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Over the course of the last five years, a confluence of regulatory change and rapid technology adoption has brought the cable industry from laggard to leader. Stimulated by the 1996 Telecom Act, cable operators began a major overhaul of their systems in an effort to enable a broader, two-way connection with their customers, costing the industry just under $50 billion over the last five years. As we turn toward the end of 2001, the rebuild is almost complete, as close to 80% of homes have been successfully enabled with access to multiple new services including high-speed data, digital video programming, and in some cases telephony. Early adoption has been better than expected, providing the industry with a proverbial “hit.” In turn, valuations have risen to historical highs as investors have priced in continued growth of new services and corresponding cash flow. The question now is, what’s next? Beyond digital, data, and some telephony, what can operators do with newfound two-way access to their consumers and how does this translate into corresponding revenue and cash flow opportunities? Is the next big thing Video on Demand (VOD), Digital Video Recorders (DVR), Interactive Television (iTV), or something we have not even heard of yet? In this report we attempt to answer some of these questions, offering our analysis of the industry as a whole, highlighting the following key trends:

• ● Consolidation over the past several years has left just a handful of influential players in the cable industry, as the top five cable operators now represent 74% market share. As further consolidation beyond Comcast/AT&T (and possibly AOL/Cablevision based on recent comments by AOL CEO Gerry Levin) appears limited, we believe take-out premiums have largely been replaced with sector growth expectations, turning investors’ attention toward company fundamentals and accelerated growth prospects of the industry. In turn, we expect an increased emphasis on discerning the potential of next-generation enhanced services as investors seek to validate further price appreciation from current levels.

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● Growth of broadband connectivity provides the industry with a core driver. As consumers continue to seek out faster Internet connections, cable providers have become the default beneficiary as one of only two primary pipes into consumers’ home. As broadband connectivity continues to grow over the next five to ten years we believe cable operators are among the best positioned, as they further provide expanded bandwidth and the corresponding services it will enable. Accordingly, we believe cable operators have a unique opportunity in helping define emerging interactive business models during the early stages of market development.

● A need for a truly convergent hybrid television/personal computer (TV/PC) experience. To date, interactive efforts involving the TV have largely focused on attempting to replace the PC. We believe this approach is misdirected, as cable operators will instead begin to recognize the natural synergy between the use of the TV and the PC in tandem with one another. Accordingly, we expect cable operators to seek out online partnerships with established portals, offering consumers a common registration interface capable of using the cable head-end as an exchange server between their PC and their TV.

● The “Killer Application” on the TV is still programming. As best illustrated by the use of the Interactive Program Guide (IPG), consumers opt for interactive services on the TV primarily when it enhances their video experience. Accordingly, we expect cable operators to de-emphasize heavy graphical overlays and cumbersome set-top boxes in favor of light applications that enhance the programming experience by offering relayed programming and marketing content to a customer’s PC.

● Industry standards will become increasingly important as operators continue the transition to an IP-environment. The success of CableLab’s open DOCSIS standard, allowing uniform delivery of high-speed data, has been a wake- up call to an industry traditionally fraught with multiple proprietary protocols. Accordingly, we expect an increasing emphasis on open standards in delivering next-generation services, as the cable industry seeks to combine the power of its systems in creating a mutually robust broadband network.

● The regulatory and market environment have never been better. Just as quickly as the merger of AOL and Time Warner, Inc. acted as a catalyst in stimulating government action, the new administration and corresponding Federal Communications Commission chief have since significantly lessened the prospect of much intervention for at least the near term. In addition, the current slump in the technology environment has provided the industry with the opportunity to more easily foster cooperative partners. Through a combined effort to both appease the government and act as a consolidator, we believe the cable industry is currently well positioned to determine its own long-term destiny.

● Visible market opportunity supports near-term valuations, less apparent opportunities pave the way for further appreciation. The cable industry is currently trading at 16.3x CY01 EBITDA, the high end of historical multiples, driven largely by the growth potential of digital, data and telephony. While these core enhanced services have led to a reaccleration of cash flow over the next several years, we believe the industry is positioned to significantly enhance its opportunity as it further develops additional enhanced services seeking to take its customer relationship to the next level. As these services evolve, we expect cash flow growth to potentially further accelerate, leading to further multiple expansion and corresponding price appreciation.

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