensive network costs and constant needs to upgrade had many skeptical about the idea of
VoIP. Many analysts and industry insiders felt it was just another money pit for the cabel
operators to dump potential free cash flow into. The Dolans, who cared very little about what

the public markets felt about them (as evidenced with our prior timeline), went ahead and
6

Wachovia Securities, Cable Industry Overview

10

aggressively pursued the roll-out while others like Comcast took a much less aggressive
approach. The aggressive move paid off. Today close to 25% of all basic subscribers receive
VoIP service, a penetration rate that is unmatched in the industry.
While there is a concern that the VoIP service is already commoditized, Cablevision can steal
away Verizon subscribers by competing on price, which in turn eats away at the bread and butter
of the RBOC subscriber base. Verizon needs these subscribers more than Cablevision does,
because quite simply they have not yet captured the video market and cannot offer a bundled
service offering. Therefore, the sooner the bundled service becomes more popular, the more
Cablevision will benefit from its first -mover advantage.
Its our overall belief that while overall subscriber growth may stay stagnant, those who remain
with Cablevision will subscribe to the bundled service play, for convenience as well as pricing
issues. Below in exhibit five we show our VoIP projections going forward, they are slightly
conservative to those on the Street, which we felt were slightly aggressive and took a bit too
much faith in the adoption of the triple play bundle.
Exhibit Five: VoIP Projected Growth 2005A 2012E
6000

180%
160%

5000
140%
4000

120%
100%

3000
80%
60%

2000

40%
1000
20%
0%

0
2005

2006

2007

2008

2009

VoIP Subscribers

2010

2011

2012

Growth

11

Competitive Analysis:
Industry Competitors & Rivalry Very High:
As mentioned previously, Cablevision will be first to the test their video product against Verizon.
Already being squeezed by increasingly aggressive DBS operators, CVC will have be kept busy
by the Verizon invasion. Cablevision now offers video content, broadband access and phone
service. With each service they compete against different competitors. Broadband service pits
Cablevision against the likes of the telecom carriers offering DSL, and VoIP pits them against
both major telecom service providers as well as smaller service providers such as Vonage. The
competitive environment for Cablevision is extremely crowded, and due to the fact that their
subscriber demographics are so attractive, this does not look like it will subsist anytime soon.

Threat of New Entrants Medium to High:

Because of the capital intensive nature of the actual development of a cable network, threat of
new cable operators is relatively low. Most cable networks have a fiber to the node architecture.
Most of these FTTN networks employ a hybrid fiber coaxial network, where optical fiber is used
for the backbone and coaxial cable is distributed between the backbone and the individual users.
Quite simply, the build out of these networks is cost prohibitive, and the only way for a new
entrant to enter the fray would be to compete on price for customers. This would prove to be
suicidal for all but the deepest of lined pockets (which do not currently exist) given the fact that
the upfront capital expenditures would be need to be paid down and competing on price would
do little to do such a thing. Such strategies such as ones used by RCN in the Northeast have
been employed in the past, but they have yet to be successful.
This is not to say that certain products of the Cablevision offering will not see increasingly
intense competition in the upcoming years. Video content and communication is fast becoming
the next growth area for both wireline and wireless operators. Within the next three years many
believe that the Regional Bell Operating Companies (Verizon, SBC) will be commercializing
video offerings. UBS estimates that Verizon and SBC will spend $11 billion in the next six
years, including $5 billion in the next three years, all earmarked to build out a video offering.
The fiber to the home strategy employed by the RBOCs is an aggressive move with a defense
mechanism built into it as well. If the RBOCs stand by and let Cablevision gain the upper hand
with a voice over internet protocol (VoIP) offering that is included in a triple play bundled
product, they will inevitably lose considerable market share within their fixed line business. By
offering a video product to bundle with wire-line and perhaps wireless service, the Verizons of
the world put themselves back into the bundled services arena.
With the threat of additional entrants such as Verizon and the ensuing pricing war that will likely
occur, the obvious concern is the commoditization of the video offering, which will crush
margins as well as increase cable and satellite operator customer churn. As mentioned
previously, we feel these are viable concerns yet they are somewhat over-hyped. The fact
remains that the RBOCs will possess a higher cost structure with massive capex debt, no
exclusive content, and no real competitive technical advantage. All of these factors mitigate the
concern considerably. To quantify the actual risk and the uncertainty surrounding the projected

