Deep Dive into Cable companies, part 1
Evolution of the cable industry and why it's still attractive here
Evolution of cable’s business model
The business model for cable is as simple as it gets, cable offers a pipe which is an efficient way to transmit information. The more fascinating part is the evolution of the business model over time mainly due to regulatory changes and more recently, due to technology and changing consumer habits.
Cable started in the 1940s as a way to provide broadcast TV in rural areas. Broadcast TV was the main way in which TV content was consumed when TVs became a thing in households. Similar to radio, broadcast TV was transmitted over the air from a local TV station to your home. Because of the local nature of TV transmission, there were only 3 national networks with sufficient local TV stations that could service the whole country. TV signals, however, were difficult to transmit to more remote, rural areas and cable was a solution to improve reception in these areas by physically connecting households to antenna towers that received the TV signals. The side effect, though of cable was that once it connected enough households with their last-mile fiber, then they could become an effective national distributor to any new entrants in the TV content arena. This allowed cable TV channels like HBO and CNN to thrive in the 1970/80s as cable became a pipe for both broadcast and cable TV. Deregulation of cable in the 1980s further stimulated capital investment into the last-mile distribution of fiber into homes. Then in the 1990s, further deregulation paved the way for cable to start offering phone services to homes and subsequently, in the 2000s as internet became more popular, cable also offered faster internet services than dial-up that was offered by phone companies. Since the heydays of the 2000s, landline phone services have been disrupted by wireless and broadcast and cable TV has been disrupted by streaming services like Netflix. Hence, the main role of cable today is to distribute high-speed internet.
Will internet be disrupted?
As discussed above, cable’s role in the distribution of services has gotten more limited over time. It is an oversimplification to say that it is only used for high-speed internet now as ~40 million households in the US still have cable TV and a similar number have landlines, but both these numbers are declining by 3-7%/yr.
In contrast, the number of households signing up for high-speed internet is increasing by 2-4%/yr due to new household formation and conversion of people from slower speed alternatives like satellite internet or DSL. The glaring difference between slower speed (~10-25 Mbps) and high-speed (~100 Mbps -1 Gbps) and the increasing demand for bandwidth for things like streaming services and high-resolution gaming is likely to continue to push homes towards high-speed internet.
But can internet be disrupted? Enter Starlink from SpaceX and fixed wireless by telecom providers like Verizon and T-Mobile. Starlink uses thousands of satellites in low-Earth orbit to offer faster connectivity of ~100 Mbps relative to conventional satellite internet.
Source: https://westeastspace.com/encyclopedia/medium-earth-orbit/
While the speed is faster, connectivity is not guaranteed and there can be downtimes based on location of the satellites, or weather and terrain that impeded access. There is also a considerable upfront hardware installation cost of ~$1000 and monthly service is twice as expensive as cable internet. Hence, Starlink and other upcoming low-Earth orbit based satellite services is likely a niche service that will appeal to those in rural areas with few other options for high-speed internet.
Fixed wireless on 5G networks is another option that is commercially offered by Verizon and T-Mobile currently.
Source: http://globepredict.com/5g-fixed-wireless-access-market/
Reviews are mixed depending on the flavour of 5G. For instance, Verizon primarily uses mmWave band spectrum for its 5G internet which can be 10x faster than mid-band spectrum that T-Mobile primarily uses but because the signal propagates over shorter distance, connectivity is less reliable. Anything that disturbs line-of-sight between the 5G reception node and the receiver antenna like bad weather, or terrain like trees, or even walls and windows can negatively impact connectivity. Hence, mmWave 5G internet offered by Verizon currently has similar speed as high-speed internet by cable and a competitive price as well but is limited in coverage and is less reliable than cable internet. T-Mobile’s mid-band based 5G internet service is more reliable but offers lower speeds of ~100 Mbps so on the lower-end of what high-speed cable internet can offer. And, households are likely to demand higher speeds over time as we continue to consume more data-intensive applications like streaming services and high-resolution gaming.
Putting speed and reliability aside, another consideration is that capacity is effectively constrained on wireless networks whereas it is not on wireline or cable networks. Hence, with wireless data demand increasing by ~20%/yr, finite wireless capacity needs to be allocated towards wireless customers first and foremost before exploring other customer types like fixed wireless. Also, the typical household consumes ~10x more data over broadband than an individual consumes over a single wireless connection so allocating so much capacity to a fixed wireless customer while charging about the same price as a wireless customer, is a highly inefficient use of finite capacity. For these reasons, fixed wireless also is more likely to be a niche case and not a widely marketed service.
Will internet be re-regulated?
Regulation is a big driver of inflections in the industry and the focus of regulation since 1980s has been de-regulation of the industry which is beneficial for the industry. In the Obama-era, there was a threat of re-regulating the cable industry. For instance, one proposal for net neutrality implied that cable should be regulated as a utility wherein there is a ceiling on what price can be charged for internet and thus, a ceiling on the returns that cable companies can earn. The proposal was never passed but with a new democratic regime, there is a possibility that this issue could come up again and again, like last time, that would be an opportunity to add to these names as like last time, the odds of passing through a severe re-regulation of the cable industry are pretty low. Of course, there could be more reason for concern if service quality for cable is atrociously low or if the price they charge for internet are abnormally high relative to other developed countries but this is generally not the case.
Death of the triple bundle
Cable companies know that the triple bundle of internet + video + voice is dead as people switch to wireless only phone service (versus having a landline + wireless) and cut their cord in favour of streaming services. The economic impact of this is negative for cable companies from a revenue perspective but counter-intuitively, it’s positive for these companies from a margin perspective. This is because internet is naturally a higher margin business relative to video as video has high operating expenses (ie., programming costs that are paid for content). The other negative is that customers are less sticky and more susceptible to churn if they only access one versus three services from a given cable company.
To counter-act the death of the bundle, cable companies have struck deals with wireless companies to purchase wireless service at wholesale rates and offer this to their customers in the form of cable-branded wireless service. The total customer base for this cable-branded wireless service is relatively small still at ~5m customers, but growing quickly and as a result, these services are close to break-even profitability for these companies.
Where do we go from here?
The cable industry has evolved from a highly fragmented one 30 yrs ago to a highly consolidated one now. The top two players, Charter and Comcast, connect ~25% of US households each and smaller ones like Altice and Verizon’s Fios (their high-speed cable brand) connect ~5% of US households each and even smaller ones like Cable One that connect ~1% of US households. However, at the local level, there are typically only 1-2 high-speed internet options implying a monopoly or duopoly status for these companies at the local level.
Implicit in the above math is that ~25% of US households are still on slower-speed internet via alternatives like conventional satellite internet. For many of these homes, high-speed internet is not an option because they are in rural areas where cable connectivity would be very expensive to have. However, there are also other homes on lower-speed internet switching to higher-speed internet as their connectivity needs are growing over time.
So that’s the industry in a snapshot. The salient points are that this is a consolidated industry with monopoly-like status at a local level that gives them pricing power, and there is still some volume growth potential as customers switch from lower-speed alternatives. While there are threats of competition from lower-Earth orbit satellites and fixed wireless, these are unlikely to really threaten cable’s value proposition of high-speed, high-capacity, and reliable internet service. Similarly, while regulation threatens to turn cable into a utility, this is a very low probability outcome.
Join me for part 2 where I’ll discuss specific cable companies, Charter, Comcast, Altice, and Cable One.