Cord-cutting is a slowly growing trend.
More American households are making due without cable, turning to over-the-top, Internet-based video services for their entertainment needs. There are now a full 10 million of these "broadband only" households. That number should rise as millennials -- a group of consumers particularly averse to cable TV -- continue to move out on their own. For the most part, the services available to cord-cutters have been limited, largely restricted to Netflix, Hulu, and Amazon Prime. But traditional networks, including Time Warner's (TWX +0.00%) HBO, are beginning to offer their content outside the constraints of the cable bundle.
Will the existence of these services spark a wave of additional cord-cutting? Analysts at UBS don't think so. In a recent research report, the company forecasts the market for U.S. paid TV providers -- and they're surprisingly optimistic about the industry's chances.
97.5 million households will keep cable
UBS believes that, five years from now, there will still be 97.5 million American households subscribing to a traditional paid-TV service. That's less than the roughly 101 million households that have cable today, but not by much -- UBS believes the industry will see compound annual subscriber loss of just 0.7% over the next five years.
Source: UBS
At the same time, the number of broadband-only households will increase, but not come close to overtaking paid-TV. In 2020, UBS expects the number of these households to stand at 24.2 million. That's more than double the number today, but paid-TV households will still outnumber broadband-only by a ratio of about four-to-one five years from now.
Only 15% penetration for HBO Now
HBO Now, Time Warner's service aimed at broadband-only households, will have 3.6 million subscribers in 2020, according to UBS. If so, just under 15% of broadband-only households will subscribe. UBS is much more optimistic about traditional HBO -- the network available to paid-TV households -- believing that it will have 37.8 million domestic subscribers in 2020, up from around 35 million in 2014, for about 40% penetration.
Source: Hbo.com
If that happens, it should be fantastic for Time Warner shareholders. HBO Now, while allowing more people to subscribe to HBO, presents a number of challenges to Time Warner as a whole. In addition to HBO, Time Warner owns a number of major cable networks, including Cartoon Network, CNN, TBS and TNT. Last quarter, these networks brought in about 38% of Time Warner's revenue and more than 60% of its operating income.
If cord-cutting as a trend continues to grow in popularity, these networks could suffer. With their focus on live sports, TBS and TNT could exist outside the bundle, perhaps offered individually like HBO or as part of a smaller, Internet-based bundle (such as SlingTV). But Time Warner's less popular networks might not make it. Perhaps for this reason, Time Warner's management has consistently argued that the existence of HBO Now would not disrupt the industry -- that, instead of competing and cannibalizing traditional cable, it would prove to be an additive service.
A wave of competing services
However, I think UBS' projections and Time Warner's proclamations ignore the second-order effects of HBO Now's existence.
Not wanting to be left behind, HBO's chief premium cable rival, Showtime will make itself available to broadband-only households later this year. Starz's management has strongly suggested that it would eventually do the same. It's easy to imagine that other networks with dedicated viewers -- perhaps ESPN -- could follow. Meanwhile, the existing Internet video services -- Netflix, Hulu, and Amazon Prime -- continue to beef up their catalog of original programming, making their products far more compelling in the process.
As both the quality and quantity of Internet video services increases, cord-cutting becomes a far more compelling prospect. While it's easy to project orderly declines in the number of paid-TV subscribers, and relatively modest growth for HBO Now, the number of paid-TV households could decline swiftly and exponentially as the Internet video landscape evolves.
Within Time Warner, HBO remains a compelling asset, and one that's likely undervalued. But the fate of Time Warner's more traditional networks, and the paid-TV landscape as a whole, looks far less certain.
