Charter Communications (NASDAQ:CHTR) has decided to step up to the big leagues, assuming the Federal Communications Commission lets it.
The company, which currently has about 4.25 million cable customers will vault into the top tier of its industry once it completes its planned purchase of Time Warner Cable (UNKNOWN:TWC.DL) and Bright House. If the FCC approves those deals, Charter would be the number two cable provider in the country and the third-ranked pay-television company. It would also be the second biggest broadband provider in the United States at a time when the demand for Internet service has been increasing.
If Charter gets federal approval to close the Time Warner Cable purchase, a deal which values the company at $78.7 billion, according to a press release announcing it, and it completes its $10.4 billion Bright House Networks acquisition, it will be a different entity entirely. Even though Charter's management would be in control, the new company would even have a new name, fittingly enough New Charter.
But, in becoming a top-tier cable and broadband player while also taking on debt to fund the deal, Charter, or New Charter as it will be called, also takes on new risks.
What problems is Charter facing?
The biggest threat to any company in the pay television space is cord-cutting. The entire industry entered Q4 having lost only about 650,000 paying customers in 2015, according to Leichtman Research Group (LRG). In the last quarter, while not every company has reported, it looks like those losses either shrunk or turned into slight gains. This suggests that cord-cutting has not yet become a huge problem, but that does not mean that it won't.
The threat that consumers will drop cable in favor of streaming services is slowly forcing the industry to react. That means offering cheaper "skinny" bundles to keep people on board. That's good for subscriber counts, but bad for the bottom line. Going forward it's almost a certainty that Charter will have to offer less-expensive pay-TV packages if it wants to hold onto its subscribers base.
Broadband has its risks too
Internet service has been a growth industry because anyone looking to go without cable, be they a cord-cutter or a cord-never, needs quality broadband to properly use the streaming services. That should continue to drive subscriber growth over the next few years and it also allows for higher pricing or even instituting data caps, which despite how much consumers dislike them can be revenue drivers.
The problem facing Charter, or any other ISP, is that technology threatens to end their monopoly. Most U.S. consumers have at best two choices when it comes to Internet service which are usually priced similarly. Going forward however there are a number of major and minor players working on finding new ways to deliver broadband.
For now that has only resulted in some heavily hyped niche players operating in a small amount of markets. Going forward however it's very possible that broadband service follows the path of wireless phone service and essentially becomes a commodity.
The Time Warner Cable factor
Being relatively small has kept Charter from having to deal with national publicity over customer service issues. Time Warner Cable has not escaped the same scrutiny and has been raked over the coals by the media a number of times. That has not helped its reputation nor has the fact that on the most recent American Consumer Satisfaction Index TWC ranked last among pay-television providers and fourth from the bottom as an ISP.
Charter did not do much better coming in one below its potential acquisition in Internet, but beating it in cable landing at sixth from the bottom. The difference is that while Charter has had its problems, it has not built up the same nationwide level of mistrusts and consumer anger.
As New Charter begins it may benefit from being able to fly the "Under new owners" sign, but the honeymoon period will be very short.
How risky is Charter stock?
Anytime a company buys a bigger rival there's a risk that the integration will not go smoothly. Charter is going to more or less quadruple in size overnight and there is no guarantee that its management, led by CEO Tom Rutledge will immediately adapt to the change in scale. In the long run there is no reason to believe they want and being much bigger comes with both cost savings and competitive advantages, but it may be a rocky start.
In addition Charter is placing a big bet on a company where about half of its business comes from an industry that may be dying. Cable as we know it may have slowed the bleeding from cord-cutting, but it's very clear that at the very least the current model of selling take it or leave it high-priced bundles has to go.
In that respect Charter is no more risky than any other cable play, but it's a risky industry and being the new big boy on the block does not make things any easier for the the company. Charter is a risky play in a risky industry where investors face a real concern that cable revenues could at some point start a precipitous fall leaving pay-TV looking a lot like the music industry -- still here, but a shell of of its former glory.
Daniel Kline has no position in any stocks mentioned. He believes the company could have done better than New Charter as a name. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.