12

roll-out, Goldman Sachs predicts that in 2010 the RBOCs will have achieved a 4.2% penetration
rate of U.S. TV households while JPMorgan believes that number will be 6.4%. In our opinion
the telecom invasion will be stumble before it gains traction, and the discount already baked into
low valuations in the cable sector is somewhat unfounded.

Barriers to Entry High:

As mentioned previously, the cost prohibitive nature of building out a cable network creates a
drastic barrier to entry. Switching costs are not prohibitive, but there is a considerable cost for
the operator to absorb in terms of set-top boxes.
On the whole, residents have become accustomed to accepting the duopoly of a cable operator
and a satellite operator as their choice for video. Calculated intrusions into the market such as an
RCN overbuild strategy, or even a telecom video strategy need to offer a strong value
proposition, such as a bundled offering, which is tremendously difficult to offer with an existing
established network.

Availability of Substitutes Medium:

Due to the recent development of network television content being allowed by network
broadcasters to be downloaded to your iPod or iTunes account, substitution is a growing concern
for operators such as Cablevision. Video content transmitted through cell phones can also be
considered an available substitute. As the cell phone technology allows for faster downstream
transmissions in the next few years, content offering will grow and the user experience will get
better and better. Is this a substitute for sitting in your living room at home and watching your
favorite show? Our bet is that it wont. It does, however, create an alternative for viewers to
watch their favorite show while they are on the road, on the train on their daily commute, or just
away from home and looking to kill some time. Much like the DVD vs. movie experience, one
is a little more of a ritual than the other (movies at the theater, watching TV at home), but one
just that much more convenient (DVDs at home, watching TV on your iPod or laptop).

Supplier Power Medium:

Cablevision has been experiencing a number of rate hikes in the past year from major content
providers such as HBO and ESPN, but on the whole it behooves the content provider to push
their product out to as many viewers as possible. HOWEVER, it should be noted that content
costs have been an issue over the last 5 years, may have cooled off as of late, but could become a
huge problem over the next 2 years. This problem would mainly be driven by the major
networks ABC, CBS, NBC and FOX who dont charge fees to the MSOs for broadcast rights.
This is a practice that goes back to the days when the FCC gave these networks broadcast
licenses (a license to transmit the signal over the airwaves) and the networks tried to monetize
their signal by selling ad time now that the country is largely converted to digital and nobody
gets the networks over antennas anymore, the networks have started to talk about why they
should be any different than any other TV network that charges the cable company a
transmission fee (i.e. ESPN charges Cablevision approximately $3/sub/month). This is
conceptually a fair point of view, and the first of these deals to come up for renewal is CBS next
year. CBS Chairman Les Moonves has been very verbal that he will demand payment from the
MSOs or he will pull the signal. Investors in CBS stock believe that he will win this fight, we

13

are skeptical but do believe it is a significant concern. This could represent massive fees to be
paid by the likes of Cablevision. As a point of reference, the telecom providers have agreed to
pay fees to the networks as part of their content deals for their TV service, so the precedent has
been set.

Buyer Power Medium to High:

With each additional service offering, and with each discounted bundling, buyer power increases
and the consumer gains more and more leverage. While many will have to get used to the fact
that video content will not be controlled by duopoly any longer, both choices and substitutes will
be heavily marketed by competitors desperate to increase market share and will make this
transition easy. The traditional unexplained rate increases by our cable providers such as
Cablevision should cease to exist in the near future, as there will be an increased focus on the
customer. Furthermore, bundled services should continue to be discounted heavily, and will only
come down in price as telecom providers enter the landscape.

