Cable: Saved by the Bundle

Broadband’s strength helps operators mitigate video subscriber losses
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With year-end reports from pay TV distributors nearly all in — only Altice USA and Dish Network remain, reporting soon — there are a lot of possible conclusions the discerning media investor could reach. But in its most basic form, investors should at least come away with this: the bundle is working.

Investors searching for evidence need look no further than the fourth-quarter reports of the three largest pay TV service providers in the country: AT&T, Comcast and Charter Communications.

AT&T over-the-top platform DirecTV Now lost some 267,000 customers in the fourth quarter as its deep discounts went by the board.

AT&T over-the-top platform DirecTV Now lost some 267,000 customers in the fourth quarter as its deep discounts went by the board.

AT&T, which for video relies mainly on a one-product bundle of either DirecTV satellite or DirecTV Now streaming services, showed a precipitous drop in subscribers in the period. For the rest, video customers were down but broadband subscriptions were up.

Analysts have been waiting for the broadband bubble to burst for years, but the product line continues to chug along. Cable broadband subscribers increased by 730,000 customers in Q3, according to Leichtman Research Group, up from 540,000 additions in the prior year. While all the numbers for Q4 aren’t in yet, the two largest cable operators added a combined 652,000 high-speed internet customers. As broadband growth has soared, video losses, at least at the top echelon of cable operators, have slowed.

Behind Cable’s Sub Trends

Leichtman Research Group president Bruce Leichtman noted that in the fourth quarter Comcast and Charter, with 38.6 million combined video subscribers, lost 51,000 video subs. That compares to 46,000 video losses for Verizon Communications on a base of about 4.5 million, and 659,000 video losses for AT&T across its three brands (DirecTV, DirecTV Now and wireline service U-verse TV) on a base of 24.5 million. The pace of video losses for top cable providers is different for others in the industry, and they may be benefiting from AT&T’s less-aggressive pursuit of video customers.

Combined video losses for cable in 2018 are less than those in each year from 2009 to 2013, Leichtman said, when telcos and satellite were more focused on the category. When all the results are in, top cable operators will have added about 2.9 million broadband subscribers in 2018, up slightly from 2017, while top telcos will lose about 500,000 broadband subscribers for 2018, their fifth consecutive year of modest broadband losses, according to his estimates.

Even as customers begin to shift their video preferences to subscription video-on-demand and over-the-top providers, fewer core video customers appear to be leaving. Comcast lost 29,000 basic video customers in Q4, an improvement over the 33,000 it lost in the same period in 2017 but considerably better than analysts’ consensus estimates of a loss of 62,000 customers.

“Video is part of the glue for their more profitable internet service,” Leichtman said. “While the margin on video is far worse than internet or business services, it is part of the glue. The bundle is one of the reasons why [cable operators] are doing so well on cable broadband.”

In a research note, MoffettNathanson senior research analyst Craig Moffett said that Comcast’s video base continues to shrink at the same rate it has in the past six months, or about 1.7%. That’s less than half the rate of overall pay TV declines, which is heavily influenced by satellite-TV losses.

“It is almost certainly the case that Comcast’s video base will continue to shrink, but it will just as inevitably continue to take share from satellite on the way down,” Moffett wrote.

And satellite is falling fast.

AT&T’s DirecTV unit shed 403,000 net subscribers in the quarter, above consensus estimates of a decline of 321,000 customers and the sixth consecutive quarter of deficits. Since Q1 2017, DirecTV has lost a total of 1.7 million customers.

While DirecTV has been expected to lose customers as its parent AT&T transitions to a streaming distribution model, its flagship streaming service, DirecTV Now, shocked analysts by shedding 267,000 customers in Q4 as it eliminated deep discounts. AT&T had guided to losses at the streaming unit, but Wall Street was blindsided by the magnitude of the declines. Consensus estimates were for DirecTV Now to lose about 19,000 customers in the period.

