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Classic Cable in a Digital World

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The services sector has changed dramatically over the last few years. Smaller, more nimble, and more profitable companies are eating away at the old guard's market share, and many of these elderly titans are feeling the pressure. So what's Time Warner Cable (NYSE: TWC  ) , the fourth-largest cable provider in the U.S., to do about all of this competition? Put them in their place with an awesome earnings report, that's what.

Is there a Warner sister?
Time Warner Cable was originally a simple cable provider, but today it also provides subscribers with digital TV packages, Internet services, and more. The diversity of its products has helped the company remain a competitor in the ever-growing media sector, and its most recent earnings report shows that TWC is still a very viable player.

Early this morning, Time Warner Cable announced its second-quarter earnings for 2012, and the news was pretty darned good. Revenue increased 9.3% to $5.4 billion, boosted by several acquisitions, including Insight Communications (which was added to the balance sheet for the first time). But because of these acquisitions, Time Warner Cable's free cash flow for the first half of 2012 decreased 11.5% to $1.5 billion, while net debt increased nearly $2.7 billion. Since these are attributed to acquisitions that will ultimately help TWC grow its bottom line, don't be too concerned about them.

TWC earned $1.43 per share this quarter, compared to $1.24 in the second quarter of 2011. This thoroughly trounced analyst expectations of $1.38, and shareholders must be pretty happy considering the stock is up more than 35% this year. There is one thing that may bug investors about TWC, though: It's losing subscribers.

Fierce competition
Since the second quarter of 2011, Time Warner cable gained 232,000 new residential video (cable and HD TV) customers; however, since the first quarter of 2012, the company has lost 169,000 subscribers. In the earnings statement, TWC notes that declines were due to fewer premium channel and video-on-demand viewers. Time Warner Cable isn't the only company struggling with fewer cable subscriptions; in its second-quarter earnings report on Aug. 1, Comcast (Nasdaq: CMCSA  ) , the largest cable provider in the U.S., announced that it lost 395,000 subscribers year over year. So what's contributing to these losses?

In the last few years, several new players have entered the cable and Internet business, and many are finding the sector quite to their liking. Smaller competitors like Netflix (Nasdaq: NFLX  ) and Hulu are providing Internet users viewing content comparable to TWC's, but for far cheaper. Meanwhile, larger rivals like Verizon (NYSE: VZ  ) with its FiOS and AT&T (NYSE: T  ) with its U-Verse are using their huge bandwidth capacity to give subscribers great packages combining Internet and cable subscriptions. All of these companies are chipping away at Time Warner Cable's market share.

So, just how concerned should Time Warner Cable investors be? While subscriptions did sink, TWC noted that the loss of revenue from fewer viewers was offset by price increases and higher revenue per subscriber. In fact, despite losing customers, TWC increased residential video revenue by 4.5%. This reflects TWC's pricing power as well as customer loyalty, and it indicates that if the company loses more subscribers in the future, it will find a way to remain profitable.

The future is now
Even with all of these new competitors, Time Warner Cable is still a smart investing choice. The company is cheap, with a P/E of 16.3, making it much less expensive than the industry average of 25.8. It also has a dividend yield of 2.6% (compared to the average 1.3%) and a payout ratio of 38% (compared to the average 21%), making it an excellent income investment for the sector. Finally, as you can tell from the company's earnings report, TWC remains a very healthy and stable company despite ravenous competition. If the company can regain some market share in the coming months, then it may be the strongest choice in the services sector.

A deluge of new competitors may be nibbling away at the company's edges, but its nougaty center remains strong (and delicious). In all seriousness, you may want to throw TWC on your watchlist and wait until next quarter to see if the company can regain some market share.

If old-school media isn't your thing, then you have a lot of investing options in the fast-growing world of digital media. One of the best companies we've found in this sector is Netflix, and you can read all about it in our brand-new premium report.

Fool contributor Mark Reeth doesn't have cable, just a laptop with Internet. That's all he needs. You can follow his adventures on Twitter @ChristmasReeth.

The Motley Fool owns shares of Netflix, and have recommended buying shares of Netflix. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 03, 2012, at 3:49 PM, BMFPitt wrote:

    Long term, classic cable is going the way of the landline.

  • Report this Comment On August 03, 2012, at 8:22 PM, SaraW946 wrote:

    I agree and lots of them will be obliterated once Apple TV is out.

  • Report this Comment On August 06, 2012, at 8:32 AM, rtichy wrote:

    "...While subscriptions did sink, TWC noted that the loss of revenue from fewer viewers was offset by price increases and higher revenue per subscriber. In fact, despite losing customers, TWC increased residential video revenue by 4.5%. This reflects TWC's pricing power as well as customer loyalty, and it indicates that if the company loses more subscribers in the future, it will find a way to remain profitable."

    That's not a business plan that gets an "A" in economics classes! The Abraham Lincoln quote about fooling people suggests this is a short lived strategy for profitability.

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Mark Reeth

Mark Reeth is an incredibly handsome Consumer Goods editor, and is an expert on all things that fall within the Consumer Goods sector (especially video games). Follow him on Twitter for all of the most important CG news.

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