Cable stocks had a strong run in 2016 — distributor shares increased almost 40% for the year — and with a more business-friendly presidential administration set to take hold later this month, the sector has ample runway ahead, according to several analysts.
That kind of optimism wasn’t quite so evident before the Nov. 8 election, when analysts had expected more scrutiny of media companies and pressure to keep pricing low and access high under another Democratic administration. But after Republican candidate Donald Trump’s surprise win, Wall Street’s attitude toward the sector has switched from “anything but” to “anything goes.”
“After yet another year of strong outperformance for cable stocks, investors might be forgiven for assuming that all the good news must at long last be fully discounted in the sector,” MoffettNathanson principal and senior analyst Craig Moffett wrote. “On the contrary, however, we think there is a good deal more room to run.”
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BARRIERS GET LOWER
Moffett’s optimism is fueled by three factors: lower taxes, less regulation and lower capital intensity.
Lower taxes, one of the promises of the new administration, should help lift all boats in the market. But cable, with high cash-flow margins (around 39% to 40%), low capital intensity (around 15%), could increase its trading multiples from about 7 times cash flow to 9.5 times cash flow if the corporate tax rate dips from 38% to 15%, according to Moffett.
On the regulatory front, the Trump administration is expected to reverse Title II regulation of the broadband business, which could open the door for usage-based broadband pricing and even material charges for interconnection or peering, two items that were off-limits under outgoing Federal Communications Commission chairman Tom Wheeler.
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Capital intensity is expected to drop as more and more functionality is placed in the cloud and more customers get their video through apps, extending the life of set-top boxes in the field and reducing the need to buy new ones. Moffett estimated that a reduction in capital intensity from 15% to 13% would result in an increase of warranted valuations of almost a full turn of cash flow.
Telsey Advisory Group media analyst Tom Eagan was encouraged by cable’s subscriber performance for the year. While pay TV subscribers fell harder in 2016 than in the prior year, cable nearly halved its losses for the year.
That could encourage some privately held cable operators to tap the public markets. Altice USA, the domestic arm of European telecom company Altice N.V., has already said it is investigating an initial public offering of a minority interest in the U.S. cable operation. Eagan said he believes others could step up to the IPO plate in 2017, including privately owned Cox Communications and Mediacom Communications.
Moffett said increased competition from over-the-top services could erode customer growth, but that the greatest threat could come from 5G wireless services. The higher-speed data technology is expected to take years to fully deploy, but already Verizon has said it plans to conduct trials in 2017.
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“If there is a downside risk to multiples, this is it,” Moffett said of 5G.
The analyst was less fearful of OTT services, in part because they have been here for years and also because what was supposed to be the category killer — AT&T’s DirecTV Now — has been plagued early on by spotty service and disruptions. New OTT offerings from Hulu and Google in 2017 are expected to have an impact, just not a very great one.
“In all likelihood, however, these services will pose a bigger headline risk than they will a financial one,” Moffett wrote. “Cable’s broadband moat provides a very powerful pricing counterbalance. By charging a premium for standalone broadband, and by upselling a portion of cord-cutters to faster broadband tiers, cable operators can relatively easily insulate themselves from subscriber losses to cord-cutting.”
On the programming side, 2016 was a mixed bag as cord-cutting and skinny bundles chipped away at what was once considered to be rock solid subscriber bases. The Walt Disney Co.’s ESPN took the highest-profile hit — it lost an estimated 7 million subscribers over the past two years and about 10 million since 2010 — but across the board networks averaged a loss of about 2% of their subscribers. That had a domino effect on other parts of the business, affecting affiliate fees and ad rates for even the strongest networks.
AT&T’s pending $108.7 billion purchase of Time Warner Inc., expected to close by the end of 2017, gave a lift to programmers and refueled interest in vertical integration. If that deal passes regulatory muster — and many analysts believe it will — it could start a chain reaction in M&A. A more laissez-faire regulatory attitude also could strengthen existing vertically integrated Comcast-NBCUniversal and others by allowing exclusive content for distributors.
OUTLOOK ON MEASUREMENT
Eagan said that despite negative headlines for the advertising business overall, ad agency stocks and fundamentals performed well. On the measurement side of the business, Eagan noted that Nielsen may have won the battle but not the war, saying both Nielsen and comScore will “benefit from marketer demand for third-party digital metric verification.”
Internal stresses helped pressure Viacom into another year of poor performance as infighting between CEO Philippe Dauman and controlling shareholder Sumner Redstone resulted in the former’s resignation in August. While the stock got a lift from talks concerning a recombination with former corporate sister CBS, those discussions ended in December with no deal.
While the hope is that new CEO Bob Bakish, a longtime Viacom international executive, can turn things around, it could take time. Meanwhile, Viacom’s ad revenue continues to slide, executives continue to leave, and its once-strong Paramount film studio limps along.
“For Viacom, if anything could go wrong for them, it did,” MoffettNathanson senior research analyst Michael Nathanson wrote in a note to clients.
AMC Networks, parent of AMC, IFC, WE tv, Sundance and BBC America, saw its stock drop more than 50% in 2016 as investors worried that it was too dependent on one program, albeit a big one: The Walking Dead. While that series remains the No. 1 scripted show on television, AMC is facing increasing pressure to come up with hits, as are other programmers like Scripps Networks Interactive (parent of Food Network and HGTV) and Discovery Communications.
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