Bernstein Research media analyst Todd Juenger returned to coverage of the industry Monday after a three-month sabbatical, upgrading Discovery Inc. to “Market Perform” from “Underperform,” but cautioning that the programmer, which agreed to merge with WarnerMedia in May, has some heavy lifting ahead.

Juenger took a three month sabbatical beginning on July 30, and Bernstein suspended coverage of media companies in his absence.  The analyst, who joined Bernstein in 2012 after heading up TiVo’s Audience Research business, has proven himself to be one of the more insightful analysts covering the programming space. 

In upgrading Discovery, Juenger also announced that he was dropping coverage of AMC Networks “to focus on stocks with broader investor interest.”

Juenger didn’t pull any punches upon his return. Although he increased his rating on Discovery, he lowered his 12-month price target on the stock to $26 from $28, reflecting his concerns about its ability to integrate the WarnerMedia business.

“[W]e continue to have high conviction that these businesses face a long list of very serious concerns, including: the legacy business is facing insurmountable structural pressure, the streaming future is riddled with risk for this set of brands, including the daunting complications of the WarnerMedia integration and rationalization,” Juenger wrote of Discovery. “However, the market seems to also share those concerns, and has driven the stock price down to a level where we can no longer argue the risk/reward for investors skews significantly negative from here.”

Juenger continued that he believed Discovery’s stock price already reflects the market’s belief that it will miss its streaming revenue guidance, cash flow guidance or both. 

“As the closing date approaches, the key question for investors from a catalyst perspective is: if the company takes down their guide, will that be bad for the stock (confirming tougher business conditions and lower financial results) or good for the stock (clearing the overhang, regaining investor confidence in a believable outlook on which to price the stock)?”

In his report, Juenger points out that Discovery WarnerMedia is not yet the “streaming powerhouse” depicted in headlines, but instead relies almost entirely on traditional linear cable network revenue to fund its streaming endeavors. How it manages to keep that linear business generating cash while its streaming business grows will be critical. 

“Ironically, the more successful the streaming service becomes in the market – the more pressure is put on the linear networks, which is the tyranny of the innovator's dilemma,” Juenger wrote, adding that the new entity will have a leverage ratio of about 5 times cash flow, and has promised to use excess free cash flow to lower debt. 

“We think this puts the company in a very difficult box to start from: promises to both invest in streaming and invest in delevering,” Juenger continued. “It also greatly amplifies risk to equity value. Any downturn in either EBITDA/FCF, or the valuation multiple of the stock, will fall sharply on the equity holders.”

Discovery shares were up more than 5% in early trading Monday to $24.70 each. The stock was priced at $24.52, up 4.6% ($1.08 each) at 12:09 p.m. on Nov. 1.  

Juenger also didn’t want to downplay the massive integration issues the combined company will face once the deal closes.

Integration Issues Loom 

“Which departments survive, which get merged or deleted, who stays/who goes, who's in charge, how to design incentives for leaders of the legacy business and the streaming business, and how to align that market by market, region by region and globally,” Juenger wrote. “All while trying to deliver/exceed on financial synergies promised to the investment community. This complex task will not only require significant expense, but also significant management bandwidth and distraction. And employee trepidation, and time. Important decisions cannot be made before the new leadership is installed (otherwise it undermines the authority of the new leadership).”

Juenger also saw some potential bright spots, including overdelivering on streaming growth and potential synergies. The analyst wrote that the market usually forgives other sins if a company manages to add more streaming customers than expected, and so far most streaming services have. 

In addition, Juenger added that if consumers pare down to three or slightly more than three streaming subscriptions, Warner Bros. Discovery will likely be among them. 

“This view would be supported by a belief that HBO would continue its history of putting forth a handful of truly distinctive premium entertainment series every year, and the addition of Discovery's portfolio would add complementary engagement value,” Juenger wrote.

As far as synergies, Juenger pointed to Discovery’s 2017 purchase of Scripps Networks. Less than three months after closing that deal, Discovery raised its cost synergy target from $350 million to $600 million. 

“One could easily expect Discovery will once again exceed the original target,” Juenger wrote. “Which, theoretically, could be additive to the $14 billion EBITDA guidance (or, give the company that much extra room to invest in streaming, or de-lever).”

Bernstein Research said Friday that influential media analyst Todd Juenger will take a sabbatical and that it would temporarily suspend coverage of media companies in his absence. 

“We are temporarily suspending coverage of U.S. Media because the Senior Analyst (Todd Juenger) is going on sabbatical,” Bernstein said in an email message to clients. “We plan to reinstate coverage following the Senior Analyst's return in a couple of months. Effective today, July 30, 2021, our previous reports, ratings, target prices and earnings estimates should no longer be relied upon. Team members can be contacted with requests for pre-existing models and content.”

Juenger joined Bernstein in 2012 after heading up TiVo’s Audience Research business. At Bernstein he made a name for himself quickly with insightful coverage of programming stocks like Viacom (now ViacomCBS), The Walt Disney Co., News Corp (now Fox Corp.), Time Warner (now AT&T), and Netflix. His April 2012 report tying Netflix licensing deals to the precipitous drop in ratings for kids’ programming at cable networks was one of the first to highlight the impact of streaming services on linear TV.

