You have to hand it to cable companies. For years, they
continually boosted prices and still managed to retain customers.
Only recently has their customer base begun to shrink modestly. But
thanks to several recent developments, the pace of customer
defections looks set to accelerate. This implies that sales and
profits may soon peak (if they haven't already), and with some
pretty hefty debt loads, certain companies may see their
Rising costs, sinking value
Cable companies such as
Time Warner (
Conmcast (Nasdaq: CMCSA)
Charter Communications (Nasdaq: CHTR)
aren't fully to blame for their current predicament. Key cable
network operators such as
, which owns ESPN and others, have forced the cable companies to
pay ever-higher fees, and those costs needed to be passed on to the
consumers. Trouble is, consumers are no longer mesmerized by
theoption of more than 100 channels, realizing that they watch only
a handful of broadcast and cable networks.
This created an opening for the likes of
and Hulu.com to start winning converts, some of whom have "cut the
cord" with cable companies. Yet it is three recent moves that
really threaten to make consumers flee in droves.
Threat No. 1
The first threat comes from
Amazon.com (Nasdaq: AMZN)
Apple (Nasdaq: AAPL)
, which announced in 2011 that they plan to develop a robust video
for consumers, presumably at monthly fees far below that of a cable
bill. This threat has been widely considered by
in recent months, though its impact has yet to be really felt.
Amazon is expected to be the first to launch a service, which is
not only a threat to Netflix (
as I noted here
), but also to traditional cable service as well, at least for
consumers that are willing to time-shift their viewing habits away
Threat No. 2
New York-based Aereo, a little-known holding of Barry Diller's
media empire (IAC Interactive (Nasdaq: IACI) owns a partial stake)
is set to roll out a $12-per-month service that lets consumers
watch local broadcast stations on mobile devices and their TVs
through a specialized box that pulls in digital signals far more
effectively than rabbit ears. The move is being contested by firms
like Disney, but could ramp up later this year. This could lead to
defections from cable subscribers who don't watch a lot of TV.
Threat No. 3
Intel (Nasdaq: INTC)
News reports circulated this week that the giant chip maker plans
tooffer an Internet-based cable service, selling various bundles of
cable networks that better target specific demographics. For
consumers who only watch reality shows or sports programming or
high-brow dramas from networks like FX or
AMC (Nasdaq: AMCX)
, this could be just what they've been waiting for.
Why Intel? Because the company appears to have realized that
further robust sales gains from chip-making may be hard to achieve,
despite an $8 billion annual expenditure on research and
development. With roughly $15 billion in gross cash and $6 billion
to $8 billion in annual
free cash flow
, Intel can afford to make a major bet on this initiative.
How will this play out? Either Intel will fail to move beyond the
thought stage of this initiative, realizing that odds of major
success are long, or it will plow ahead anyway, likely creating a
lose-lose for itself and the cable companies and a win-win for
consumers that get more choice and lower prices.
For the cable companies, the prospect of a shrinking customer base
is a real concern. These companies carry huge debt loads, and an
increasing portion of their operating
may simply fund interest expenses (as
falls and interest expense stays constant). This means their shares
will be worth less and less if current operating and free cash flow
multiples stay in place. In a worst case scenario, cable operators
would be forced to pay higher interest rates when it comes time to
roll debt over, as interest coverage weakens.
Risks to Consider:
A rebounding U.S. consumer may feel less stressed and more
willing to tolerate high cable bills.
Action to Take -->
For many investors, cable stocks have been a core long-term
holding. The time has come to rethink this strategy. The four cable
companies I mentioned have seen their subscriber base modestly
shrink in recent quarters, though that process looks set to
accelerate. By 2013, as these threats really start to bite,
analysts will begin to identify the real risk in these business
models as falling cash flow and still-high debt loads look like an
increasingly mismatched pair. Aggressive investors may feel the
urge to short these stocks, but investors should steer clear of
buying these stocks at the very least.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of INTC in one or more if its "real money" portfolios.