Despite losing basic video subscribers quarter after quarter, the cable TV sector still presents investors with a compelling opportunity, according to a segment analysis from Value Line's Nils C. Van Liew.
That's because of the status of companies like Comcast, Cox and Time Warner Cable as well-established, consumer-driven franchises. Big subscriber bases (and the strong recurring revenue and cash flows they generate) provide the major cable companies "a good degree of stability in both good times and bad," he said.
Those large subscriber bases (25 million, in the case of Comcast) also give providers the opportunity to upsell and cross-sell new services. The roll-out of consumer broadband and business services have more than made up for lost revenue in basic video, for instance.
"Adding further to the industry's allure is a likely inflection point with respect to capital intensity and the good prospects in the commercial space," said Van Liew. "On the minus side of the ledger, the industry faces competition from well-funded companies looking to better leverage their own strengths. Competitive inroads may very well result in increased pricing and earnings pressure."
He noted that the industry began in the 1940s when, amid a licencing freeze for new broadcast TV stations, the proprietor of an appliance store began offering his rural Pennsylvania customers a crude precursor to today's cable service. "Now, some 60 years later, approximately 85% of American households subscribe to some form of pay-TV service," Van Liew said. "Generally, traditional cable companies rule in high-population metro areas. Satellite broadcasters have a leg up on the competition in rural areas, where landline infrastructure investments make less economic sense and there are fewer impediments to signals and dish installations. Still, technical constraints on interactive services put the satellite providers at somewhat of a disadvantage."
The cablers' core video subscription model provides a good degree of revenue visibility and recurring cash flow—a winning combination when one factors in fairly fixed programming fees and low variable costs: there is little incremental expense associated with an increase in subscriber viewing. "Given good cash flow, the companies are comfortable with heavy debt loads (50%-60%)," said Van Liew. "Indeed, pay-TV providers have been generating an increasing amount of excess cash. Debt pay-downs are often less of a priority than is returning cash to shareholders in the form of dividends or stock buybacks."
High barriers to entry are also a plus. It can easily cost a company $500 million or more to roll out a satellite or wireline TV network. "Traditional cable companies must secure franchise rights from municipalities, which, while not typically exclusive, provide a significant hurdle to newcomers," Van Liew said. "Local leaders, after all, don't want a gaggle of service providers tearing up city sidewalks to lay broadband conduits...[and] the wherewithal to build out a network, before securing a critical mass of bill-paying subscribers, requires the support of patient, well-funded backers."
To boot, many of the major service providers already have substantial, technically advanced networks and, thus, need little additional capital to support growth.
Of course, there are risks afoot as well. For instance, competition.
"Over the years, following a near-monopolistic rein by certain providers, the competitive environment has heated up," the analyst said. "Traditional phone service providers, for example, are now offering data and video packages to compete with cable companies' offerings. More and more content providers are also marketing TV shows and movies directly to consumers through the Internet."
There are also significant cost considerations. Cablecos generally pay a per-subscriber fee to carry popular networks as ESPN and USA. But programming fees and retransmission costs are escalating at each contract renewal. "What's more, contract renegotiations between content providers and distributors can take months and lead to carriage disruptions," Van Liew said.
Also, while cable viewership tends to be fairly stable, a weak economy can lead budget-conscious subscribers to purchase fewer premium channels and on-demand events. "Accordingly, cable investors should keep an eye on the broader economy and such gauges as unemployment claims, home sales and consumer confidence," he observed.