Big Cable Is About to Get Bigger

The cable industry, already known for its relative lack of competition, could be headed for more consolidation. We learned from a report this week in The Wall Street Journal that Charter Communications (NASDAQ: CHTR  ) is raising cash for a potential buyout of rival Time Warner Cable (NYSE: TWC  ) . So let's take a closer look at these two companies, and what their merger might mean for the industry -- and for consumers.

Charter Communications is the nation's fourth-largest cable operator. Like all the major video players, it gets only about half of its revenue from selling cable services to residences, with the rest coming from Internet, telephone, and business services. Charter counts about 7 million customers, many of which subscribe to several of its offerings. All told, Charter's average customer pays about $109 a month for some combination of those products. The company booked a total of $7.5 billion in revenue last year.

Time Warner Cable, meanwhile, boasts about 15 million customers, making it the second-largest cable operator in America. Like Charter, Time Warner has been losing video subscribers for the last few years, as the sluggish economy pressures consumers, and as more video viewing has migrated online. But the company has so far been able to make up for that loss by boosting its Internet subscriber base, raising prices, and by promoting bundles of its services; the so-called "double play" and "triple play" packages. Time Warner's average revenue per user ticked higher by 2% to $105 per month this past quarter. That figure was just $97 back in 2010. The company logged $18.2 billion in revenue in 2012, more than twice Charter Communication's haul.

One might wonder how a smaller company with half the subscriber base, half the revenue, and less than half of the market cap, could buy its larger rival. The answer is that Charter has some well-capitalized friends. The company is partially owned by Liberty Media, which acquired a 27% stake earlier this year.

But just because Charter technically could pull this deal off, it doesn't mean that it will. Charter will have to craft a proposal that's attractive enough to Time Warner's shareholders, which will be difficult to do without taking on a huge amount of debt.

Still, there's one excellent reason for the two companies to join forces, and its true for all cable companies these days: There's a growing imbalance between content producers and content distributors. Time Warner's programming costs jumped 8.4% last quarter, much faster than the 2% increase it managed in average monthly revenue. Charter Communications, which saw its programming costs spike by almost 10%, described the problem like this in its latest annual report:

We expect programming expenses to continue to increase due to a variety of factors, including ... annual increases imposed by programmers with additional selling power as a result of media consolidation.... We have been unable to fully pass these increases on to our customers nor do we expect to be able to do so in the future without a potential loss of customers .

So, if cable companies like Charter want to be able to counteract the expanding power that media companies are gathering, they have little choice but to consolidate their own purchasing. Raising prices on customers won't work, as that will just quicken their migration to digital services like Netflix. And while bundling and high-speed Internet sales help, it's not a long-term solution.

That's why consolidation makes sense in that it can restore balance between buyers and sellers of content for cable TV programming, which should also take some pressure off of those cable bills that keep marching higher.

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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 November 25, 2013, at 9:09 AM, BigRiskSkeptic wrote:

    Are you guys for real? You write articles like this based on pure speculation. There is no deal in the works. This is nothing but a stock pump and dump scheme created by the media on behalf of their media mogul bosses to run the price of their stock up . Show me one credible source on this story. TWC stock will tank once reality catches up with irrational exuberance.

  • Report this Comment On November 25, 2013, at 11:26 AM, TMFSigma wrote:

    Hi BigRisk, I would call the Wall Street Journal a credible source, but the New York Times and Reuters have also reported on this potential deal. And here's a more recent article from the LA times:

    http://www.latimes.com/entertainment/envelope/cotown/la-et-c...

    It could fall through, but all the reporting that I've seen suggests that consolidation is coming to the cable industry, and TWC looks like a target. But that doesn't make it an automatic buy, of course.

    Best!

    Demitrios

    @TMFSigma

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