Cable stocks, hammered during the beginning of the year, are enjoying a resurgence after most of the sector reported strong first-quarter results. But according to a panel of analysts at last week’s 2008 Cable Show, investors should brace for a seasonal downturn in the traditionally weak second quarter.
Cable stocks were down a collective 40% in 2007, as investors fled the sector because of concerns about competition and continued to fall in the beginning of this year. But because of an April resurgence — fueled by strong first-quarter basic and advanced-services subscriber growth — the stocks are up about 10% so far this year as a whole. Cable stocks are up about 19% since April.
Goldman Sachs cable analyst Ingrid Chung said that the tide began to turn as investors could see that cable was indeed fighting back the competition.
“Sentiment around the sector has really changed in the past two months,” Chung said during the panel discussion. “People are a lot more positive.”
Wachovia Securities media analyst Jeff Wlodarczak said that the reason for the 2007 downturn was that investors believed at first that Comcast would not report strong telephony subscriber-growth numbers during the first quarter of that year. When the company did — Comcast added 571,000 phone customers in the first quarter of 2007, more than twice that of the previous year — sentiment went in the other direction, with investors expecting the company and the cable industry as a whole would report growth that they couldn’t ultimately achieve.
“What happened in 2007 was an unwinding of unrealistic expectations,” Wlodarczak said.
While the sector has reported strong results across the board for the first quarter of 2008 — Time Warner added 50,000 basic subscribers and Comcast added 639,000 phone customers, just to name a few — investors could be in for a little surprise in the second quarter, the analysts said.
“The second quarter is usually the weakest,” Wlodarczak said. “We’ll see how people react to a pretty dramatic reversal in the second quarter.”
One metric that usually takes a hit during the second quarter is basic-subscriber growth, as some customers disconnect service as they leave for their summer residences. And though the industry has tried to move investors and analysts away from emphasizing basic customer growth too much, the panelists still believe it is an important metric.
“A lot of people look at basic subscribers as a building block for the business,” said Deutsche Bank media analyst Doug Mitchelson.
Wlodarczak said that the efforts to de-emphasize basic subscriber growth may be coming too soon. The analyst believes that cable operators still have basic customer growth potential — he pointed to privately held Insight Communications, which grew basic subscribers by 5% last year and publicly traded Cablevision Systems, which grew basics by about 4,000 customers in 2007.
“I’m a little nervous that cable gave up a little too quickly,” Wlodarczak said.
Despite the promising first quarter, cable stocks continue to trade at near historically low multiples — about 6 times cash flow.
Chung said that cable operators should trade higher, if just for the fact that they have higher growth rates. She added that recent developments like the Sprint Nextel-Clearwire joint venture — which also includes Comcast, Time Warner Cable, Bright House Networks, Intel and Google — to build a WiMax high-speed wireless broadband network, should give cable an ever greater advantage.
“If the Sprint-Clearwire JV is the magic pill, and there isn’t this additional cycle of capex in front of them, there should be higher multiples,” Chung said.
While cable may still have the potential to grow basic customers, another segment — business voice and data services — could prove to be a bigger growth driver in the near future.
At a separate panel discussion last Tuesday, Heavy Reading senior analyst Alan Breznick said that small businesses — those with fewer than 100 employees and initially the main focus of cable operators — spend about $50 billion annually on phone and data services.
While cable has been relatively slow to the business market — the industry has roughly 1 million business customers, led by Time Warner Cable with 280,000 customers — the industry is beginning to gather steam, Breznick said.
“The key is if cable can step up to the plate and show that they can match or exceed the performance reliability of the phone companies,” Breznick said.
From a Wall Street perspective, the potential returns from commercial communications are huge. Morgan Stanley media analyst Ben Swinburne estimated that cable companies could generate about $300 per month of revenue from each commercial phone and data customer, translating into a cash flow margin of between 50% and 60%. Given the capital outlay for providing the service — about $1,000 for each customer added — Swinburne estimated there is about a six-month payback for commercial service.
Swinburne added that cable companies also stand to reap big returns from other business services like cellular backhaul. He estimated that Wall Street expects total commercial revenue from the sector to reach between $6 billion and $8 billion by 2012, with cash flow in the $3.5 billion to $4 billion range.
UBS Securities media analyst John Hodulik said the biggest advantage for cable operators will be on the customer service front. Very small businesses — those with less than 10 employees, like pizza parlors and doctor’s offices — have been virtually ignored by the telcos.