In the last year or so, we've seen the rise of what I'll call "TV-Lite" cable bundles. These are services like Comcast's (NASDAQ:CMCSA) Internet Plus, which includes high-speed Internet along with basic cable and HBO. AT&T (NYSE:T) and Verizon (NYSE:VZ) have jumped in recently with packages of their own that include over-the-top services like Netflix and Amazon Prime coupled with local channels and premium networks like HBO and Showtime. These bundles put the emphasis on Internet access and the online video offerings from HBO, Netflix, Amazon, and Showtime instead of on the actual television package -- hence "TV Lite."
This is enough to make people think cord-cutting is a serious threat to pay-TV operators, but it's actually evidence to the contrary: Cord-cutters or cord-nevers are a huge opportunity. These TV-Lite bundles attract people who have yet to signup for broadband Internet by showing them everything high-speed Internet has to offer. (At the same time, they entice broadband-only households to switch service providers.) From the end of 2011 to the end of 2013, the U.S. added approximately 3.1 million new Internet households, but Internet penetration still stands at just 79%. Among the 21% of households without an Internet connection, 12.2% said they don't see a need for it, which represents about 3 million households of opportunity.
Finding growth in a mature market
Over the past couple of years, growth in the U.S. pay-TV industry has been hard to come by. Some estimates say the subscriber base is actually shrinking due to cord-cutting and slow household growth.
But high-speed Internet continues to steadily add customers. Over the last year, the market grew about 4% to 5%, compared to a flat market in pay TV.
Indeed, Comcast over the last four quarters lost 155,000 video customers, but added 1.3 million Internet customers.
Meanwhile, AT&T and Verizon are taking market share of the pay-TV space from traditional cable providers, but their Internet subscriber base has grown much more quickly. At the end of the third quarter, AT&T had twice as many Internet customers as television customers. Verizon had 6.5 million Internet subscribers and 5.5 million television subscribers, and Internet additions are growing much faster.
Taking the next 15 million customers
Eventually, high-speed Internet will be as prevalent as cable television, which means there is still plenty of growth left in the industry. But the competition for that growth is fierce as AT&T and Verizon strive to expand their networks while Comcast works to defend its territory. At the same time, companies like Google and local businesses are trying to attract customers with higher speeds.
But the pay-TV providers have an advantage over the Internet-only providers -- at least, for now. They can offer things like HBO and Showtime, which are unavailable to noncable subscribers. That will change next year, when HBO and Showtime go over the top, but the opportunity to strike for pay-TV providers is now.
As the a la carte menu continues to grow, we might see different TV-Lite bundles from pay-TV providers that are unavailable to broadband-only households, but I doubt it. Instead, pay-TV providers will be able to undercut the a la carte pricing to attract Internet subscribers to their services.
Won't TV-Lite hurt profits, though?
Investors in pay-TV operators might worry that picking up the tab for a year of Netflix or Amazon Prime will cut into their company's profits. Considering the pay-TV operator has to split revenues with HBO and Showtime, and pay retransmission fees for its basic cable package on top of that, AT&T, Verizon, and Comcast likely aren't making any profits on the cable subscriptions.
But that's not the point of TV-Lite.
The point is to attract more broadband subscribers (and boost video subscriber numbers for appearances). If Comcast, AT&T, or Verizon break even on the rest of the bundle, which seems to be the case for the most part, the company is improving the bottom line by attracting Internet subscribers away from the competition. These aren't customers who were going to buy a big cable bundle anyway.
Getting caught up in margins can blind investors. These are certainly low-margin customers, but the key is that they're Comcast (or AT&T or Verizon) customers, and not someone else's. And who knows, maybe they'll become high-margin customers in the future.