In recent years, cable operators like Comcast (NASDAQ: CMCSA ) and Time Warner Cable (UNKNOWN: TWC.DL ) have faced a variety of new competitive threats. First, satellite TV companies sprang up and phone companies started offering pay-TV services. More recently, the Internet video revolution has led some people to "cut the cord" entirely, relying instead upon "over-the-top" services like Netflix (NASDAQ: NFLX ) .
In spite of these challenges, cable operators' profits have been surprisingly resilient. Time Warner Cable's net income doubled between 2009 and 2012, while Comcast's operating income from the cable communications division (which excludes the company's acquisition of NBCUniversal) grew 22% from 2010 to 2012.
However, the slow bleeding away of video customers from cable providers will put severe pressure on these companies over time. Cable operators have kept earnings growing primarily by moving TV customers up to "double-play" and "triple-play" packages that also include Internet and/or phone service. As the base of video customers continues to erode, it will be harder to do this.
Customer drift at Comcast
Let's start by taking a look at Comcast, the largest cable provider in the U.S. In the company's most recent earnings release, it noted that its combined customer count was 52.1 million at the end of second quarter, up 3.1% year over year from 50.5 million.
However, those 52.1 million "customers" are not all unique households or businesses. Comcast sells video, high-speed Internet, and voice services, and double-counts (or triple-counts) the customers who take bundled packages with multiple services.
If we look just at the video segment -- the company's "bread-and-butter" and the largest segment by revenue and customer count -- Comcast's had 21.8 million subscribers at the end of second quarter, down about 1.5% compared to the prior year. In other words, more than 100% of the growth in total customer numbers was attributable to high-speed Internet and voice services.
Comcast's primary tool for driving this growth has been bundling: selling high-speed Internet and voice services to existing video customers. At the end of second quarter, 77% of Comcast's video customers had at least one of the two other services, and 42% of video customers had all three.
Comcast's already-high penetration rate creates one barrier to maintaining the current growth rate in voice and Internet services. The shrinking of the video subscriber base will add to the pressure. With fewer video subscribers left to move up to higher-priced bundle packages, Comcast will have trouble replicating its recent earnings growth in the cable business going forward.
Same old story
A similar dynamic is playing out at Time Warner Cable, the second largest U.S. cable company. In 2012, Time Warner Cable added 1.6 million residential "primary service units" (a measure similar to Comcast's customer count). However, the vast majority of that growth came from the acquisition of Insight, a small Midwestern cable operator. Excluding that acquisition, residential primary service unit growth was less than 100,000 for the full year.
Moreover, video customers have been fleeing. Including the acquisition, Time Warner Cable added 141,000 residential video customers. The Insight acquisition brought 673,000 new residential video subscribers, though. Thus, on an organic level, Time Warner Cable lost more than half a million video subscribers last year: more than 4% of its video subscriber base! In the first half of 2013, the company lost another 300,000 video subscribers.
Time Warner Cable has posted solid growth with business customers recently, which has helped offset the poor residential performance. The company has also aggressively moved data customers into higher-priced, faster services. Still, residential video accounts for roughly half of the company's revenue, and if customers continue canceling their video services, they may also take their data and voice business elsewhere.
Foolish bottom line
The market for cable TV services is under pressure from multiple long-term threats. The advent of satellite TV and the entry of telecom providers into the TV market have made the market much more competitive over the past 20 years or so. Today, the growth of Internet video services is convincing some people to give up pay-TV service entirely.
Despite these competitive threats, Comcast trades for a healthy 16 times forward earnings, while Time Warner Cable trades for 15 times forward earnings. These valuations imply that investors expect at least modest growth -- not decline -- beyond 2014.
Yet the crutches that both companies have been leaning on may become less helpful over time. With fewer video subscribers left, there is less of a market for upgrades to "double-play" and "triple-play" service. Furthermore, new entrants like Google could potentially upend the high-speed data market, disrupting the last bastion of growth for cable operators. As a result of these competitive challenges, I am not inclined to invest in any cable provider for the foreseeable future.
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