Cable companies such as Comcast (CMCSA +0.14%) and Time Warner Cable (NYSE: TWC) have for the last few years been threatened by rampant fears that consumers were soon going to cut the cord in favor of online technologies and send these companies into an early death spiral. Comcast, the biggest cable company in the country, seems to be feeding these fears with its continued loss of TV subscribers, with the company's subscriber base falling 1.6% in the last 12 months from slightly more than 22 million to around 21.6 million.
Yet, far from floundering in this age of video streaming and a slowdown in household formation, Comcast has actually been thriving in recent years. This is mainly thanks to its robust Internet offerings and a laser focus on small businesses. And there is good reason to believe that the company will continue going strong by continuously reinvigorating itself to keep up with the pace of innovation.
Broadband hedge pays off for Comcast
Comcast's cable business relies on a subscription/recurring-revenue model that usually generates lots of free cash flow. However, Comcast's TV subscribers are slowly decamping, with intense competition from AT&T (T +2.11%), which has aggressively been growing its U-Verse network as part of its Project VIP, mainly to blame for the erosion. AT&T expects to expand the availability of its U-Verse service by as many as 8.5 million customer locations from 2013 through 2015.
Comcast has managed to add more than 1 million high-speed Internet subscribers in the last 12 months alone, thus adding a cool 7.9% to its top line in the process. The cable giant's sales to small and medium businesses shot up a very healthy 26.4% in a similar time span. Providing Internet services, including voice and TV, to small and medium businesses, is a huge growth driver for cable companies. Time Warner has also been growing its business-services revenue by a 20% annual clip.
The company's revenue per subscriber for its high-speed Internet comes in at around the $43 range--that's better than what rivals Time Warner and Cablevision Systems manage. But the good news is that the figure is likely to grow even further by riding on the industry shift toward usage-based data and faster Internet speeds, which will command higher rates.
Smart bundling strategy
Comcast has been getting all that admirable growth by utilizing a clever trick that involves getting its existing subscribers to double play or triple play by bundling video, Internet, and voice services into one. The company has been very successful at this strategy too: two years ago, 70% of its residential video customers had subscribed to at least one other service while 36% of customers had all three; at the end of the third-quarter 2013, 78% of customers had at least one other service while 43% had a triple play. The ideal scenario would be where 100% of its customers had a triple play, so there is still plenty of room to run.
The company gets additional revenue from cable-television upgrades, including high-definition TV and video on demand, and also from rate increases. Its voice service enjoys a price advantage over telecom companies for customers who bundle services and helps it compete favorably with them. According to Paul DeSisto, a senior portfolio manager at MR Capital Management, the net effect has been that Comcast has many customers who pay on average $160 per month.
How will Comcast stem the loss of subscribers?
Comcast must find a way to stop losing subscribers. If the rate at which the company is losing subscribers holds steady at 1.6% per annum, then five years down the line the number of subscribers could be down to around 20 million. But Bill Smead of Smead Capital Management believes that Comcast will keep its existing customers going forward helped by three powerful forces: inertia, that force that stops customers from switching providers; leveraging the information it has gleaned from its huge customer base; and demographics, which have shown that household formation is quickly accelerating from its recession lows.
Comcast will start selling films directly
Comcast had an industry-leading 28% share of the $1.3 billion pay-television VOD market in 2012, according to an NPD Group report. But the cable giant is not resting on its laurels, and now plans to start selling films directly through cable boxes in 2014.
This is great news, considering that movies served digitally are far more profitable for companies than rental movies. Consumers typically pay around $5 per movie rental through pay-TV on demand, whereas they fork out $15-$20 for a digital purchase. Digital Entertainment Group estimates that the digital entertainment for online movies and television show sales is worth around $765 million, or 15% of the $5 billion DVD sales market.
Although the market is still relatively small, it's growing at a blistering pace, with sales growing 49% this year compared to a year ago. Assuming the growth rate stabilizes at around 30%, it won't be very long before the size of this market rivals that of traditional DVDs.
Comcast has a proud history of making great movies, and economically too. It released Despicable Me 2 this year, which totally eclipsed Walt Disney's (DIS +0.15%) The Lone Ranger and turned out to be the company's best five-day gross ever, pulling in $141.2 million during that screening period. Meanwhile, The Lone Ranger was a major box-office flop and could only manage a measly $48.94 million in a similar time span. Worse still for Disney, the company spent a staggering $220 million to create the movie, whereas Comcast spent a mere $72 million on its motion picture.
With a new and highly profitable channel through which to release its movies, Comcast should see a significant increase in the revenue it derives from its filming segment in the coming years.
Bottom line
Enterprise continues to be a huge growth opportunity for Comcast. Wi-Fi use by small businesses is growing in leaps and bounds. The company's focus on offering voice services to small businesses has allowed Comcast to offer a personal touch and helped it wrench a lot of market share from telecom companies. Overall the company is a good, strategic long-term investment.