Key Drivers of Demand

Maintenance of Extraordinary Growth Rates: With basic subscriber numbers reaching

industry high penetration rates, average revenue per user must increase for Cablevision to
keep pace. Margins have to increase on all vertical services as key capital expenditures have
already been built out, and Cablevision has stronger operating metrics than anyone else in
the industry. Can they keep this up or is there a saturation point?

On-Demand and Pay-Per-View Lineup: Just as with any other cable operator,
Cablevision will need to depend on an enhanced video on demand line-up going forward,
and the utilization of consumer home theater set-ups to bring the cinema home to the living
room. These services are high-margin, and are vital to driving healthy ARPU numbers.

Success vs. Verizon and Adoption of Triple Play Offering: Consumers will need to see
the value and convenience of the bundled service play that Cablevision offers. Given
Cablevision has enormous subscriber exposure to the Verizon service offering (22% of basic
subscribers) they will be the first to see if they hold onto valuable subscribers. The bottom
line is that consumers will now more than ever be likely to choose one carrier for all their
communications needs. Can Cablevision compete against the Verizon holy grail of four
services (wireless, VoIP, cable, and internet)?

Consumer Adoption of HDTV: Current subscriber penetration has been ramping up

considerably. Increased penetration equals both an increased ARPU and a greater tendency
to purchase from an on-demand selection that mimics the theater experience. With the sale
of the Voom satellite service that was almost exclusively HDTV content, Cablevision has
whet the consumers appetite for high definition television, and then taken it away. The
major and cable networks continued rollout of content could be vital to HDTV adoption.

14

Concerns Going Forward:

Management Irrationality: The Dolans. Enough said. We have no idea of what to expect
from management. In a few years, Cablevision could very well be a very attractive LBO
candidate or it could be buried in additional debt the Dolans have incurred to pay out
dividends to themselves, it really is a wildcard.

Saturation of the Subscriber Base: We are concerned that penetration rates are high and
susceptible to significant churn going forward. Part of the investor mentality in the past has
been to reward based on potential, and in the future Cablevision has limited upside and a
very big downside. How will Wall Street react to a business that could be holding serve,

The Verizon FiOS threat: The telecom video threat is very real and very imminent. How
Cablevision is able to manage SG&A costs in competing areas, as well as hold on to their
own customers will be a key test to the sustainability of the business itself.

Alternative Businesses: How will MSG and Rainbow fare in the future. The mean value of
sports franchises is a constantly fluctuating number. Will the Dolans sell high at some point?
Furthermore, the current mismanagement of the New York Knicks has got to raise a red flag,
with the highest payroll in the NBA they are consistently finishing at the bottom of the
standings losing valuable playoff revenue and robbing the Madison Square Garden of any
type of excitement.

15

Valuation
Methodology
On April 7th, Cablevision announced that its Board of Directors approved a $10 per share special
dividend payable April 24th. To finance this special dividend Cablevision issued $3 billion in
debt. This leveraging of the balance sheet to pay out a dividend will significantly raise the debt
to equity ratio for 2006 as compared to 2005. After 2006 we anticipate Cablevision will start
reducing debt levels to reduce its interest burden and bolster its balance sheet. Our thesis that
Cablevision will begin reducing debt is based on the fact that Cablevision has a high degree of
below investment grade debt and will start generating positive free cash flow in 2006. Therefore
we opted to use the adjusted present value as our primary valuation methodology to account for
the changing debt to equity ratio.

Income Statement Assumptions

Telecommunications Revenue Growth
We projected telecommunications revenue based on total basic subscribers and average revenue
per basic subscriber. Telecommunications revenue comprises Cablevisions video, voice and
internet divisions. Our telecommunications revenue projection for 2006 is generally in line with
managements guidance. Management has been fairly good at hitting revenue growth targets
over the last three years. (see exhibit 1)

Basic Subscribers: We projected annual basic subscriber growth of 2% through 2012.

