Cable One's broadband-first strategy has 'some critical holes,' analyst says

Newly spun off MSO Cable One is being carefully scrutinized as it preps for its first stand-alone earnings call on Aug. 6 for its notable strategy of downsizing video operations in favor of building up broadband.

"We certainly have some sympathy for the notion that a broadband-only cable operator might be more profitable," wrote analyst Craig Moffett in an investor note published today. "But there are some critical holes in the Cable One story. Does the company truly believe that all costs are variable such that cutting video will bring endless margin expansion? Are Cable One's new shareholders really better off for having played hardball with Viacom?"

Cable One, which spun off from Graham Holdings on July 1, made industry-trade headlines last year when it famously eschewed a program licensing renewal deal with Viacom, traditionally one of cable TV's lynchpin programmers. The Phoenix-based MSO has subsequently lost more than 20 percent of its video subscribers. In fact, the company lost 103,232 video customers in the first year after dumping Viacom, ending the first quarter with 421,331 video customers.

In meetings with investors, Cable One executives have touted the improvements to EBITDA and free cash flow that have been yielded by substantially reducing the MSO's bill for video programming. After programming costs and capex are factored in, Cable One estimates that it only nets a free cash flow of 96 cents per video customer -- or about 1 percent of overall revenue.

This viewpoint is shared by other top cable industry executives, including Cablevision's (NYSE: CVC) James Dolan. He recently told investors that high-speed data has become Cablevision's "No. 1 product," and added that "the video product has lost a tremendous amount of margin."

"No one would argue that Cable One's thesis isn't directionally correct. But whether it is more than that, indeed, whether this is proof-of-concept for an entirely new business model for cable operators, is a matter of intense debate," Moffett wrote.

The analyst placed a neutral valuation on Cable One's earnings, noting that the company is currently an acquisition target. European telecom magnet Patrick Drahi has mentioned the MSO, along with Cablevision, as possible purchases in what he says will be an upcoming U.S. cable asset shopping spree.

"We all know the consensus opinion is that someone will buy Cable One," Moffett wrote. "But the above questions still matter. Any potential acquirer would still place value on a video business, or pay less for the fact that Cable One has less of one. Even with the very real prospect of a sale, we conclude that the stock is fairly valued where it is trading today, and create the company neutral with a target price of $380."

For more:
- read this MoffettNathanson report (sub. req.)

Related links:
Moffett to Congress: Pay-TV program pricing reform needed to spur broadband investment
Cable One officially spins off, enjoys strong first day as M&A target
The video business is dead … for those without the will and resources to compete in it
Analyst applauds Cable One's strategy of replacing video revenues with data services revenues