Quick Thoughts: Cable Myopia

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Peter Kafka “Big Cable Loses More Subscribers, Still Says It Isn’t Seeing Cord-Cutting”  All Things D

Cable companies try to explain away TV subscriber losses, but even if cord cutting is just a trickle today, the deluge may be closer than the industry wants to think.

Another quarter has come and gone and the cable industry’s tap dancing to explain away declining video subscriber levels is once again generating a sizeable clatter.  Cablevision shares were pummeled last week on a clear miss that included a 0.5% QoQ drop in video subscribers.  Time Warner Cable disappointed a day later and announced its own 1% sequential decline in TV customers.  Comcast followed on Wednesday with an earnings miss but a revenue beat and a deceleration in the pace at which it is losing video subs to 0.7%, which settled investors who had already hit the stock in the wake of the TWC and CVC numbers.

The cable bull explanation is “It’s the economy, stupid”.   With more than 15% of Americans not working, it is reasonable to believe that some of them would forgo cable television, and its nearly $140 average monthly bill, to ease the strain on household economics.  At the same time, we note that high-speed internet and wireless subscriptions continue to grow, so at the very least, cable TV seems to be an increasing victim of budget triage as it tumbles down the list of consumer priorities.  Whether or not we call them “cord cutters” is academic, as former cable subscribers will need to find something else with which to occupy their time, and the exploding usage statistics on all forms of Internet delivered video suggest that it is a more likely alternative for most than curling up in the corner with a good book.  All of us know at least one family delighted to share their cord cutting story with anyone willing to listen.

 

Cable bulls could also make the argument that the outflow of video subscribers – off 2-4% YoY, and down 6-8% vs. 2009 – is just a trickle, more than compensated for by the 8% annual growth in monthly revenue per video household (Exhibit 1).  To my eye, this revenue growth, driven in large part by rate increases, is a part of the problem rather than evidence of a solution.  Monthly cable bills have, with health care and secondary education, the distinction of being “big household expense categories that have been growing faster than 6% per year since the 1980’s.  Like the providers of health care and secondary education, cable companies are not able to pocket the price hikes, but rather are themselves under the thumb of spiraling costs.  In this case, it is cable networks demanding ever higher fees for their channel portfolios to compensate for their own rising costs of procuring programming.   For example, on Halloween, DirecTV Group announced that it had reached agreement with Fox to continue carrying its networks at an undisclosed increase in fees.  Three days later, DirecTV guided that total costs for all of its programming would be up by “high single digits” in 2012.  This is not a sustainable model, particularly as the quality and availability of alternative video entertainment on the Internet continues to improve.  It would seem that a trajectory of endless price increases could only exacerbate the cord cutting problem.

Another bullish argument for cable is that the game is rigged.  For 70% of Americans, the only option for broadband fast enough to support Internet video is their cable provider.  If these Americans want to cut their cable TV service with its thin margins and insatiable network providers, fine – the cable industry makes higher margins on Internet service with far more controllable costs.  By the way, current cable architecture limits total system capacity to 152Mbps shared amongst 500 households, so if more than 20 of these households want to watch Netflix on Friday night, OOOPS!  If you want better service, you will have to pay for it.

In the status quo, the cable industry has the leverage to make this stick.  However, the status may not remain quo for long.  First, the FCC has already made one serious run at putting the broadband industry under more restrictive regulation.  Consumers are unequivocal in their distaste for their cable providers – combining annual 7% rate increases with indifferent customer service at best will do that.  Comcast was voted the single worst company in the U.S. in 2010 by the readers of the Consumerist web site and followed it up with a last place in Temkin’s 2011 consumer trust ratings of 143 large US companies.  Deteriorating broadband performance and usurious pricing for higher speeds could bring the sort of constituent pressure needed to unfetter the FCC from Congressional opposition.

Second, competition is coming.  It will take a few years, but the technology roadmap for 4G LTE wireless will enable residential broadband at speeds far beyond current cable modem service, with competitive costs and wide availability.  A rapacious cable industry would find itself seriously undercut by wireless operators that can sweep into a neighborhood with a single base station.  We’ve written about this threat extensively, and believe that cable operators are not prepared for how quickly it will advance and how widely it will be deployed.  Until then, the threat remains that Cable will throttle internet service to thwart would be cord-cutters into staying aboard with regular evening brownouts and usage cap restrictions.  This will likely hold near term subscriber losses to the 2-4% annual trickle, while creating a reservoir of consumer resentment that could result in massive defections once the dam breaks.

So in the near term, cable investors ought not to take comfort in TV subscriber numbers, even if they turn upward for a quarter here or there.  In addition to the long term threat of cord cutting, there are other scary dynamics in play.  For example, high margin telephone service is now pushing 10% of revenue for the leading cable operators, and more than 15% of profits.  To date, cable telephony has thrived by siphoning off traditional wired telephone customers from Ma Bell with cheap service bundled in a “triple play” package.  Meanwhile, there is another force afoot.  Cable operators are used to a strong kick to profits from a fast growth residential telephone business that has gone from 0 to nearly 25% market share in 15 years.  Meanwhile, the bigger bite for traditional telcos has been the almost 30% of Americans that are now wireless only, a phenomenon that has really only built over the past 6-7 years.  Soon, this trend will become painfully obvious to cable MSOs and their investors as well.

The other scary trend for cable operators is the growth in audience and advertising spending for on-line video.  So far, the numbers are small enough that they don’t really siphon off much from traditional cable TV, but the trajectory will soon force the issue.  Already advertisers are willing to spend 20% more for an impression via internet video than via broadcast TV (Exhibit 2).  As budget constraints begin to force them to choose, it will put serious pressure on broadcast advertising rates.  It is a self-reinforcing cycle – on-line video eyeballs beget advertising dollars, which beget more and better content, which attracts more eyeballs.  I don’t think that the genie can be stuffed back in the bottle.



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