Cord-cutting, as the investment community is aware, has greatly increased over the past few years. Competition from internet streaming content providers has increased as the traditional television bundle has gotten more expensive, causing more and more consumers to shed linear TV -- or never sign up for it in the first place ("cord-nevers"). This year, cable subscriptions are projected to fall 3.8% -- an even higher rate than the 3.4% drop in 2017.
That is at least one of the reasons cable company stocks have been hit over the past year or so, with Charter Communications (NASDAQ:CHTR) being a prime example. Charter delved into the subject of cord-cutting on its recent earnings call with analysts. The company emphatically believes the phenomenon won't materially affect its financial results going forward and pointed investors to a few reasons why.
How profitable is cable really?
The first thing Charter wants you to know is that the linear video business, while providing the largest portion (40%) of its revenue, has been less and less profitable for years and currently makes up a smaller portion of company profits than investors might think. According to management in a presentation, "Video product gross margin has declined over the past 10 years, yet overall cable customer relationship and financial growth has remained healthy. ... The cash flow contribution of video grows smaller by the year and the transition remains manageable for cable even if video units decline."
CEO Tom Rutledge told analysts during the company's conference call that:"Cable success as an industry, despite the challenges of stand-alone video product margin pressure, is because at our core, we provide connectivity. ... We've never looked at product-specific margins at Charter, but rather at the profitability and returns of an individual customer or passing."
Indeed, investors have no real way of knowing exactly how profitable Charter's video segment is, since the company doesn't break out profits of its individual products. That being said, the company is in fact getting more profitable as it adds more overall customer relationships. While the company grew revenue 4.8% last quarter, adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) grew 5.3%, showing company margins are expanding, not declining.
The margin expansion happened while Charter lost 73,000 video customers (while adding 223,000 broadband customers). So as long as the company continues to add more broadband customers over its fixed network, moderate video losses shouldn't affect overall profitability. Also encouraging was the fact that Charter lost fewer video customers than in last year's second quarter, when it shed 91,000. That bucks the overall industry trend of accelerating losses.
So while cord-cutting is happening, it doesn't seem to be a mortal blow to the company's growth.
Could video even turn around?
It's also not entirely crazy to think that video subscriptions may turn around, especially at Charter. In fact, last fall, Rutledge predicted the company could grow video subs over the next three years. So far, that hasn't proved true, but the losses are declining.
In addition, total video consumption is actually rising -- it's just coming from skinny packages, premium streaming channels delivered over the internet, and, of course, unauthorized password sharing (you know who you are!).
The company believes it can adapt and retake some of that pie in the medium term. Charter is still in the process of converting its remaining analog cable lines to all digital, which allows for two-way communication between the cable company and a customer's set-top box. The company plans to roll out a more modern Spectrum Guide, which helps you find things to watch, on its new WorldBox (which can be upgraded digitally via software), a cloud-based DVR product, and also mentioned potentially more innovative video packages in the future. These upgrades are still taking place, but the company should be 100% digital and implementing the new hardware by the end of 2018.
An incoming bundle
Unless Charter can restrain the increasing costs of programming from the cable content industry, I'm not sure it can pull off video growth. At the same time, I also don't think Charter's video segment will fall off a cliff. Household formation is on the rise, the U.S. economy is in relatively strong shape, and the cable bundle is still a decent deal if you stay at home and watch a lot of TV.
Charter also just began offering a wireless phone service, licensing its network from Verizon. The video offering, when combined with a leading broadband product, could very well help grow this new mobile product via customer-friendly bundling. The triple-play bundle may also persuade those who are on the fence to stick with Charter's video packages going forward.
Plug in to Charter?
Investor skittishness over cord-cutting has caused a sell-off in cable stocks such as Charter, but if the company can manage to grow overall customer relationships and keep video losses at a reasonable rate, today's stock price may seem like a bargain in a few years.