Juenger’s current coverage list includes programmers ViacomCBS, Discovery, AMC Networks, Disney, Lionsgate Entertainment, and Netflix; ratings measurement giant Nielsen; music companies Spotify Technology and Warner Music Group; and video game companies Activision Blizzard, Electronic Arts, and Take-Two Interactive Software.    

Bernstein's coverage of U.S. cable operators, satellite TV and telecom companies, currently handled by senior analyst Peter Supino, will not be affected.  

With the three top publicly traded cable operators expected to report second quarter results later this week, all eyes will be on whether the slowdown in broadband subscriber growth will be larger than, less than or equal to expectations.

Cable broadband growth broke records in 2020, as the pandemic forced most Americans to work from home and buy faster and faster tiers of service. The expansion of streaming video, as services like Disney Plus, HBO Max, Paramount Plus and Discovery Plus chewed up bandwidth normally occupied by SVOD stalwarts like Netflix, Amazon Prime Video and Hulu, also increased demand. 

When the dust cleared, cable operators added about 5.6 million broadband customers in 2020, more than double the 2.5 million added in the previous year. Most operators warned that subscriber growth would slow this year and probably next, most likely to 2019 levels. That appeared to hold true in the first quarter, when total cable broadband additions were about 3.8 million, according to Wells Fargo Securities media analyst Steven Cahall.

In a research note, Cahall added that as Q2 is usually a seasonally weaker period, overall broadband growth is expected to be at about 0.6%. He noted that while this is a 400 basis point decline from the previous quarter, it would still be the highest Q2 growth rate in five years (excluding 2020). 

Cahall is one of the more bullish analysts regarding broadband growth, noting that the segment outpaced expectations in the first quarter, as many operators said trends associated with COVID-19 continued. While Cahall still expects a deceleration in growth for the full year in 2021 (3.5%, compared to 5.6% in 2020), he notes it is still higher than the growth rate in the prior four years. 

“Commentary from most of our covered companies suggests subscriber gains similar to 2019 levels, with a back-half weighted growth profile,” Cahall wrote.

Altice USA is the first major publicly traded operator out of the box, expected to report its Q2 results on July 28 after the market closes. Analysts are expecting the operator to add between 10,000 and 28,000 broadband customers in the quarter, compared to Q1 2021, when it signed on about 12,000 high-speed internet customers.

Altice USA, which operates as Optimum in its East Coast markets and as Suddenlink Communications in the Midwest, has some of the highest broadband penetration rates in the industry, which has limited its subscriber growth in the past. Earlier this month the company said it would rebrand its wireless service as Optimum Mobile across all of its systems, a move it said was the first step in rebranding all of its products under the Optimum name. 

Also Read: Analyst: After a Strong 2021, Cable’s Broadband Trajectory Could Reverse in 2022 

At Comcast, which is scheduled to report its Q2 results on the morning of July 29, analysts believe that broadband additions could come in at nearly half the level the company reached in Q1. Cahall estimates that Comcast will add about 260,000 residential broadband customers in Q2, while Evercore ISI Group media analyst Vijay Jayant and Bernstein media analyst Peter Supinio are in agreement that Comcast should add about 275,000 residential and commercial broadband customers in the period. Still, that’s nearly half the 461,000 residential and commercial additions the company added in Q1.

Charter is expected to release its Q2 results on July 30, and Supino, who downgraded the stock to “market perform” on July 12, expects the nation’s second largest cable operator to add about 250,000 broadband customers. That is about in line with Cahall’s estimate of 246,000 additions. Jayant predicts the company will add about 265,000 high-speed data customers in the period. 

For the full year, analysts are pretty much in agreement that growth will be slower than in 2020, with some predicting it could be even less than in 2019. 

MoffettNathanson expects the top three operators to add about 2.4 million broadband customers in 2021, around half a million subscribers behind the 2.9 million they added in 2019. Supino estimated that overall growth would be about 2.7 million. Supino predicted that Charter would have the biggest drop in growth over the next two years -- he estimated the company would add about 1 million broadband subscribers in 2022 and under 1 million in 2023 -- spurred by expected increased regulatory scrutiny and stepped up competition from AT&T and T-Mobile.

T-Mobile has said it expects to add 7 million to 8 million 5G wireless broadband customers by 2025, implying additions of about 1.5 million annually. While Supino wrote that wireless broadband can’t match fiber-to-the-home, he believes a new segment is emerging in the market. 

“Consumer markets naturally segment ‘good, better, best,’" Supino wrote. “Historically, the enormous up-front capital costs and logistical challenges of supply growth have inhibited the segmentation of the broadband market. We believe the natural segmentation of the broadband market will provide more consumers with an opportunity to pay a lower price for ‘good enough’ broadband.”

Charter Communications shares fell as much as 3.1% in early trading Monday after Bernstein media analyst Peter Supino downgraded his rating on the stock from “out-perform” to “market-perform,” citing competitive concerns and already-baked growth estimates in the share price.  

