U.S. Cable TV Industry: Comments on Cable Industry

Paul Holman /  416-593-5577 ext.2234/ e-mail: @dbrs.com

 

The U.S. cable industry is about to undergo significant change propelled by both consolidation and growing business risk as competition intensifies.  The proposed merger of Comcast Corporation and AT&T Broadband is expected to trigger a series of mergers and acquisitions, wherein the more ambitious cable operators will become aggregators as they vie for strategic advantage.

 

This is expected to happen in two stages.  The initial stage will take place in 2002, where operators make opportunistic acquisitions.  Once the larger consolidating mergers are complete, the next stage will be a rationalization whereby cable operators exchange assets to build larger clusters in select regions.  Improved clustering will become the key motivating factor, as operators strive to acquire cable operations in areas adjacent to existing service areas, in exchange for operations in regions of lesser importance.  This will drive scale economies and lower operating costs.

 

At the moment, the U.S. cable industry remains fragmented, with business risk quite low.  Cable companies have stable subscriber bases, with low churn, and franchise areas that are effectively free from competition from other cable companies.  Accordingly, each company controls the only means of potential broadband access into the residential home. While cumbersome regulation in the U.S. will initially limit the pace of industry change, there are several drivers that, over time, will accelerate change. 

 

This includes the proposed merger of satellite TV operators, EchoStar and DirecTV.  With this, the cable companies are expected to face an ever-growing competitive challenge from satellite TV, as acceptance grows from the rural markets into the more urban markets.  The satellite operators provide a fully digital product, with huge channel selection, at a competitive price. 

 

To compete, cable companies must upgrade networks to provide two-way service, with digital channels, despite the fact that commercial paybacks are slow.  Even so, the cable operators, with their upgraded networks, will still provide a somewhat inferior channel offering, where only the newer specialty channels are digital, while the first 60 channels or so remaining analog.  As a result, cable companies will compete with satellite TV in the premium service market without a competitive advantage.  Hence, cable TV’s basic subscriber growth is stalling, while satellite TV has taken much of the growth in the industry. 

 

In the future, cable companies’ comparative advantage will likely remain with those core customers who are satisfied with cheaper, traditional basic analog service, with little interest in the digital upgrades and the up-front costs.  However, this group is not a high-growth segment of the market.  As a result, the key to stimulating future growth will be the ability of each cable provider to attractively price analog services, and bundle new services such as high-speed internet, video-on-demand, interactive television and telephony.

 

Overall, the cable industry’s credit profile generally remains within the investment grade (“BBB”) category for those operators that maintain reasonable financial risk.  However, those companies with significant leverage can easily fall well into the high-yield credit range.  Accordingly, future survivors in the cable industry will be those with stronger balance sheets.  Management will need to reconsider historical levels of financial risk, as rising business risk will pressure them to lower leverage and improve liquidity.