Cable Operators

What Recession?

Cable Stock Surge Nearly 40% During First Nine Months of 2012 10/07/2012 8:00 PM Eastern

Cable stocks experienced their biggest growth spurt in two years in the first nine months of 2012, rising nearly 40%, fueled by strong fundamentals and a renewed optimism in the cable model.

The four publicly traded MSOs — Comcast, Charter Communications, Cablevision Systems and Time Warner Cable — rode a wave of investor optimism virtually unseen since 2010, when the sector rose 39% for the full year.

But unlike the 2010 rise, which came after big declines in the previous two years, this uptick is building on increasing momentum — stocks were flat in 2011. That, coupled with strong fundamentals and an everincreasing lead in broadband service, has some analysts predicting that this run could last for the rest of the year and beyond.

Time Warner Cable led the pack, rising 47.5% ($30.88 per share) to $95.71 per share on Sept. 28 from $64.88 on June 29. The country’s largest cable operator, Comcast, ran a close second with a gain of 46% ($11.25 per share) to $35.75 each on Sept. 28 from $24.50 per share on June 29.

Charter Communications, which has a new CEO in former Cablevision chief operating officer Tom Rutledge, rose 31.2% ($17.87 per share) from $57.19 to $75.06 on Sept. 28. Even Cablevision, which has struggled to squeeze further growth out of its industry-leading penetration rates, saw its stock increase 7.2% ($1.07 each) in the nine-month period from $14.78 on June 29 to $15.85 on Sept. 28.

Pivotal Research Group principal and media communications analyst Jeff Wlodarczak said part of the reason for the uptick was the misplaced belief that after second-quarter 2011 results — when pay TV subscriber growth was negative for only the second time in history — cable had no further room to grow. Instead, operators have continued to add high-speed Internet subscribers, raised prices on some products (he pointed to Time Warner Cable’s recent move to increase cable-modem rental fees by $3.95 per month) and managed to maintain strong cash-flow margins.

“The outlook is for potentially accelerating growth,” Wlodarczak said.

ISI Group analysts Vijay Jayant and David Joyce added that recent M&A deals — at prices equal to 7 times to 8 times forward-looking cash flow — have validated cable valuations, while macroeconomic improvements have made it easier for companies to lower their debt cost and fund share buybacks.

The MSO sector handily beat the Dow Jones Industrial Average (up 10%) and the Standard & Poor’s 500 Index (up 14.6%) for the first nine months of the year. Perhaps more telling is how cable has stacked up against other sectors over the same time frame — the top six airline stocks (United, Delta, Jet Blue, Southwest, US Airways and American) rose 15.6%; retailers Walmart, Target, Home Depot, Sears and Macy’s were up a collective 33.6%; and automakers Ford, General Motors, Toyota, Honda and Nissan rose just 6.4%.

Canaccord Genuity media analyst Tom Eagan cited three factors that have helped fuel cable’s growth: solid fundamentals; a reduction of regulatory and over-thetop risk; and increased capital allocation.

The four MSOs average annual cash-flow growth of between 4% and 5%. While that is almost half the 8% to 9% growth the sector averaged three years ago, it has translated into lower capital expenditures and a sharp rise in free cash flow. That increase in free cash flow — about 40% over the past five years — has given operators the firepower to issue dividends and to buy back stock at an accelerated rate. Aside from Charter, which just started reporting positive free cash flow in 2010, the major MSOs have longterm share buyback programs and by the end of the second quarter had repurchased a combined $2.4 billion of their own stock and issued $1.2 billion in cash dividends.

On the fundamental side, cable operators have made big strides in reducing basic video-subscriber losses. Comcast alone cut video-customer losses by 40% between 2010 and 2011. At the same time, cable has maintained its dominance of the broadband sector — Eagan predicts that cable operators will add 1.07 million high-speed data subscribers in the second half of this year, or about 80% of total broadband additions in the period.

Eagan said that Federal Communications Commission chairman Julius Genachowski’s virtual endorsement of broadband usage fees has eased one of the biggest regulatory overhangs on the sector. The recent deal by the SpectrumCo consortium (consisting of Comcast, Time Warner Cable and privately held Bright House Networks) to sell its wireless spectrum to Verizon Wireless for $3.9 billion also has removed the fear that an MSO would make a big telco purchase, possibly buying Sprint.

Eagan added that these moves and others have also removed the onus of one of the industry’s biggest threats, over-the-top competition.

“We’ve seen some of the over-the-top players deflated,” Eagan said. “Whereas two years ago, there was a real concern that Netflix was going to be taking subscriber share from cable operators and satellite, I think that is less likely today.”

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