Cord-cutting accelerated in the 2nd quarter of 2019, as video subscribers declined 4.4% year-over-year vs. 4.3% in 1st quarter of 2019 and 3.0% in Fiscal Year 2018.1 However, this continues to be more than offset by healthy data subscriber growth and price increases. The surge in video streaming associated with cord-cutting is fueling demand for broadband. The average cable customer is taking in excess of 100Mbps broadband speeds which should support a sustainable competitive advantage versus telco peers. Given the stronger Earnings before interest, taxes, depreciation, and amortization (EBITDA) margins in data (>60%) versus video (low double digits2), this trend will support higher cable margins over time. Video margins continue to erode as content providers negotiate higher affiliate fees, further reducing the importance of the video business. Cable free cash flow has improved in 2019 due to lower capex from completion of DOCSIS 3.1 network upgrades.
Our Industry Assessment is supported by:
Level of Competition
Competition among cable providers is minimal, but cable providers are experiencing intensifying competition from over-the-top video services such as Netflix and Hulu. The lower price points with narrower product offerings are particularly attractive for price sensitive consumers. This competition will increase when Disney and AT&T launch similar streaming services. The competitive risks are more significant for satellite providers who do not have the defensible broadband services to fall back on. Cable companies are increasingly broadband-centric businesses and their competitive position is strengthening after DOCSIS 3.1 network upgrades which provide a competitive advantage versus telco’s slower DSL offerings. Telco Fiber remains under- penetrated within cable provider footprints. While 5G remains a potential long term threat, the buildout costs will be high and reliability will be a concern compared to fixed line cable. 5G also requires substantial backhaul which increases the need for fixed lines.
Regulatory Environment
The regulatory environment is neutral for the sector. Large merger and acquisitions (M&A) transactions will receive expected regulatory scrutiny, but the regulatory environment is largely balanced. It does not actively protect the sector nor create an unnecessary regulatory burden on participants.
Activism
Risk of transformational spin-offs or breakups remains balanced. Although the sector is pressured to adapt to a changing business model, the major players are more likely to increase breadth of services rather than break up to adapt to these changes. Shareholder returns are generally funded through internally generated cash flow.
M&A Risk
Transformational M&A remains a sector theme as competitors adapt to an evolving industry landscape. Cable providers are expanding into wireless and content businesses to offset pressures in pay-TV. Pressure to expand ancillary services increases the risk of overspending on acquisitions outside of core competencies.
ESG/Transformational Risk
Core pay-TV business models based on large channel packages are under threat and video revenue will continue to decline. However broadband internet now represents the substantial majority of EBITDA for cable companies and offers much better margins than video. Broadband speed and reliability provide cable companies with a competitive position which will be difficult to erode in the foreseeable future. Key Environmental, Social, and Governance (ESG) Factors: Litigation regarding anticompetitive behavior and data security are relevant ESG concerns for the sector, however, we believe these risks are relatively minimal compared to other sectors.
Position in Credit Cycle
Revenue and EBITDA are expected to grow in-line with GDP. Broadband revenue growth remains sufficient to offset weakness in video services. Rising programing costs and declining video subscribers will continue to pressure margins, but gains in broadband will help offset this pressure.