This rate coincides with recent historical growth rates and the fact that Cablevision has
heavily penetrated its footprint allowing for minimal incremental growth.

Average Revenue per Basic Subscriber/Month: The availability of the triple play and
increasing demand for additionally services (VOD, HDTV, DVR) will drive
ARPU/Month higher through 2008. Thereafter, we believe that Verizons FIOS will
become a formidable competitor. Verizons strong push into the video segment, its
significant footprint overlap, and its ability to offer a lower price point will pressure
Cablevisions average revenue per basic subscriber. As such, ARPU/month will increase
from $112 in 2006 to $125 in 2008. In 2008 ARPU/month will stabilize at $125 and hold
constant through 2012.

Rainbow and Madison Square Garden Revenue Growth:

Rainbow Revenue: We project annual revenue growth of 5% through 2012 in line with
management guidance and historical trends.

Madison Square Garden: We project annual revenue growth of 3% through 2012.

16

REVENUE MODEL
(in thousands)
Video Subs
yoy growth

High Speed Data Subs

yoy growth

2006
3,088

2007
3,149

2008
3,212

2009
3,277

2010
3,309

2011
3,342

2012
3,376

2%

2%

2%

2%

1%

1%

1%

1,948

2,241

2,577

2,963

3,260

3,586

3,944

15%

15%

15%

15%

10%

10%

10%

VoIP Subs

1,463

2,048

2,662

3,194

3,673

4,224

4,858

yoy growth

100%

40%

30%

20%

15%

15%

15%

Total RGU

6,499

7,438

8,451

9,434

10,242

11,153

12,178

19%

14%

14%

12%

9%

9%

9%

112.00

120.00

125.00

125.00

125.00

125.00

125.00

4,149,654

4,534,979

4,818,415

4,914,783

4,963,931

5,013,570

5,063,706

15%

9%

6%

2%

1%

1%

1%

870,444

913,966

959,664

1,007,647

1,058,030

1,110,931

1,166,478

5%

5%

5%

5%

5%

5%

5%

828,527

853,383

878,984

905,354

932,514

960,490

989,304

3%

3%

3%

3%

3%

3%

3%

-65,000

-65,000

-65,000

-65,000

-65,000

-65,000

-65,000

5,783,624
12%

6,237,327
8%

6,592,063
6%

6,762,784
3%

6,889,475
2%

7,019,991
2%

7,154,488
2%

yoy growth

Avg Rev Per Basic Sub/Mon

Telecommunications Rev
yoy rev growth

Rainbow Revenue
yoy rev growth

Madison Sq Garden Rev

yoy rev growth

All Other
Total Revenues
yoy growth

Expense Growth:
We projected annual expenses as a constant percentage of sales in line with its 3 year average.
Over the last three years Cablevision has reported SG&A and technical & operating expenses as
a percentage of sales within a tight range. Therefore, we were comfortable using the three year
average of 25% for SG&A and 46% for technical and operating expenses.
Depreciation and Amortization:
We projected depreciation and amortization expense as a constant percentage of PP&E in line
with its 3 year average. Once again, this line item has been relatively constant historically.
Therefore we were comfortable using the three year average of 26% through 2012.

17

INCOME STATEMENT

Revenues, net
Technical and operating (excluding
as % of revenues

Selling, general and administrative

as % of revenues

Other expenses
as % of revenues

Depreciation and amortization (including

as % of PPE

Operating Expenses
Operating income
Gain/Loss on der,affiliates, investments and
EBIT
yoy growth