Charter shares were down as much as 3.7% ($27.53 per share) to $708.94 each in early trading Monday (July 12). The stock closed at $719.80 per share, down 2.3%, or $16.67 each on July 12.

In his report, Supino noted that he remains convinced of Charter’s “business plans, financial strategies and structural competitive position in most of the US,” adding that its growth trajectory in the medium term shouldn’t change.

But the analyst is worried about the growing competitive threat from T-Mobile and AT&T Fiber, as well as the possibility of a stricter regulatory environment. 

T-Mobile is aggressively rolling out fixed wireless high-speed internet access across the country, and expects to have 7 million to 8 million residential internet customers by 2025, implying 1.5 million additions per year.

Also Read: Analyst: After a Strong 2021, Cable’s Broadband Trajectory Could Reverse in 2022 

While several analysts, including Supino, have noted that fixed wireless is technologically inferior to cable broadband service, he sees it as carving out a niche in the market with customers that are looking for lower-cost, “good-enough” broadband access. 

“We believe the natural segmentation of the broadband market will provide more consumers with an opportunity to pay a lower price for ‘good enough’ broadband,” Supino wrote. “While the telco networks are absolutely constrained in terms of the number of residential customers they can serve, we believe the 5G technology and MHz expansions of mobile networks create a niche business opportunity for the ‘Big 3,’ led by T-Mobile as the first-mover on the more scalable, economical mid-bands.” 

AT&T’s recent plans to spin-off DirecTV with TPG and a separate merger between its WarnerMedia programming assets and Discovery Inc.,  will provide added financial stability to the phone company, Supino wrote. That should help AT&T Communications chief Jeff McElfresh achieve his stated goal of transforming AT & T into the country’s “premier broadband connectivity provider, period.” 

Other analysts have warned of a possible slowdown in the  broadband market, and Supino estimated that Charter, which added a record 2.1 million high-speed data customers in 2020, will see that growth slow substantially to 1.3 million in 2021 and 1 million in 2022. 

On the regulatory front, reports that Gigi Sohn, once a top adviser to former FCC chairman Tom Wheeler, is in the running to become the next chair of the agency, and the indecision around the long-term role of acting FCC chair Jessica Rosenworcel make the possibility that Sohn could ultimately lead the agency closer to reality. That, according to Supino, could mean that net neutrality and the reclassification of broadband as a Title II telecom service could rear its head once again. 

“As chairwoman, we think Sohn would probably pursue a form of broadband price regulation,” Supino wrote. “Were Sohn appointed, we would expect cable stocks to tumble. In such a scenario, we would expect Charter to decline more than Comcast given its much higher mix of EBITDA from internet service provision.”

Supino fully expected some backlash from the decision to downgrade Charter stock, and added that he expects the company to have strong cash flow and free cash flow growth in 2022 and beyond. But the potential volatility in the broadband segment is too great to ignore.  

“Charter's valuation multiples, while elevated, exist in a low interest rate, secular growth hungry world which has bid up nearly all valuations,” Supino wrote. “A seller of Charter who is in the business of managing stock portfolios must buy another stock … In the end, as is so often the case, our business model defines the decision. While we advise clients seeking to be right for the next 5 years and others focused on the next 5 months, Bernstein's price target horizon is 12 months. And on that horizon, we think Charter's stock looks ‘fair but full.’ For each unit of potential upside, we see about as much downside.”  

Bernstein analyst Peter Supino launched coverage of seven cable, telco and satellite companies Wednesday with a positive outlook, adding that cable operators should enjoy mid-single digit revenue growth even as video customers decline.

Supino initiated coverage of Charter Communications (Outperform, $541 price target); Altice USA (Outperform, $38); T-Mobile (Outperforms, $103), Comcast (Market Perform, $50), Verizon (Market Perform, $63), AT&T (Market Perform, $36), and Dish Network (Under Perform, $29).

Supino noted in his detailed 84-page report that while Dish Network and the telcos have their own pressures to deal with, cable appears to be well positioned, based on strong broadband performance and prospects for commercial and mobile growth.

“With margins and [free cash flow] likely to improve and video less important to financial results, cable stocks enjoy multiple valuation tailwinds that offset the weight of the sector's high penetration levels,” Supino wrote.

He added that with capital expenditures expected to continue to decline, cash flow growth should be in the high-single digit percentages for cable operators.

The analyst introduced four investment themes to value the sector:

• Focus on pricing: Although the market is increasingly saturated, Supino believes there are sustainable opportunities in pricing and industry structure.
• Margins will be “stronger for longer” – Increased scale will continue to drive margins.
• Fiber is the key – As data demands grow and 5G continues to be hampered by siting and backhaul needs, “dense fiber networks are precious.”
• Video subscriber declines aren’t worth the worry: Supino believes that video losses “obscure otherwise rapid and durable cash flow growth.”

Cable stocks have been on a tear this year -- the sector was up about 50% for the first nine months of 2019 -- and are expected to continue on that pace. Supino appears to be equally optimistic -- his 12-month price targets on Charter, Altice, and Comcast represent a 10% to 30% premium of their closing prices on Oct. 15