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Shift to broadband in US cable industry will mitigate TV subscriber loss: Moody's

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BENGALURU: Rising demand for broadband services will compensate for the loss in TV video subscribers and help sustain industry growth through 2016, says Moody's Investors Service. As a result, the rating agency maintains its stable outlook on the US cable industry.

Broadband gaining ground, video slides, voice stable

Key takeaway:

The key takeaway is that the broadband offset is substantial, and much higher than in the past couple of years. In 2013, for every video subscriber lost, cable signed up 1.4 broadband customers. In 2016, Moody’s are projecting a 2.4x multiple.

Broadband subscribers outnumbered total video subscribers in Moody's rated universe for the first time at the end of 2014, and the agency forecasts that this spread will widen to seven per cent by the end of 2016 as demand for broadband continues to grow.

"This change in subscriber demand represents a fundamental shift in consumer appetite and the economics of the cable business model," said Moody's vice president and senior analyst Jason Cuomo. "The loss of video subscribers is a fundamental weakness, but broadband demand and pricing actions are more than fully offsetting the negative video trends."

The report says that broadband demand continues to grow faster than pay-TV subscriber losses. Companies in Moody’s rated universe had a little more than 126 million (12.6 crore) Revenue Generating Units (RGU - equal to the number of subscriptions at a service level) at the end of last year. Moody’s project that RGUs will grow to over 130 million (13 crore) by the end of 2016, representing a CAGR of approximately 1.7 per cent. Broadband is now the leading product, as video continues to slide and the number of phone customers holds steady.

Moody’s says that the number of pay-TV subscribers in its universe has gone done from 50 million (5 crore) in 2013 at the rate of about 1 million (10 lakh) per year and its predicts that by 2016, the number will reduce to 46 million (4.6 crore). During the same period, broadband subscribers would increase from 49 million (4.9 crore) in 2013 to 57 million (5.7 crore) by 2016. Voice subscribers in 2013 at 25 million (2.5 crore) would increase to 27 million (2.7 crore) by 2016.

Phone subscribers have also been growing between three - four per cent, but the report says that the pace is trending down and could moderate to below two per cent by 2016.

Lower revenues, better margins

This mix shift has changed the economics of the business, with the top line suffering from the loss in video revenues, while creating opportunities to grow EBITDA and margins that are better in broadband.

The industry continues to raise prices for broadband services, driving average revenue per unit higher. Demand is being largely driven by video consumption, which requires more and faster bandwidth, positioning cable companies to further monetize their high-speed distribution system. At the centre of this transformation is streaming content "over-the-top" to deliver video-on-demand services, which is growing quickly, according to the report "Pricing, Broadband Demand Ease Pressure from TV Subscriber Losses."

The report says that Broadband generates much lower revenues than residential TV, (roughly half, on average) but much higher margins and EBITDA per customer. In addition, the business is growing much faster than the rate of loss in video subscribers (more than 2:1,) which supports both revenue and profits.

Pay-TV produces the highest revenue per customer among the three main service offerings, significantly exposing the top line when subscribers defect. To put the risk in context, Charter’s annual video revenue per residential subscriber was $1,068 in 2014, much higher than the $540 for residential broadband and $235 for residential phone service. However, programming costs are high, and rising despite the loss of revenue, squeezing EBITDA and margins.

The net effect of the mix shift is revenue growth of nearly four per cent, a rise in EBITDA of approximately three - four per cent, and relatively stable EBITDA margins of 38-39 per cent.

"Despite the concerns that the cable industry is about to lose its competitive footing, it still maintains a steady share of the triple-play bundle -- offering a package of video, broadband and phone services," said Cuomo.

Growth drivers are new subscribers, SMEs

The large majority of growth is coming from new residential customers. Commercial is only a small contribution but growing quickly. Small to medium-sized business demand for broadband is growing and cable is attracting their business with competitive speeds. Time Warner Cable and Charter, for example, have reported growth rates over the last four years that average 15 per cent and 22 per cent, respectively.

Although their commercial businesses are less than five per cent of total revenues, for both companies, new commercial broadband subscribers represented approximately eight per cent of all new broadband subscribers in 2014.

Video going over-the-top, but on cable's terms

In video, the big story continues to be consumer demand for viewing content 'Over-the-Top' (OTT) on multiple devices — arguably the number one threat facing cable. OTT is the epicentre of risk in an industry at the very early stages of a rapid transformation. The speed of broadband, proliferation of devices, and emergence of content streamers such as Netflix Inc. have made this type of “non-linear” alternate possible. The pace is accelerating (Netflix now has over 40 million subscribers, starting from zero in 2007 when it was first introduced in the US) as the awareness of alternate viewing options grows. This may also be at least partially responsible for driving subscriber losses — although Moody’s believes the great majority of users are also pay-TV subscribers that migrated OTT as a complimentary service.

Content companies facing huge challenge

Rapid development of new content, more widely distributed through new media channels, over a larger number of devices, and at lower cost, is a huge challenge for content owners struggling to maintain market leverage by controlling content rights. Extracting value from every property they own is easier when it’s all sold in a bundle. This neat and simple packaging model is beginning to break down, however, as content is offered in skinnier bundles and a la carte. In this model, the value shifts to the highest-quality content assets, exposing those with lower viewer ratings and therefore lesser value.

As the industry transforms, the friction of change could temporarily slow video-subscriber defections. The move to OTT can be stalled by a rise in broadband price or recognition that stacking OTT content is more costly than expected, especially when buying sports and other high-value content. Content unbundling and programming offered via apps may also create confusion and inconvenience for the customer. Issues including new bills to manage, more frequent ID authentications, and the need to search, find, and switch between apps may end up being more cumbersome than simply switching channels on a cable remote. Until addressed, these issues will help cable buy time.

Cable’s pricing power is driving ARPU higher

The industry has consistently raised prices as they continue to pass through most of the rising programming costs and charge higher rates for more services. This pricing power could rise further once pending acquisitions are completed. Based on Moody’s forecast for ARPU of $837 by the end of 2016, the CAGR will be approximately 2.5 per cent from 2013 with a slope in ARPU that has been essentially linear, despite the rise in competitive threats. This has been largely driven by the rise in content costs, but can also occur as owners attempt to reprice OTT programming on the same, or similar, terms as current pay-TV economics.

Moody’s expect this trend to continue given cable’s strong market position. In particular, we think the cable industry is positioning itself to charge higher prices for broadband to offset the loss in video ARPU. This could come in the form of higher prices for more data consumption, faster speeds, data limits that force customers to pay for higher speeds, or a fee for the use of Wi-Fi hot spots, which so far has been free. Given the high cost of mobile broadband and limited coverage of mobile Wi-Fi, viewing streaming video in-home, on cable Wi-Fi is currently one of the lowest-cost/highest-quality experiences available — and ripe for price increases.

While there is healthy growth in prices, competition will keep growth rational. Another major constraint to higher broadband pricing is regulation, now that broadband is subject to Title II of the Communications Act of 1934. Price hikes are likely to be tolerated by regulators, but only as long as they are reasonable and customary. The government has stated that they are disinterested in pricing regulation, but their position would likely change if prices rose aggressively and consumer complaints mount. Moody’s outlook assumes no regulatory intervention.

Industry Consolidation

Moody's notes that industry consolidation resulted in a number of transformative deals over the past year, but further consolidation is unlikely through 2016 given the size and concentration of the largest and smaller players.

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