Up-and-Down 2Q for Time Warner Cable

8/03/2007 8:05 PM Eastern

After a first quarter that made some investors and analysts believe the triple-play bundle of voice, video and data would indeed be the gift that keeps on giving, the latest results from the nation's two largest cable operators gave investors pause that the party could be coming to an end.

The first signal came on July 26, when industry leader Comcast reported a loss of 95,000 basic-television subscribers in the second quarter, compared to a gain of 75,000 in the first, and sluggish growth in high-speed Internet customers. Despite near-record second quarter revenue and cash-flow growth, investors drove the stock down 4.7%, or $1.33, to $27.21.

The pain continued last week, when No. 2 cable operator Time Warner Cable said it lost 57,000 basic customers in the second quarter, versus the 9,000 to 11,000 subscriber losses most analysts expected. It reported 9% increases, year over year, in revenue and cash flow, which was in line with Wall Street estimates.

Time Warner also showed some vulnerability in high-speed data customer additions. It added 188,000 subscribers, short of analysts' consensus prediction of 254,000 additions.

Investors took the sluggishness at Time Warner as a signal to bail out of the stock. Time Warner Cable shares dipped as much as 5.5%, or $2.09 per share, last Wednesday to $36.13, before closing at 36.78, down $1.44 each. The declines continued last Thursday, as the stock dipped another 23 cents per share to close at $36.55 each.

In a research report last week, Sanford Bernstein cable and satellite analyst Craig Moffett wrote that ever since Comcast's second-quarter results, investor sentiment has taken a darker turn.

“Sentiment surrounding the cable stocks has shifted from puzzling indifference (given historically low valuations) to doom-and-gloom bearishness,” Moffett wrote.

Moffett added that in light of the soft high-speed data numbers at Time Warner Cable, investors for the rest of the year will likely watch closely how many new broadband subscribers are signed up.

“Broadband has been the key driver of cable growth in recent years (notwithstanding the more recent contribution from VoIP),” Moffett wrote. “Today's result — which fits a pattern of slowing broadband additions already in evidence this quarter at Comcast, Verizon, and AT&T — raises questions about the longer term growth prospects for the broadband market.”

Time Warner Cable attributed the slower growth to several factors: normal seasonality typical for the second quarter as snowbirds and college students leave for summer residences; slower housing starts; and tougher comparisons to last year's second quarter, when Time Warner Cable had a significant back-to-school promotion for high-speed data service.

Moffett stressed that he was still bullish on cable. He said he expects a big rebound in high-speed data subscribers in the second half of the year.

But he added that the seesaw in subscribership between summer and fall could could become more pronounced in the future.

“The growing installed base of subscribers suggests we should expect accelerating seasonality in the future, with seasonal 2Q churn rates operating on a larger and larger subscriber base, yielding steeper Q2 decelerations and commensurately steeper Q3 rebounds,” Moffett wrote.

While some investors may have been seeking out the exits, Time Warner cable chief operating officer Landel Hobbs said the company had a plan to goose growth by focusing on offering a variety of low-cost tiers of voice, video and high-speed data service to address price-conscious consumers.

TWC said on a conference call with analysts that about 80% of the basic subscriber losses were in the former Adelphia systems, particularly in Los Angeles and Dallas.

On the call, Hobbs said TWC is implementing four different tiers of high-speed data service in all of its divisions — a “lite” tier at 768 Kilobits per second, a basic tier at 1.5 Megabits per second, a standard tier at 7 Mbps to 10 Mbps and a turbo tier at 10 Mbps and above.

On the voice side, Hobbs said TWC has introduced an unlimited in-state phone service in about two-thirds of its divisions. The service is aimed at the estimated 30% of consumers that spend between $25 and $44 per month on landline telephony, as well as a second-line service.

The cable operator has also created a local-only tier, which addresses the 15% of phone users that never make long-distance calls and generally spend between $15 and $25 per month on phone service. That tier has already launched in four TWC divisions in the past 30 days, Hobbs said. The cable operator also plans to launch an international calling plan in the third quarter.

“We're never happy with losing basic subscribers,” Hobbs said on the conference call. “By mixing and matching parts of the bundle, we'll develop a bundle that is attractive to these low-end customers, even these basic-only video customers, to retain them and upsell them into higher-priced packages. That's how we will attack the basic video issues you saw this quarter.”

But not everyone was convinced that such tiering would solve Time Warner Cable's problems.

In a research note, Pali Capital media analyst Richard Greenfield said he was a little stunned that TWC was just waking up to such segmented marketing. He noted that telephone companies and cable operators like Charter Communications have been doing it for years. And he wondered if TWC hasn't been distracted from its underlying marketing strategy by the problems with the integration of the former Adelphia systems.

Greenfield also appeared a bit frustrated that TWC management continues to focus on its technological gains — with products like Start Over and Look Back — while financial metrics continue to disappoint.

“Management keeps speaking at conferences indicating how great their technology is and how compelling their bundles are, yet they tell investors during [second-quarter] earnings that they were disappointed with their subscriber metrics and [cash-flow] growth,” Greenfield wrote.

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