Cable and Satellite: Investing Essentials

Americans love watching TV. TV-watching accounts for more than half of a typical person's leisure time, according to the Bureau of Labor Statistics. In fact, in recent years, surveys by Nielsen have repeatedly shown that on average, Americans watch about 35 hours of TV each week! This rises to more than 50 hours per week for senior citizens.

Considering the amount of time we spend glued to the TV, it's no wonder cable and satellite firms make lots of money delivering huge bundles of channels to our homes. Cable firms also have huge revenue streams from providing Internet and phone services. As a result, investing in cable and satellite can be very rewarding -- but the industry is not without its risks.

What is the cable and satellite industry?

Traditionally, cable and satellite have been the main conduits for TV service in the U.S. and elsewhere. Cable systems were originally built in the U.S. in the late 1940s and 1950s to provide better quality TV service to people who could not get good reception of free broadcast TV.

Cable operators typically offer TV, Internet, and home phone service. Photo: The Motley Fool

Over time, cable systems began to offer programming that was not available through free over-the-air broadcasts. For example, Ted Turner created the TBS "superstation" in the 1970s, offering programming from an independent Atlanta broadcast station to cable subscribers nationwide.

Today, large collections of channels are packaged together for sale to customers (although some premium TV channels are sold separately). Most cable operators also offer Internet and home phone services.

The satellite industry sprang up later in a bid to break the market dominance of cable firms. Satellite companies primarily offer stand-alone TV service, although some also offer limited Internet service.

How big is the cable and satellite industry?

Total annual revenue for the North American cable and satellite industry as of 2013 was about $170 billion, according to Bloomberg, and growing gradually. The vast majority of that goes to cable companies, largely because they generally offer high-speed Internet and phone service -- and sometimes other services such as home security -- in addition to TV. .

Despite being a large industry by revenue, there are only a few major players in the cable and satellite industry. Cable and satellite firms enjoy huge economies of scale: the marginal costs of adding new subscribers are relatively low compared to the fixed costs necessary to operate a cable or satellite system.

This is because the cable and satellite infrastructure -- one of the biggest expenses for cable and satellite companies -- is already in place to deliver TV and other services to subscribers.

How does the cable and satellite industry work?

Technologically, cable and satellite have significant differences. Cable companies build wired ("cable") connections to homes and businesses. They negotiate bulk deals with the owners of TV channels to pay a set fee per subscriber for each channel. The cable companies then package those channels into different tiers of service at various price points. (More expensive packages have more channels, particularly for sports.)

Cable companies can also transmit data over their wired connections. This allows them to offer high-speed Internet and voice services. Cable companies typically try to boost their revenue and margins by signing up customers for combinations of TV, Internet, and phone services..

Satellite companies offer TV service, competing with cable providers. Photo: The Motley Fool

By contrast, satellite companies own (or lease space on) communications satellites that orbit the Earth. These satellites transmit TV signals that can be picked up by satellite dishes that are installed on each customer's property. Like cable companies, satellite companies negotiate deals with TV channel owners to carry those channels as part of various TV packages.

Satellite companies can also offer Internet service, but satellite Internet tends to be slow and has high latency (a delay in sending or receiving information) because of the long distance between the satellite and the user. Satellite Internet is improving, but it is still primarily used in remote areas where wired broadband is unavailable or prohibitively expensive.

What are the drivers of the cable and satellite industry?

Cable and satellite companies aren't immune to economic conditions, but they tend to have fairly stable subscriber bases. But the cable and satellite industry is being affected by secular shifts in the market for TV and Internet services.

For cable companies, one significant long-term challenge is "overbuilding." This challenge essentially amounts multiple cables companies being able to provide service in a specific geographical area, with each company having its own proprietary cable lines. The result has been that most Telecom firms maintain wired connections to most houses in the U.S. Over the past decade or two, they have upgraded many of these connections to support TV service and faster Internet connections.

Cable operators refer to this entry of telecom companies into the pay-TV market as overbuilding. The entry of a telecom competitor into a new geographical market can often spark a price war with the local cable company.

Meanwhile, satellite companies are being affected by the trend toward bundling TV, Internet, and phone service into discounted packages. Satellite companies today can only deliver TV service efficiently. Sometimes they can partner with local telecom companies to offer Internet and phone service -- other times they have to compete on price alone.

The whole cable and satellite industry also faces a long-term threat from the rise of subscription Internet video services. An increasing number of people have found that they can find all the video they want online, and are dropping their pay-TV service (or never signing up in the first place).

For now, it's unclear whether millennials who have never had pay-TV service will sign up for cable or satellite TV when they get older. If cable and satellite TV service becomes less ubiquitous in the future, then cable and satellite companies could be in for a lot of pain.

Fortunately, cable companies are more diversified due to their Internet, home phone, and other service offerings. As Internet TV grows, people may trade up to more expensive, higher-speed Internet connections. By contrast, satellite companies' fortunes are tied much more to the health of the pay-TV market.


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