2006
5,783,624

2007
6,237,327

2008
6,592,063

2009
6,762,784

2010
2011
2012
6,889,475 7019991.3 7154488.3

2,667,412

2,871,972

3,000,364

3,103,662

3,156,596

3,211,078

46%

46%

46%

46%

46%

46%

46%

1,484,569

1,574,829

1,667,565

1,718,051

1,744,174

1,778,808

1,813,906

26%

25%

25%

25%

25%

25%

25%

0%

0%

0%

0%

0%

0%

0%

968,728

962,859

906,216

853,483

818,067

774,800

735,373

26%

28%

27%

27%

27%

27%

27%

5,120,709

5,409,660

5,574,144

5,675,197

5,718,837

5,764,686

5,827,294

662,915
0
662,915

827,667
0
827,667

1,017,919
0
1,017,919

1,087,588 1170638.3 1,255,306 1,327,194

0
0
0
0
1,087,588 1,170,638 1,255,306 1327194.1

21%

25%

23%

7%

8%

7%

3,278,015

6%

Balance Sheet Assumptions

Cash and Equivalents and Accounts Receivable:
Cash and cash equivalents and accounts receivable are projected to grow as a constant
percentage of sales in line with historical averages. Historically, current asset levels have
remained at a relatively constant percentage of sales. Therefore we were comfortable using the
three year average of 8% for both cash and equivalents and accounts receivable.
Plant, Property and Equipment:
We projected -5% growth per annum in PP&E. This growth rate reflects the fact that the
majority of Cablevisions infrastructure has been built. The primary growth driver of PP&E
going forward will be expenses related to subscriber growth.
Accounts Payable:
We calculated accounts payable growth based on a constant percentage of sales. Accounts
payable as a constant percentage has been relatively stable over the last few years. Therefore we
used the three year average of 7%.
Debt:
For 2006, we added $3 billion in debt to account for the increase in leverage associated with the
one time dividend. After 2006, we believe Cablevision will aggressively pay down debt from its
free cash flow. We estimate that 50% of free cash flow will go to pay down debt until 2012. We
reason that Cablevision will pay down debt since it has a high degree of below investment grade
debt increasing its interest burden and capital expenditures are declining.

