How High Is Up?

Can Cable Stocks, After Swelling 60% In 18 Months, Continue To Rise?
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If you bought into cable in 2012, you’re a happy investor.

After an impressive run last year, when MSO stocks shot up 40%, cable stocks across the board are having a stellar first half of 2013, with all three sectors — cable operators, satellite-TV providers and programmers — up about 20%.

And while strong fundamentals (and a little deal speculation) helped drive media stocks ahead in the first six months of the year, the question remains: Can the good times last?

Cable stocks have gone up more than 60% in the past 18 months, a nearly unprecedented run that has helped fill investors’ coffers and has completed the transformation of the industry from an also-ran in its infancy to a front-runner today.

To be sure, the increases in 2012 came after a relatively flat year for the stocks in 2011, a year also marked by a strong first half — MSO stocks rose 21%, satellite shares were up 37% and programmers gained 7% in the first six months of 2011, only to fall back on competitive concerns. And though there is no guarantee that this year won’t play out the same way, some analysts think it will prove to be different.

Pivotal Research Group principal and media and communications analyst Jeff Wlodarczak said he believes the continued strength of broadband, an easily upgraded plant and growth opportunities in business services and home security and monitoring will continue to drive the stocks upward. Cable companies also have been returning huge amounts of capital to shareholders through buybacks and dividends, which should continue to support the sector, he added.

“I think there is plenty of upside left in cable stocks,” Wlodarczak said.

Returns have been incredibly strong for MSOs — for example, Comcast is expected to grow earnings per share by 108% over the five years between 2012 and 2017, a 15.7% compound annual growth rate, according to Moffett Research senior analyst Craig Moffett. And Comcast and Time Warner Cable alone paid out more than $7 billion in the form of stock repurchases and dividends to shareholders in 2012.

Several stocks have already broken through analysts’ price targets for the year, including Charter Communications, Time Warner Cable and Cablevision Systems, with others expected to grow another 5% to 20% for the rest of the year.

Cable MSOs have outperformed the Standard & Poor’s 500 Index by 150 points over the past four years, Moffett estimated. But that success may come back to haunt the sector.

Taking a slightly more contrarian view, Moffett, in initiating the cable sector earlier this month, opined that the ride might be over. With threats from satellite, telcos and over-the-top providers, as well as increasing programming cost pressure, Moffett believes that cable stocks may have run out of steam.

 “The cable bull case is now consensus, and we no longer see material upside to intrinsic value for the sector,” he wrote in a recent report.

Coupled with declining pay TV subscribers and rising programming costs, slowing broadband penetration and an expected “choppy” next few months in Washington that could bring added regulatory risk, the upside may have been drained from the stocks, he said. “In short, it’s a very, very good business,” Moffett continued. “But it is not without its risks, and, as an industry, it is priced fairly.”

Despite that risk, new investors are crowding into the sector — including mutual funds lured by cable’s fat returns and one legendary investor from Denver in particular, Liberty Media chairman John Malone.

Malone’s re-entry into the cable business through a March investment in Charter has been a huge catalyst for MSO stocks. Charter stock is the single largest gainer in the sector, rising 54% since the beginning of the year almost entirely on Liberty’s investment in the stock and deal speculation.

Charter stock has been something of a perfect storm in the cable community — it attracted perhaps the best operations executive in the industry in CEO Tom Rutledge in 2011; it has the lowest penetration rates in the industry in virtually every product category, meaning the potential for growth is enormous; and, after emerging from bankruptcy in 2009, it has low debt.

Seeing that potential, Liberty Media agreed in March to invest $2.6 billion for 27% of Charter stock, a stake that can rise above 40% after January 2016. Malone, who has called Charter a “horizontal acquisition machine” in the past, has said the MSO could be a vehicle for further industry consolidation.

Speculation grew earlier this month when reports surfaced that Liberty Media CEO Greg Maffei had met informally with Time Warner Cable chairman and CEO Glenn Britt to discuss industry consolidation in general. TWC is said to not be interested in a merger with Charter, but the M&A wheels have helped drive up both stocks, along with the rest of the sector.

Charter stock rose 31.1% between March 15, when shares sold for $90 — the day before the Liberty announcement — and June 18, when it was priced at $117.95.

TWC shares, languishing after a disappointing first quarter with higher-than-suspected subscriber losses, have surged on speculation of a Charter deal. The stock was up 10.9% between its June 12 mark of $92.90 and its June 18 price of $103.01, when talk of a Charter merger was in full swing.

Cablevision Systems, which has been hit hard as its growth appeared to peak in the past few quarters, also saw a benefit. Shares were up nearly 10% between June 12 and June 18, on the hopes that the Bethpage, N.Y.-based operator could be the next acquisitios target.

HAPPY RETURNS FOR PROGRAMMERS

While MSO investors eagerly await the next consolidation boom, holders of programming stocks enjoyed even larger returns in the past six months. Stocks of the 12 largest programmers rose an aggregate of 24.8% in the fi rst six months of the year, driven by a return to growth in the advertising market and continued healthy increases in carriage and retransmission-consent fees.

But there also was a little MSO-type deal speculation driving some of the stocks. The biggest gainer in the sector for the period, premium channel Starz, is a former Liberty Media subsidiary that was spun out at the beginning of the year and is a prime candidate for a merger with a larger programmer. Starz stock was up 72% in the first six months of the year on the hope it would be snapped up at a premium price.

The rest of the sector rose on strong fundamentals, a return to ratings growth and double-digit increases in affiliate and retransmission-consent fees.

“Programmers have a lot of market power right now,” said GAMCO Investors portfolio manager Chris Marangi, whose funds own a substantial interest in several distribution and programming stocks. “The near to medium term looks favorable for programmers, although there are definitely some long-term issues with affordability that they need to confront.”

Viacom, which was pounded last year after a huge drop in ratings at flagship networks Nickelodeon and MTV, rebounded strongly in the first half. Armed with several new hits at both channels, Viacom also saw a return to advertising growth — domestic ad revenue rose 2% in the fiscal second quarter ended in March, soundly beating analysts’ consensus expectations of a decline of 1%. And Viacom said it expected ad revenue to rise sequentially in the fiscal third quarter.

Cyclical elements and the ongoing battle for share with online ad outlets are expected to put continued pressure on the ad market going forward, Marangi said, but he sees growth opportunities in international and targeted advertising.

RBC Capital Markets media analyst David Bank agreed, adding that he believes the secular and cyclical fundamentals for the sector remain incredibly robust.

Content monetization opportunities through retransmission consent, digital deals and advertising remain strong, Bank added, and despite possible threats from over-the-top players such as Aereo and Netflix, as well as calls for unbundling of networks, “there is very little risk that anything changes to the negative for quite some time.”

Some cable stocks have already broken through several analysts’ 12-month price targets, Bank noted, and though he did not want to reveal any changes he may have in store, he added that typically, analysts roll forward price targets around the middle of the year.

“I suspect all Street price targets will go up this summer, assuming no shift in the fundamentals,” he said.

That could mean that the best part of the ride for cable investors is yet to come. 

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