Author: Grant LacKamp
Cable companies (Cable) are going through a period of intense change in their business models. Those who do it fastest will best position themselves for a more profitable future.
Historically, Cable made money as the middleman to distribute content from the creators to the viewers. Big media like ESPN and HBO, down to local broadcasting stations, sold content to Cable, who sold access to subscribers and collected a monthly revenue stream. For decades, Cable provided the only avenue to content like Game of Thrones or certain sporting events. High-demand creators, recognizing the value of their assets, often increased fees. Cable protested to keep distribution costs lower but ultimately capitulated, knowing those costs would pass to viewers and that the lack of important content would lead to fewer subscribers.
At the same time, technological advances allowed for better and faster internet connectivity and speed, increasing demand from viewers. Cables responded by upgrading their broadband networks and began selling internet access separate from distributing content. Given the growing development and expanding capacity of broadband networks, alternative viewing options arose for subscribers. Tired of constant price increases and being forced to subsidize weak channels to obtain good channels under the packaging system, viewers dropped their cable subscriptions, turning the historically excellent video business into a very average business. Viewers accessed content in other ways over broadband networks, a process that picked up speed with the recent growth in video streaming.
As a result of growing distribution options and demand for connectivity, Cable broadband subscribers have been increasing while video subscribers have been decreasing. Following COVID, broadband subscriber growth accelerated even more quickly, 50% higher in 2020 than any previous year. The new habits and practices following stay-at-home orders and work-from-home decisions mean strong broadband demand will continue, though at a moderated pace.
Broadband has terrific benefits for the Cables. There are no content development costs. Compared to video cable, broadband entails minimal upkeep and capital expenditures. Broadband reliability is much higher than video cable, which means less call center volume and fieldwork. And because broadband is seen more as a utility rather than an entertainment mechanism, broadband subscriber turnover is lower than video subscribers, helping support greater profitability. Taken together, this helps explain why broadband subscribers are four times more profitable than video subscribers.
Cables don’t have broadband to themselves. Wireless players have spent billions filling the gaps in their networks, called densification, in anticipation of 5G and the faster speeds it promises by running fiber-to-the-home (FTTH). To help pay for these projects, they started offering residential broadband and video themselves in direct competition to the Cables. But they have two disadvantages to Cable. One, the fiber used for wireless applications is much more expensive than the copper coax used by the Cables. Two, both fiber and coax offer more capacity than is demanded right now. But fiber is more limited in how far capacity can expand given their primary usage is for wireless mobile demand. Even as FTTH has increased over the last several years, Cables have maintained and grown their market share.
The other threat to Cable broadband is satellite broadband. Satellite makes the most sense for isolated or rural areas where costs to install coax or fiber are prohibitive. In urban areas, satellite broadband is a weaker competitor because of lower latency or the breadth and speed of your connections. To say nothing of a problem unique to satellite operators, complaints from other countries that their hardware is taking up too much space in a lower orbit.
Cable companies aren’t looking to reduce video subscribers sooner than is necessary. But their reduction paves the way for a more profitable future where broadband resembles a Software-As-A-Service (SaaS) company with sticky consumers, low capital expenditures, higher gross margins, and strong free cash flows. Equity markets are slowly recognizing this transition, but Cable companies still garner lower multiples than other SaaS businesses. We believe Cable offers an opportunity to invest in a trend with solid cash flows and a long runway for higher valuations.