2 Reasons Why Investors Should Tune in to Cable TV Stocks

Two recent events may have drastically changed the future for cable television providers. Potential industry consolidation and a propitious court ruling could make industry share gains much easier to achieve, with companies like Time Warner Cable and Cablevision the biggest beneficiaries.

Jan 21, 2014 at 7:00PM

Interesting things are happening in cable television. Signs of further consolidation among service providers and a recent U.S. Appeals Court decision rejecting "net neutrality" could make the operating environment much more cordial. The changes might benefit companies like Time Warner Cable (NYSE:TWC) and Cablevision Systems (NYSE:CVC) the most. 

An industry needing to consolidate
Consolidation among cable TV providers looks increasingly necessary. Saturated markets and new competitive threats have made company combinations the surest path for growth. Charter Communications (NASDAQ:CHTR), the nation's fourth-largest cable operator, is a good example of the urge to merge. While still absorbing a $1.6 billion summertime purchase, Charter recently offered to acquire Time Warner Cable, a much larger competitor, for approximately $38 billion. Charter believes the pooling will help profitably rationalize cable TV's very competitive marketplace.

Time Warner rejected Charter's $132-per-share bid as "grossly inadequate" and declared the proposal a "non-starter." The company conceded, however, that it would be willing to discuss a transaction at a higher price, suggesting $160 per share could get the ball rolling.

While the companies appear at odds on price, both seem to agree that a merger would be beneficial. Creating a single large entity, with its accompanying pricing power and cost savings, may be the only way these service providers can deliver meaningful growth in a sluggish operating environment.

Service providers struggle with growth
Time Warner's latest quarter unveils the difficulties industry participants face. While overall revenue increased a moderate 2.9% year-over-year, residential service sales hardly budged. Both a price increase and growth in broadband customers barely offset an exodus of the company's lucrative video subscribers. The loss of such customers has been a headwind for the entire industry. While not catastrophic, it has been a nagging trend that's not likely to change any time soon. In Time Warner's case, the number of video clients declined by about 6% over the past year. 

Growth in high-speed data, or broadband, subscribers has been a bright spot for the industry, however. Charter grew broadband customer levels about 7% over the last twelve months, and Time Warner added around 2%. But, these increases come at a price. Besides generating less revenue per subscriber, increased numbers of broadband users also means additional, and often significant, network building and upgrade costs.

A deal looks necessary, but at the right price
Continued video subscriber losses, together with an increased number of lower-yielding, but higher cost, broadband customers will likely drive industry merger activity. Time Warner's inclination to deal at the "right price" seems to support that fact. But, what is the right price for Time Warner Cable?

Based upon expected revenue near $22.1 billion and cash earnings of around $3.7 billion, the company looks to be trading around 10.3 times cash earnings. Time Warner's enterprise value is roughly 2.9 times total revenue, which is a noticeable discount compared to Charter Communications' share valuation of 13.6 times earnings and enterprise value of 3.3 times sales, given expected revenue of $8.5 billion and cash earnings of $1 billion.

These figures suggest that Time Warner's insistence on a higher offer may be reasonable. While its $160-per-share prompt, which values the company near 12.5 times earnings, may not be achieved, Charter will need to up the bid if it wants the benefits a merger can provide.

No net neutrality is a big "yes" for the industry
A recent federal appeals court decision might help Charter justify that higher bid. The ruling struck down the concept of net neutrality, which is the principle that Internet service providers should treat all data on the Internet equally, without discriminating or charging differently by user, content, or mode of communication. The notion has been supported by Internet service providers because they pay for building and maintaining much of the Internet infrastructure and believe they should have the option to charge differing rates based on the volume of data a customer might access through the system.

While the ultimate effect of the recent ruling is still uncertain, the decision is clearly a win for cable operators who offer broadband service. One company that might get a significant boost is Cablevision Systems. Cablevision, with about 3.2 million subscribers, mostly in the greater New York metropolitan area, has found growth difficult. In its most recent quarter, core cable and related services revenue increased a paltry 1.8% year-over-year, while operating income dropped 1.6%. 

However, the ability to increase prices on high-volume data users might help boost future results. With much of its business located in a relatively small, but desirable, geographic location, Cablevision could gain from a virtuous cycle of increased broadband revenue, funding an improved network and allowing for further data sales gains.

This potential benefit and the possibility of continued cable provider consolidation doesn't appear to be fully factored into Cablevision's share price, making the stock an interesting consideration. Trading around 6.9 times expected cash earnings of $631 million, with an enterprise value of  2.1 times anticipated sales of $6.3 billion, shares may offer noticeable upside as peer mergers and a better operating environment support positive industry revaluation.

The cable television industry is changing. A need for consolidation among service providers, and a recent court ruling regarding net neutrality, could justify higher valuations throughout the sector. While all industry participants will likely benefit, investors may want to consider companies like Time Warner Cable and Cablevision Systems, which might have the most to gain.

Profit from coming changes to the cable television industry
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.


Bob Chandler owns shares of Cablevision Systems. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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