Cable stocks, beaten down in recent quarters because of competition, subscriber saturation and regulatory concerns, may be turning the corner.
In recent weeks, most big cable companies have staged a mini-rally on Wall Street, after showing surprising strength in first-quarter earnings in what some see as a sustainable trend. Despite worries from the credit crunch and lurking recession fears, operators' stocks have been climbing since February, bolstered in part by the basic cable networks, which are on a ratings hot streak (see NCTA preview, p. 18).
Since February, B&C's index of cable system stocks has jumped 21%, though that's off a low base as cable stocks posted anemic performance for roughly five years due to fears of price wars with telephone and satellite-TV competition. Top MSOs Comcast and Time Warner Cable shares are up more than 35% from their bottom at the start of the year. Still, cable stocks are off 47% from their recent B&C index peak in February 2007.
Many on Wall Street feel that cable turned a corner because even after rivals have taken their best shots, “the core drivers of the cable business have held up well,” says investment researcher Sanford C. Bernstein & Co. Consumer “pricing has remained strong. Digital voice has continued to grow. Demand for HDTV and DVRs has been remarkably resilient” so far.
In recent months, Wall Street analysts have lowered their five-year forecasts for penetration for telco video, while raising cable estimates. Estimates for telco video penetration of all subscription TV homes by 2012 have dropped to 9%-10%, which is down from the low-to-mid teens. That represents a shift of millions of subscription TV subscribers to the cable side of forecasts.
Cable operators are naturally bullish. “We are confident about our competitive position and our ability to further grow our business, as illustrated by our outlook for 2008 free cash-flow growth of at least 20%,” Comcast Chairman and CEO Brian Roberts recently told investors.
In earnings for the first quarter ended March 31, Time Warner Cable reported a net gain of 55,000 subs (to 13.3 million total basic TV subscribers), which surprised stock analysts expecting a net decline. Comcast and Cablevision Systems also posted what Wall Street felt were strong basic TV subscriber results. Wall Street is impressed given competition since 2005 from telcos Verizon with its FiOS service (1.2 million subs) and AT&T with its less sophisticated U-verse (379,000).
Satellite rival DirecTV has been on the longest win streak in multichannel TV by raising its stock price 75% since a bottom in early 2006, as its early investment in high-definition TV is now paying off. DirecTV posted a healthy 275,000 net gain in U.S. subscribers in the first quarter (to 17.1 million total U.S. subs). Meanwhile, the other satellite platform, DISH Network—whose big selling proposition is bargain consumer pricing—cautioned investors in its first-quarter earnings that its outlook is clouded as it reported a de-acceleration in net additions of subscribers. Its 35,000 net ads (giving it 13.8 million total subs) was down sharply from 310,000 net adds a year earlier.
Cable has fattened subscriber bills this decade by diversifying into digital voice and broadband, which carry gross profit margins estimated around 75% versus about 50% for video (those margins exclude the sizable cost of physical infrastructure). Thus, cable is moving to a more profitable mix of services.
New York-centric MSO Cablevision Systems reported that the total monthly bill of its basic video subscribers averaged $129.56 in the first quarter, up a healthy 11% (at DISH, the comparable figure is just $67.93 per sub). Fattening those cable bills are add-ons such as voice service, which skyrocketed industrywide from 1.3 million units in mid-2001 to 15.1 million at the end of 2007, according to the NCTA.
Sanford C. Bernstein & Co. forecasts cable will grow its share of total residential voice, video and broadband subscription units from 44.9% in 2007 to 53.6% by 2012—leaving satellite and telcos to battle over the shrinking balance.
MORE POSITIVES THAN NEGATIVES
The cable picture is not all bright, but the positives seem to outweigh negatives. Cable so far lacks a compelling wireless strategy that integrates all of its services, which is a worry given consumers' desire for wireless services. New wireless and other enhanced services require capital expenditures, though so far cable is seeing a payback on its investments in upgrading physical plant. Moreover, cable industry leaders complain that the FCC consistently makes life difficult by favoring competitors in regulatory decisions.
Rivals seem to have more significant disadvantages. Satellite TV, which lacks a built-in return path, is not well positioned to offer the voice and broadband components of cable's triple play. Telcos find cablers are cutting into their cash-cow voice and Web access businesses, while they expand into the lower-margin subscription TV segment. Fortunately, telcos have more business lines to draw from, such as cell phones and communications services to businesses.
The boom in basic cable networks is a trend benefiting all platforms. Across the board, basic networks are increasing investment in original fare, which so far is paying off with higher ratings, and, despite the mass movement, cable networks are not simply cancelling each other out. “We are seeing returns from this investment…in new series and extensions of established shows,” Viacom President and CEO Philippe Dauman told an investors' conference call, in what is echoed across the business. Turner Entertainment Networks vows to make 80% of its primetime programming original by 2010, up from 20% currently. Cable has picked up audience lost by broadcast networks due to the 100-day Hollywood writers' strike, which ended in February.
Is the current mini-boom a passing fad or sustainable? Certainly, cable fundamentals are strong, and some analyst point to “private market valuations” of cable that indicate room for share price gains. SNL Kagan says the public market trading price in late April of six leading cable companies was just 60.4% of private market valuations—which is a benchmark for a buyout. A 75% ratio is the norm, indicating potential for more share price growth.