I had always been skeptical about cord-cutting. That is, I was skeptical right up until I took a look at the packages DirecTV (NASDAQ:DTV) was offering … and then I realized I could save myself more than $20 per month by downgrading my package.
See, I’d really only be giving up AMC channel, for which I only watched The Walking Dead. So I downgraded, and bought the new seasons on-demand at Amazon.com Inc. (NASDAQ:AMZN) for less than $20. Then I added Better Call Saul for another $20.
And then I believed in cord-cutting.
Of course, I didn’t stop there. Then I just got a Roku, then HBO announced it would stream HBO Go for $16 per month, and apparently Apple Inc. (NASDAQ:AAPL) is going to offer a 25-channel streaming service across broadcasters such as ABC and CBS. That goes along with all the other streaming services that are out there.
Now I really believe in cord-cutting.
I’m not alone, if rising subscription numbers are any indication, and that means cable TV stocks are in big trouble.
The problem is in how cable operates. Individual networks pay carriage fees for cable companies to carry their channel. Going forward, they can bypass the distributor altogether and instead of paying to be carried, they can have individual consumers pay them to watch their content.
Cable is toast — not today or tomorrow, but soon. So at this point, it bears looking at some of the individual names to see just how ugly the picture is.
Time Warner Cable Inc. (NYSE:TWC): TWC is showing cracks in its revenue. Programming-tier revenue, which is the area I’m discussing, has declined 10% since 2012. Video on demand has fallen 25%. Premium programming fees is flat, as is DVR service. Equipment installation is down 7%. Programming costs per subscriber is up 25%. Some of this has been offset by Time Warner’s upgraded Internet services. TWC also is moving into telephone and home security.
Time Warner Cable carried $22.6 billion in debt at about 7% interest. While the company is profitable, its free cash flow has been declining, from $2.425 billion in FY12 to $2.25 billion in FY14. Net income has been flat from 2012 to 2014.
None of this is apocalyptic, but it isn’t going in the right direction. Tack on an EV/EBITDA ratio of 8.5, and there’s nothing screamingly good here.
Charter Communications Inc. (NASDAQ:CHTR): CHTR, which has launched a hostile bid for Time Warner, is faring better. Revenue was up 10% year-over-year, included an 8% increase in video and a 13.5% increase in Internet, but voice fell 10%, while commercial revenue was up 16% and advertising sales not including political ads grew 9%. Free cash flow isn’t that impressive, generating only $140 million annually, but it has been relatively stable. It also carries $21 billion in debt.
CHTR is even more expensive, at an EV/EBITDA ratio of 13.5.
Comcast Corporation (NASDAQ:CMCSA) has a bit more diversification in that it owns a content provider: NBC Universal. Then again, the network and the studio are in total disarray. The networks in particular are in big trouble, with many in last place in their respective field. That being said, total revenue is on the upswing; it increased 6% in FY14. All revenue segments were up.
Operating income was up 10%, net income was up 23%, and free cash flow jumped from $4.6 billion to $8.2 billion — and CMCSA carries $44 billion in debt at about 5.2%. CMSCA trades closer to TWC at 8.4 EV/EBIDTA.
Bottom Line
So am I crazy? Are things really not that bad at the cable companies? Heck, Comcast even seems to be doing really well!
Look, if you want to run with cable stocks, be my guest. The issue isn’t that cable companies are in a bind this very moment. The issue is that the trend is no longer their friend.
I wouldn’t short anything, because the financials are still pretty solid. But I think you want to be in a sunrise industry, not an industry that may be on its way out.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He is the manager of the forthcoming Liberty Portfolio, has 20 years’ worth of experience in the stock market and has written more than 1,200 articles on investing. As of this writing, he was long AMZN and had sold DTV April $87.50 puts. He can be reached at TheLibertyPortfolio@gmail.com.
