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Cable Stocks Lose That Consolidation Feeling

Cable stocks, fueled by a consolidation frenzy over the past few years, are beginning to run out of gas.

The euphoria associated with the expected deal bonanza in the wake of the Comcast-Time Warner Cable merger has been increasingly overshadowed by fears of onerous regulation and increased compet it ion from over-the-top video service providers.

Cable operator stocks were down slightly for the third quarter — 0.5% — as investors found out they had to wait a bit longer for the Comcast-TWC closing (now expected in early 2015 instead of by the end of the year) and learned that over-the-top video offerings from Sony, Dish and Verizon are coming closer to reality.

OTT LINEUPS TAKE SHAPE

Sony signed up Viacom’s 22 cable networks — including MTV, Comedy Central, Nickelodeon and VH1 — in August for its over-the-top service, and more are expected to join the list.

Dish Network has already signed The Walt Disney Co. and A+E Networks to its OTT offering — which could be called nuTV — slated for an early 2015 release, and Verizon Communication is readying its own over-the-top service, expected by mid-2015, based on Intel Media’s former OnCue service.

Although distribution stocks are still up by about 8% year-to-date, it seems like a slowdown compared to the 35% gain the stocks enjoyed in the first nine months of 2013 and the 50% gain they experienced in the full year.

For the most part, cable distribution stocks were fairly stable — the highs weren’t too high and the lows weren’t too low.

In the third quarter, Comcast and Cablevision Systems showed slight gains — Comcast was up 2% to $54.86 per share, and Cablevision was up 2.3% to $18.05 each.

Charter, Time Warner Cable and Liberty Global all fell slightly during the period, but the declines were well under 1%.

MoffettNathanson principal and senior analyst Craig Moffett said in an interview that cable stock performance in the quarter wasn’t the result of one factor but a series of them. And though the sector is still in positive territory for the first nine months of the year, he said he fears investors may not be taking the larger picture into account.

“I think the bigger issue is that the level of regulatory uncertainty has just ratcheted higher,” Moffett said. “It’s hard to make a big new commitment to the sector when you’re waiting to find out what’s going to happen with Title II and merger conditions and a laundry list of regulatory items.”

Moffett said investors are keeping an eye on regulatory possibilities, but are not as wary of other issues.

“What people are worried about is regulation,” Moffett said. “They’re not worried about OTT. I don’t think OTT is very top-of-mind, and arguably it should be. It’s easy to imagine a scenario where [cable operators’] ability to respond through usage-based pricing or higher interconnection charges are limited by regulation.”

Moffett also wasn’t sure whether the stocks would rebound in the fourth quarter. He said he doesn’t expect to see any strong positive signs until the early part of 2015.

“Eventually it all comes down to how much cash fl ow you can generate,” Moffett said. The cash-fl ow picture for these guys is pretty good.”

While distributors were stable, their programmer counterparts as a whole were down about 1.7% in the quarter and are down 4.5% for the year.

Although the sector got an early lift in the quarter when 21st Century Fox revealed it had made an $80 billion unsolicited off er for Time Warner Inc. (whose shares rose 23% on the news), it retreated just as quickly when Fox withdrew that off er in August, adding that there were no other merger targets on its radar.

The content consolidation wave, which was supposed to happen in response to Comcast-TWC and DirecTVAT& T, doesn’t look like it’s going to happen — at least in the near term.

That leaves investors to worry about an increasingly competitive advertising market, and possible regulatory backlash from retransmission consent and high programming costs.

Pivotal Research Group media analyst Brian Wieser said negative sentiment comes partly from a sluggish upfront and a fear that advertisers are shifting dollars away from television and into digital.

That showed in the performance of some top companies in the sector — CBS dropped 11.7% ($7.29 per share) in the quarter and Viacom, which has been at the center of affiliate fee controversies over the years, dipped 9.9% ($8.60 per share).

‘LAST YEAR WAS TOO STRONG’

Some bright spots emerged: Time Warner Inc. was up about 8.5% in the quarter ($5.95 each) and 13.8% for the year. But most of those gains were residual effects from the aborted Fox takeover attempt.

Disney also maintained a healthy growth clip — up 4.3% for the quarter and 17% for the year — while Starz, Liberty Media and Discovery Communications remained relatively stable.

Wieser said he believes fears that the TV ad market is drying up are mostly unfounded and that the problem lies in comparisons with last year.

“The problem is that last year was too strong,” he said. The sector outperformed his estimates by about 2 percentage points in 2013.

This year the ad market is on track, and Internet ad spending is actually declining.

While Wieser conceded that the upfront was sluggish and that most advertisers overestimated the strength of this year, he said he sees signs of a rebound.

He pointed to recent reports that automotive ad spending is expected to increase next year and that videogame maker Activision will spend about $500 million to develop, market and promote its latest game release, “Destiny.”

“What drives total market growth is the creation, introduction and execution of spending by new brands and new marketers,” Wieser said. “If the economy fails to produce new marketers, then you should worry.”