18

DEBT LEVEL

FCF to equity
% to pay down debt
Debt

2006
998,896

2007
840,329
50%

2008
933,904
50%

2009
944,227
50%

11,666,573 11,246,409 10,779,456 10,307,343

2010
1,002,427
50%

2011
2012
1,061,419 1,116,481
50%
50%

9,806,130

9,275,420 8,717,180

BALANCE SHEET

Cash and cash equivalents

as % of revenues

Accounts receivable, trade (less

2006
462,690

2007
498,986

2008
527,365

2009
541,023

2010
551,158

2011
561,599

2012
572,359

8%

8%

8%

8%

8%

8%

8%

462,690

498,986

527,365

541,023

551,158

561,599

572,359

as % of revenues

8%

8%

8%

8%

8%

8%

8%

Other Current Assets

1,445,906

1,559,332

1,648,016

1,690,696

1,722,369

1,754,998

1,788,622

as % of revenues

25%

25%

25%

25%

25%

25%

25%

Total current assets

2,371,286

2,557,304

2,702,746

2,772,742

2,824,685

2,878,196

2,933,340

Property, plant and equipment, net of

3,674,673

3,490,939

3,316,393

3,150,573

2,993,044

2,843,392

2,701,222

-5%

-5%

-5%

-5%

-5%

-5%

-5%

4,337,718

4,677,995

4,944,047

5,072,088

5,167,106

5,264,993

5,365,866

75%

75%

75%

75%

yoy growth

Other Non Current Assets

as % of revenues

75%

75%

75%

11,000,429
0%
500,814

yoy growth

Accounts payable

404,854

436,613

461,444

473,395

482,263

491,399

7%

7%

7%

7%

7%

7%

7%

2,429,122

2,619,677

2,768,667

2,840,369

2,893,580

2,948,396

3,004,885

as % of revenues

Other Current Liabilities

10,726,239 10,963,186 10,995,403 10,984,835

3%
2%
0%
0%

10,986,582
0%

10,383,677
5%

Total Assets

as % of revenues

42%

42%

42%

42%

42%

42%

42%

Non current Liabilities

533,482

574,394

600,073

620,732

631,319

642,216

655,603

20%

20%

20%

as % of revenues

20%

20%

20%

Debt

11,666,573

20%

11,246,409 10,779,456 10,307,343

9,806,130

9,275,420

8,717,180

Total Liabilities

15,034,031

14,877,093 14,609,640 14,241,840 13,813,292

13,357,431

12,878,482

Shareholders' Equity

-4,650,354

-4,150,854

-2,370,849

-1,878,053

-3,646,454

-3,246,437

-2,828,456

Adjusted Present Value Analysis

Present Value of Equity Cash Flows:
Unlevered Beta: =Beta(levered)/(1-(1-Tax rate)*(Debt/Equity)
We regressed the last 60 months of Cablevision returns versus a value weighted market index to
determine its equity beta. This analysis yielded an equity beta of 1.78. We were comfortable
using the equity beta of 1.78 given the relatively stable debt to equity ratio through the
calculation period. Additionally, we calculated a 60 month rolling average over ten years
illustrating a steady increase. We then used the historical equity beta and the historical beta to
calculate an unlevered beta with the above formula. This gave us our unlevered beta of 1.07.

19

Cost of Equity: =Rfree+Beta(unlevered)*Risk Premium

To determine the cost of equity we used the CAPM formula. We calculated the risk free rate of
4.01% by trimming the 10 year T-Bill by the historical risk premium of one percent. We
selected a risk premium of 7% representing the markets historical excess return. We calculations
gave us a cost of equity of 11.5%.
Unlevered beta calculation
Current Beta
Mkt Value of Debt
Mkt Value of Equity
D/E
Tax rate
Unlevered Beta

Beta/(1+(1-T)*D/E
1.78
8,666,573
8,090,000
107%
39%
1.07

Cost of equity calculation

10 Year Treasury Yield
Historical risk premium
Risk free rate
Risk Premium
Unlevered Cost of Equity

Rfree+Ubeta*Risk Premium
5.01%
1.00%
4.01%
7.00%
11.5%

PV of equity cash flows

Based on our revenue and expense assumptions (detailed above) we derived the earnings before
interest and taxes through 2012. We tax effected the earnings before interest and taxes and
discounted it at the cost of equity. We used a terminal growth rate of 3%. We projected capital
expenditures to decline steadily reflecting Cablevisions built out infrastructure. We built in a
slight cushion to managements capital expenditures guidance to account for managements
historical record of underestimated capital expenditures. (see exhibit 1)
Present value of equity cash flows
EBIT
Tax rate
After tax EBIT
Capital Expenditures (-)
Depreciation (+)
Change in WC
FCF to equity
PV(of Equity CF through 2010)
Terminal growth rate
Terminal Value
PV of Terminal Value

1
2006
662,915
0%
662,915
750,000
968,728
-117,253
998,896
$3,986,684
3%
$13,084,711
$6,797,519

PV of equity cash flows

$10,784,203

2
2007
827,667
39%
504,877
700,000
962,859
-72,592
840,329

3
2008
1,017,919
39%
620,930
650,000
906,216
-56,758
933,904

4
5
6
7
2009
2010
2011
2012
1,087,588 1,170,638 1,255,306 1,327,194
39%
39%
39%
39%
663,428 714,089 765,736 809,588
600,000 550,000 500,000 450,000
853,483 818,067 774,800 735,373
-27,315
-20,271
-20,883
-21,520
944,227 1,002,427 1,061,419 1,116,481

20

Present Value of Debt Tax Shield:

PV of annual interest tax shields:
To determine the present value of the debt tax shield we projected debt levels through 2012. We
then used the market rate on Cablevisions outstanding debt to determine the interest payments.
Next, we used the historical default rate on BBB bonds to determine the default adjusted interest
expense through 2012. We multiplied this figure by the tax rate to determine the debt tax shield
per year. Since the debt on the balance sheet is below investment grade, we added a 150bp
premium to the risk free rate to derive the cost of debt.
Present value of tax shield
Debt
Interest @ 8.5%
Historical default rate(1)
Default adjusted interest
Tax rate
Interest tax shield
Cost of debt
PV of tax shield
PV of terminal value of tax shield
Total PV of tax shield

