Despite largely stable expansion of cord cutting in Q1, Wall Street engaged in a rather steep sell-off of pay TV operator stock Friday after Charter Communications reported the unexpectedly high loss of 112,000 video customers.
Charter had its worst day of trading in nearly a decade, with its stock down nearly 16% Friday. But Comcast, AT&T, Dish Network, Liberty Global and Cable One all had bad days, as well.
The popular boogey man was once again competition from over-the-top suppliers, with the Wall Street Journal headlining a report on the crash with “Cable TV’s cord cutting woes grow, highlighting divergence with Netflix.”
For his part, MoffettNathanson analyst Craig Moffett agreed that the sky really is falling on pay TV operators, describing these companies as being in the later stages of their life cycle.
But Moffett doesn’t believe that the sky is falling quite as fast as some on Wall Street seem to think it is.
“Those who would attribute the sell-off on Friday to a generalized melt-down in linear Pay TV might be surprised to learn that, at least at this point through the quarter, the rate of cord-cutting does not appear to have accelerated from last quarter (we’re tracking to the same -3.4%),” Moffett wrote in a note to investors this morning.
“And although broadband growth rates have continued to gradually decelerate, as expected, the offsets—higher ARPU and higher margins—came through just as one would have hoped,” Moffett added.
OK, so what gives? How did cable companies and other telecoms in the business of packaging video on wireline internet get so unpopular so fast?
For his part, Moffett sees the problem as pay TV operators not doing what companies in their life stage should be doing—returning cash to investors.
“As the growth of the cable (and satellite) business slows, and as capital intensity falls (and margins rise), this will be, or at least should be, a period of rapid free cash flow (FCF) release for pay TV distributors,” the analyst said. “The appropriate strategy for companies in this stage of their life cycle is to return that cash to shareholders. But for a variety of idiosyncratic reasons, NONE of the companies in the sector are pursuing this strategy.”
Those reasons, Moffett added, vary: Comcast is plunging its cash into media acquisition, for example, while Dish is fixating its resources on wireless.
Moffett said investors should focus on companies that at least have the intention of sticking to the FCF-return program. And, ironically, he believes it’s the company that was hit hardest by Wall Street Friday that most fits that bill.
“To us, the best of these is still Charter,” Moffett wrote. ‘Yes, what was once a simple free cash flow story has suddenly become rather complicated. Billing system problems resulting in unexpectedly high bad debt levels (and churn), and rising commitments to a wireless launch and high capital spending on finishing their digital set-top box conversion (all coupled with atrocious expectations management) have all combined to blow up near-term free cash flow and share repurchase forecasts, and, well, let’s face it… a cash return story that isn’t returning cash is… well, it’s a problem.
“But Charter hasn’t changed its strategy of returning cash,” Moffett added. “Remember, EBITDA was fine. And the evidence that capital intensity really will fall after 2018 is sufficiently compelling that it’s not even all that controversial. Margins are rising as programming cost growth slows and as mix shifts away from low margin video. Yes, Charter’s short-term free cash flow forecasts have been cut. But their longer-term free cash flow estimates haven’t. And their strategy of returning that cash to shareholders through share repurchases hasn’t changed either.”