That turnaround is a dramatic shift from just a few quarters ago. After its official launch in November 2016, DirecTV Now astounded Wall Street with its rapid growth, reaching 1.8 million customers by the end of June 2018. It was thought by many to be on a steady pace to reach 2.5 million by the end of that year. Instead, DirecTV Now added just 49,000 customers in Q3 and the bottom fell out in Q4.

Moffett conceded that AT&T had warned it could lose DirecTV Now customers in the period. “But nobody expected this.”

Morgan Stanley media analyst Ben Swinburne acknowledged that the video performance was dismal, but didn’t totally count out AT&T’s chances of righting the ship.

“The convergence strategy faces challenges, but video concerns are overdone,” Swinburne wrote in a research note, in which he said the bundle might save the distribution giant yet. “AT&T has noted it faces challenges in markets where they don’t have a competitive broadband product to bundle with pay TV.”

AT&T mainly offers DSL broadband, largely considered to be inferior to cable high-speed offerings, and it lost about 32,000 DSL customers in Q4. AT&T said, though, that it passed about 11 million homes with fiber at the end of Q4. While it only added 6,000 IP broadband customers in Q4 — compared to 95,000 in the prior year — momentum could build over time.

DirecTV’s performance will likely further cloud analysts’ expectations for the other satellite TV service provider in the sector, Dish Network, which is scheduled to release Q4 results on Feb. 13.

Like most other analysts, Swinburne expects the robust gains of the past to catch up with Dish’s OTT product, Sling TV, which for the most part has avoided heavy discounting but still offers a fairly hefty programming package for a low price. In his December report, Swinburne estimated Sling TV would add 237,000 customers for the full year 2018, down from 711,000 in 2017. The falloff is expected to continue for the next few years, with additions slowing to 214,000 in 2019 and 160,000 in 2020.

While streaming video may be entering the dog house, Charter is coming out into the light after three quarters of unspectacular growth and a perception that the cable operator was ignoring the shifting landscape. That changed with Q4 results.

Charter’s 36,000 residential video losses — 22,000 when a gain of 14,000 business video customers is counted — were in line with consensus estimates of a loss of 33,000 residential customers. Residential broadband additions of 289,000 solidly beat consensus estimates of 257,000 additions.

While noting that some of the credit for that growth should go to robust new housing formation, Moffett added that weak Q4 performance by AT&T and a strong quarterly showing from Comcast indicates that “cable’s share gains have reaccelerated.”

New Attitude at Rutledge’s Charter?

Analysts seized on Charter’s guidance on capital expenditures, expected to drop by $2 billion this year, and that led to a 15% spike in Charter’s stock price.

But Charter also seems to have adopted a new attitude — at least in the eyes of some observers — to the changing landscape. Chairman and CEO Tom Rutledge had been criticized by some analysts in the past for what they believed was a somewhat cavalier attitude toward the new OTT paradigm, insisting that cable had a superior video product while evidence was mounting to the contrary.

In Charter’s Q4 conference call with analysts, though, Rutledge said the video business is obviously changing, but there is also consistency there, as evidenced by the fact that bundled products still dominate offerings.

The business is now about connectivity, Rutledge said, and there are still ways for Charter to be in that space while using video to drive the core operation.

As the mix of direct-to-consumer services and bring-your-own device hardware changes over time, the market will ultimately dictate that shift and Rutledge pledged that Charter will try to make its products work on all relevant devices.

“We’re open to being a supermarket of video services, however those services develop,” Rutledge said. “We think that that we can run our traditional models and new models simultaneously.” He said Charter is rolling out its Worldbox guide throughout its footprint which should enhance the video offering as well as the overall customer experience and help sell more bundles.

“We think it’s an excellent consumer experience and we think that it’ll add to our ability to both sell bundled packages, streaming packages, a la carte packages and to do those in a way that is coherent and consumer-friendly across all devices in the home, including our own mobile devices,” Rutledge said.

With year-end reports from pay TV distributors nearly all in — only Altice USA and Dish Network remain, reporting soon — there are a lot of possible conclusions the discerning media investor could reach. But in its most basic form, investors should at least come away with this: the bundle is working.

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