How To Fuel Growth Through Limited Partners

Tom Keaveney kept control of his business by growing with tax-sheltered partnership dollars.

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Late last year, Tom Keaveney wanted to expand his mini-kingdom of cable television systems headquartered in Hershey, Pa., by buying and upgrading a subscriber service near Charleston, W. Va. As president and principal shareholder in Cable Management Associates Inc. (CMA), Keaveney was a principal of Phoenix Communicatins Inc., which was manager and general partner of four cable systems with 12,500 subscribers. The new West Virginia system would more than double the operations under his control.

But Keaveney faced two big problems. For one, how was he to finance the $10 million-plus purchase price and the $2 million to $3 million he needed to upgrade the system from 12 to 20 channels? And how could he attract capital without diluting his 83% control of CMA?

Traditional sources of financing were neither feasible nor palatable for Keaveney, who, despite recent success, was cash poor. Since it usually takes several years for a cable system to generate adequate revenues to pay off loans, banks don't like lending more than about 65% of required funds to small operators. On the other hand, selling equity to an individual investor or in a public stock offering would threaten Keaveney's controlling interest in his company. "We want to continue on our own for now," he says. Given that goal, Keaveney selected a financing tool that he has used successfully on several occasions over the past five years -- the limited partnership.

Since 1977, limited partnerships have permitted Keaveney to attract the capital necessary to purchase other cable television franchises in Pennsylvania, West Virginia, Virginia, Maryland, and Delaware. Under the Economic Recovery Tax Act of 1981, the limited partnership has become even more attractive to investors. Indeed, because ERTA permits faster write-offs of capital equipment, cable operators and other capital-hungry businesses have been some of the biggest beneficiaries. At the same time, the former winners among the traditional limited partnerships -- those devoted to oil and gas drilling and real estate development -- have recently gone begging in the wake of the oil glut and high interest rates.

With his past loan experience, Keaveney, 47, who was formerly a broker in the equipment-leasing business, knew that banks wouldn't consider lending enough to finance his whole Charleston deal. But he was able to get a large bank to agree to lend $7.5 million to $9 million of the project's $13 million requirements at an interest rate of one percentage point above the prime. Meanwhile, Keaveney knew that precisely those factors that made banks uneasy about financing an entire cable project -- chiefly, the anticipation of large, early-year losses -- helped make the deal enticing to investors looking for a tax shelter.

Since start-up costs are heavy and depreciation write-offs are substantial in the early stages of cable TV projects, operators tend to report losses for about five years before revenues from monthly subscriber fees allow them to break even. In deciding how much to lend, banks figure it usually takes at least seven years for a small cable company to sign up enough subscribers to pay off a loan. To bridge the gap between the loan from the bank and the $13 million required, Keaveney set out to find the difference from limited partners.

Keaveney's Cable Management Associates sought to nail down final commitments from participating investors by mid-August; in addition to the bank loan, the Charleston operation would be financed by the sale of 45 units to limited partners for $150,000 per unit.

According to Butcher & Singer Inc., the Philadelphia brokerage firm that syndicated the deal, as much as 75% of the cost of a cable system is tied up in capital equipment, including residential converter boxes and miles of cable (costing some $10,000 per mile). Under ERTA, this equipment can be depreciated over 5 years, compared with 8 to 12 years previously.

In the light of these necessary front-end expenditures and all the depreciation, Keaveney figures that each limited partnership unit will be losing $15,000 to $50,000 per year for about four years. The precise figure will depend on how fast subscribers sign up for cable service. During the life of the limited partnership, moreover, he estimates that each investor will also receive annual cash distributions of $4,000 to $5,000, which for the most part will be tax-free as long as the over-all Charleston operation -- a string of five small cable systems serving 24 towns -- loses money. The investor group will start turning a profit in five or six years, Keaveney anticipates. If the limited partnership decides to liquidate, Keaveney would have the first right to buy the Charleston system at perhaps $30 million -- depending on the market value. These partners, says Marshall Pagon, who packaged the deal at Butcher & Singer, expect to be able to nearly triple their capital investment by then. An alternative to buying the system would be selling the cable system to somebody else.

Before even attempting to arrange financing for the Charleston operation, Keaveney invested a lot of time studying both the past performance and the potential of the properties. He hired an engineer to assess the existing equipment and determine what improvements would be needed, and he studied the local market and economic climate. Since subscribing to cable television is a discretionary expense for many households, which pay an average of $7.50 per month for cable service, Keaveney says he was pleased to find that Charleston "was a steady employment area." Moreover, he discovered that the cable operator who was interested in selling had not been very aggressive.

Overall, only 8 of the system's 12 channels were being used at all for programming, and only about 34% of the existing subscribers were wired to receive, at extra fees, such services as Time Inc.'s Home Box Office. Says Keaveney, "I saw an opportunity to bring in more programming and additional pay services."

Keaveney's homework served two functions. Not only did it demonstrate to him and others that the Charleston investment was attractive, it also helped convince the proposed syndicator, Butcher & Singer, that Keaveney would be a strong general partner for the deal -- an essential ingredient for lining up limited partners. As the managing general partner, Keaveney will receive a fee of 6 1/2% of the gross revenues.

Even before the ink on the Charleston deal is dry, Keaveney is thinking about expanding his company further with additional limited partnerships before the year is out. Recently, he has begun looking at three new candidates. If he created limited partnerships to purchase any more than three, Keaveney figures he would be spending too much of his time on expansion and not enough on running the business. Keaveney notes that it takes at least 90 days to do all the necessary ground-work to put one deal together. "Timing becomes a critical factor," he says.

Keaveney believes that limited partnerships are more effective for financing smaller cable TV projects than larger ones. A franchise serving more than 30,000 subscribers, for example, might require more money than banks would lend. Moreover, the number of limited-partner investors required would result in less-attractive tax benefits and capital appreciation per investor -- making the deal harder to sell.

The opportunity to expand his cable empire quickly, or a sudden souring of today's bullish market for cable properties, might one day prompt Keaveney to tap the public equity market. Selling stock to public investors would, of course, mean that he would have to relinquish some of the ownership. But Keaveney says his aim now is to hold on to at least 51% for as long as he can.