The Best Return on Equity in Cable: Time Warner Cable Inc.

A popular way to analyze a company's profitability is with its return on equity, or ROE. ROE is calculated by dividing a company's net income by shareholder equity over the past 12 months, and it tells us how efficiently it turns invested money into profits. Profitability varies widely across industries, so investors should only compare a company's ROE to its direct competitors.

In the cable industry, profitability can be tough due to intense regional competition and the rise of cord cutting. Competition from other types of pay TV -- like satellite and broadband Internet solutions -- have turned publicly traded "pure play" cable companies into an endangered species.

Source: Pixabay

As a result, many "pure play" cable TV companies have low ROE ratios. Charter Communications (CHTR -1.44%) and Cablevision, the third and fourth largest cable companies in the U.S., both have negative ROE ratios due to weak bottom-line growth. Comcast (CMCSA 1.57%), the top cable company in the America, has a decent ROE of 17%, but it isn't a "pure play" cable company. Last year, over a third of its revenue came from its media arm, NBCUniversal. That leaves Time Warner Cable (NYSE: TWC), the second largest cable company in America, which has an ROE of 26% -- the best ROE of any "pure play" cable TV provider.

A popular takeover target
Time Warner Cable has been a popular takeover target over the past few years. Comcast agreed to buy Time Warner Cable for $45 billion last year, but the deal was abandoned earlier this year after intense regulatory scrutiny.

After the Comcast deal died, Charter stepped in and offered a new $55 billion deal for Time Warner Cable. The proposed merger includes a separate acquisition of smaller cable company Bright House Networks for $10.4 billion, which would give the new company, New Charter, 23.9 million customers across 41 states. That would make it slightly smaller than Comcast, which has about 27 million subscribers. New Charter would control less than 30% of the broadband Internet market, while the abandoned Comcast-Time Warner merger would have claimed 57%. New Charter would also have more clout in carriage negotiations with TV networks.

But this is actually the fourth time that Charter has tried to buy Time Warner Cable. Previous efforts fell apart under regulatory scrutiny, but the company believes that consolidating three companies under New Charter can keep Comcast's growth in check.

Strengths and weaknesses
It's unclear if the FCC will approve the merger, but investors should still be familiar with Time Warner Cable's strengths and weaknesses as a stand-alone investment.

Time Warner Cable's core strength is user growth. The company added 650,000 high-speed data subscribers last year, compared to 210,000 in 2013. It also lost fewer pay-TV subscribers in 2014 than it did in 2013. Like most of its industry peers, Time Warner Cable has struggled with "cord cutters" who ditch pay-TV services but use their Internet services for streaming services.

Last year, Time Warner Cable's video revenue slipped 4.6% annually but still accounted for over half of its top line. Its high-speed data revenue rose 10.4% and accounted for 35%, while the remainder came from voice and other services. To balance out this lopsided growth, Time Warner Cable is offering more bundles of TV, Internet, and phone services. It's also steadily hiked its average fee per broadband subscriber from $42 per month to over $54 between 2007 and 2014. But when we look at Time Warner Cable's top and bottom line growth over the past three years, we notice that its top-line growth has been slowing down.

Source: Annual reports.

Jackdaw Research claims that by 2018, Time Warner Cable's revenue growth will flatline due to cord-cutting trends. Rising competition could cause broadband fees, which have supported its bottom-line growth, to slip. To make matters worse, Time Warner Cable still has $22.6 billion in debt, which would give New Charter twice the debt-to-earnings ratio as Comcast if the merger is approved.

Looking beyond ROE
We should remember that ROE is just one way to analyze a stock. Responsible investors should also compare it to other metrics -- like price-to-earnings, price-to-sales, and free-cash-flow ratios -- to gain a clearer picture of a company's financial health.

As for cable TV companies, investors should also be aware that disruptive trends like cord cutting can cloud their long-term outlooks. For now, cable giants like Time Warner Cable are relying on broadband Internet, bundles, and their own streaming services to support them through the cord-cutting transition.