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Why Cable Companies Should Fear The Worst

By: StreetAuthority
Posted: 3/17/2014 3:30:00 PM
Referenced Stocks: GB

The recent price wars initiated by T-Mobile (NYSE: TMUS ) are causing all kinds of headaches for the wireless service providers. These firms had enjoyed a stable and profitable pricing environment in recent years, but are now being forced to slash their own prices to keep customers from defecting.

AT&T (NYSE: T ) is among the casualties, as I recently noted , and its shares have lagged the S&P 500 by more than 30% over the past year.

#-ad_banner-#This is not how things were supposed to turn out. AT&T and its peers spent tens of billions of dollars constructing national networks with an eye toward charging monthly service fees that would always rise a bit every year.

The nation's cable companies have deployed a similar business model, making heavy investments in broadband access, and at the moment, are reaping a huge windfall as they charge $30 to $50 for various levels of Internet access. Yet like the wireless carriers, these cable/broadband firms may also soon get a rude wake-up call. And it's coming from the skies.

Over the past decade, satellite TV providers such as DirecTV (NYSE: DTV ) had hoped to undercut their terrestrial rivals by offering broadband service from orbiting satellites. Though such service has emerged as a viable option for customers that have no access to land-based broadband, the technology has never been good enough to go mainstream. The distance from satellites to Earth is just too far.

Perhaps the clearest threat to cable companies' broadband dominance comes from Google Fiber.

But the notion of airborne broadband access received a fresh look when Google (Nasdaq: GOOG ) announced "Project Loon" in June 2013. The company has launched a series of balloons that hover more than 10 miles above the Earth along an east-west axis in the Southern Hemisphere (the 40th parallel, to be specific).

How seriously is Google taking this project? In a recent article in Technology Review magazine , Google's Rich DeVaul predicted that "in the next year or so, we'll see some big announcements."

Still, the need to traverse that much space means that Google can only generate transmission speeds akin to 3G wireless technology, which may not be good enough for mainstream users. Google engineers are presumably looking for ways to increase transmission rates.

They may want to check out the approach reportedly being pursued by Facebook (Nasdaq: FB ) . Rumors abound that Facebook is looking to acquire Titan Aerospace , a maker of solar-powered drones. These drones are capable of delivering transmission speeds of up to 1 gigabyte ( GB ) per second, which would satisfy almost any Web surfer's needs.

Perhaps the clearest threat to cable companies' broadband dominance comes from Google Fiber. So far, the high-speed wiring of major cities has been limited to Kansas City, Mo.; Provo, Utah; and Austin, Texas (which is slated for service to begin next month).

Yet Google is now in talks with more cities and in any city where consumers can choose from more than one broadband provider, price competition will be the end result. Right now, Google's stated plans would only make a modest dent in the national cable footprint. "The highly profitable (cable) HSD market could potentially be faced with a compelling alternative in roughly 10% of its footprint (with Comcast (Nasdaq: CMCSA ) the most heavily exposed, with a 33% share in these markets)," notes Merrill Lynch analyst Jessica Reif Cohen. Still, she sees Google Fiber as more of a long-term threat rather than near-term.

UBS analyst Eric Sheridan suggests a mid-term threat: "Were GOOG to build out substantial networks in each of the markets mentioned, we believe the cable industry would begin to see an impact to fundamentals within the next 4-5 years."

The question for investors: At what point will cable industry share prices start to reflect the emerging pressures that Google Fiber (and perhaps those airborne approaches) represent? As it stands, cable companies are suffering from a slow attrition of TV viewers, as consumers "cut the cord." For a company like Comcast, which already has $44 billion in bonds, it will eventually have to pay off (before the assumption of Time Warner's (NYSE: TWC ) debt), the prospect of diminishing cash flows is unwelcome.

Risks to Consider: As an upside risk, cable companies will likely keep raising your TV and broadband bills until true competition emerges. So 2014 and 2015 forecasts may get upwardly revised.

Action to Take --> Shares of Comcast have risen 300% over the past five years, doubling the gain of the S&P 500. Charter Communications (Nasdaq: CHTR ) is up a whopping 400% in that time. But storm clouds are beginning to form for this industry, and though they are unlikely to impact financial results in 2014, they may start to lead investors to question whether these companies are really positioned for strong cash flow in the years ahead.