1
2
3
4
5
6
7
2006
2007
2008
2009
2010
2011
2012
11,666,573 11,246,409 10,779,456 10,307,343 9,806,130 9,275,420 8,717,180
991,659
955,945
916,254
876,124 833,521 788,411 740,960
12%
12%
12%
12%
12%
12%
12%
872,660
841,231
806,303
770,989 733,498 693,801 652,045
0%
39%
39%
39%
39%
39%
39%
0
328,080
314,458
300,686 286,064 270,583 254,298
6.5%
6.5%
6.5%
6.5%
6.5%
6.5%
6.5%
0
289,255
260,324
233,730 208,793 185,439 163,642
$7,265,645
$8,443,186

Derived Equity Value:

As stated earlier, our equity value was determined by adding the present value of the all equity
cash flows to the present value of the debt tax shield, and then subtracting out the market value
of the debt.
Total PV of tax shield
Total PV of equity cash flows
Adjusted present value

$8,443,186
$7,265,645
$19,227,389

Market Value of Debt

$11,666,573

Derived Equity Value

$7,560,816

Current Market Capitalization

$8,090,000

Percent Return

-7%

21

Exhibit 1
CAPITAL EXPENDITURES
$1,000
$888

$900
$776

$800

$725
$695

$700

Capex (millions)

$625

$600

$600
Proj Capex
Actual Capex

$500

$400

$300

$200

$100

$0
2005

2004

2003

Year

Exhibit 2
REVENUE GENERATING UNITS
1.40
1.30

1.20

1.13

1.13

1.00

0.96
0.88

RGU Net Adds

(millions)

0.83
0.80
Proj RGU adds
Actual RGU adds
0.60

0.40

0.20

0.00
2005

2004

2003

Year

22

Exhibit 3
CABLE REVENUE GROWTH
18%

16%

16%
15%

15%

14%
13%

13%
12%

Percent Increase

12%

10%
Proj Cable Rev
Actual Cable Rev
8%

6%

4%

2%

0%
2005

2004

2003

Year

23

Sources

National Cable & Telecommunications Association

http://www.ncta.com/docs/pagecontent.cfm?pageid=46
2005 Mid-Year Industry Overview
Federal Communications Commission
http://www.fcc.gov/mb/csrptpg.html
Annual Assessment of the Status of Competition in the Market for the Delivery of video
Programming
YahooFinance!
http://www.finance.yahoo.com
Bloomberg
Wikipedia
http://en.wikipedia.org/wiki/Cable_tv
The Wharton Research Data Service
http://www.wrds.upenn.wharton.edu
JP Morgan Securities
Cable TV/DBS December 22, 2005
UBS Investment Research
The UBS Media Video Primer April 27, 2005
Lehman Brothers
Cablevision Systems March 22, 2006
Ladenburg Thalmann
Cablevision Systems March 7, 2006

24

Important Disclaimer
Please read this document before reading this report.
This report has been written by MBA students at Yale's School of Management in partial
fulfillment of their course requirements. The report is a student and not a professional report. It
is intended solely to serve as an example of student work at Yales School of Management. It is
not intended as investment advice. It is based on publicly available information and may not be
complete analyses of all relevant data.
If you use this report for any purpose, you do so at your own risk. YALE UNIVERSITY,
YALE SCHOOL OF MANAGEMENT, AND YALE UNIVERSITYS OFFICERS,
FELLOWS, FACULTY, STAFF, AND STUDENTS MAKE NO REPRESENTATIONS
OR WARRANTIES, EXPRESS OR IMPLIED, ABOUT THE ACCURACY OR
SUITABILITY FOR ANY USE OF THESE REPORTS, AND EXPRESSLY DISCLAIM
RESPONSIBIITY FOR ANY LOSS OR DAMAGE, DIRECT OR INDIRECT, CAUSED
BY USE OF OR RELIANCE ON THESE REPORTS.

25