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Industry Analysis: Cable TV
The Cable TV sector presents investors with a compelling opportunity to own stakes in well-established, consumer-driven franchises. Big subscriber bases (and the strong recurring revenue and cash flows they generate) provide the major cable companies, and their satellite-broadcast brethren, a good degree of stability in both good times and bad.
A large number of loyal subscribers also gives pay-TV providers good sell-in opportunities for new services. 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. 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.
A Brief Primer
The industry traces its roots back to the 1940s when, amid a licensing 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. A growing number of people are also now relying on their local cable company for basic phone and Internet service.
Investors have their choice between landline providers and satellite broadcasters. 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.
What's to Like
The cablers' core video franchises employ a subscription model, whereby a customer pays a regular monthly fee for unlimited access to a basic package of channels. The subscription model provides the companies herein with a good degree of revenue visibility and recurring cash flow. Fixed programming fees and low variable costs mean that there is little incremental expense associated with an increase in subscriber viewing.
High barriers to entry are also a plus. Traditional cable companies must secure franchise rights from municipalities, which, while not typically exclusive, provide a significant hurdle to newcomers. Local leaders, after all, don't want a gaggle of service providers tearing up city sidewalks to lay broadband conduits. Additionally, it can easily cost a company $500 million or more to roll out a satellite or wire-line network. The wherewithal to build out a network, before securing a critical mass of bill-paying subscribers, requires the support of patient, well-funded backers.
Many of the major service providers already have substantial, technically advanced networks and, thus, need little additional capital to support growth. Given good cash flow, the companies are comfortable with heavy debt loads (50%-60%). 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.
Last, but not least in the list of pluses, is strong consumer acceptance. While these companies provide a discretionary service, cable-TV is increasingly regarded as a basic utility (almost akin to electricity and gas service) that a homeowner or apartment renter pays for each month without hesitation. Based on total cost per hour, pay-TV is a cheap form of entertainment compared to movie theater and amusement park outings.
Over the years, following a near-monopolistic rein by certain providers, the competitive environment has heated up. 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. Cablers generally pay a per-subscriber fee to carry such popular networks as ESPN and USA. Keeping these programming fees under control is no easy task. What's more, contract renegotiations between content providers and distributors can take months and lead to carriage disruptions.
What to Watch For
While cable viewership tends to be pretty 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. On a company level, monitoring the trend in key performance metrics, including subscriber growth, account churn, and Average Revenue Per Unit (ARPU) will also be instructive. That said, subscriber growth and churn should be viewed within the context of pricing. Growth or low churn at the expense of ARPU suggests stiff competition and/or a less-compelling product offering.
Investors should consider the cable sector as part of a well-rounded portfolio. The companies here have strong consumer-driven franchises and generate a good amount of recurring revenue and cash flow. On the downside, as time goes by, the sector has to deal with greater competition. As the market matures, there are fewer opportunities to boost revenue and earnings growth.