Mitigating Risk And Profiting From Imminent Downgrade Of All Entertainment Networks

by: Individual Investment Strategist

I was working on an article about the entertainment industry and cord cutting with respect to where the industry is headed when I heard about Time Warner Cable (TWC) and the blackout of all CBS (NYSE:CBS) stations in its major markets. This outage is said to affect 3 million out of 11.911 million of Time Warner Cable's video subscribers. In an NPR on August 2nd the problem was said to stem from the inability of these two companies to reach an agreement regarding licensing and re-broadcasting fees. I personally find the whole situation amusing and sad at the same time. As with everything in life there are at least two sides to the story, with this particular story though there at least four sides.

The Cable Company

On one hand you have the cable company who is a very profitable business entity that brings internet and video to a vast majority of homes in the United States. Lately this entity has been facing an exodus of video subscribers for various reasons and Time Warner is not alone in this regard. The number of video subscribers for Time Warner Cable has gone from 13.402 million at the end of 2006 to 11.911 million in the second quarter of 2013. While this might not seem like a mass exodus, it is nearly equivalent to the population of the City of Philadelphia according to the 2010 Census data.

If the reports are correct that CBS is demanding a 600% increase on the fees charged, from last year, what part of the shrinking client base for video would this new hefty charge come from? The answer is twofold. The first portion is easily found in almost every 10-K document issued by cable companies and in their own words the increase in customer revenue related to video for the past 7 years has largely been from additional video services bundled together and increased prices of those bundles. The second part of the answer is in more aggressive bundle pricing making it more difficult to justify dropping the video service and simply retaining internet service; this practice is one that John McCain has been fighting on Capitol Hill and one that Deloitte in its 2013 Predictions has said is a good way for these companies to mitigate their losses.

From the end of 2006 to the end of Q1 2013, the four cable companies that report on their video customers, Comcast (NASDAQ:CMCSA), Time Warner Cable, Charter (NASDAQ:CHTR), and Cablevision (NYSE:CVC) have lost a combined total of 4.32 million video customers. Back in 2007 and 2008 the cable companies did not want to admit that there was a problem and instead cited a slowing economy; in recent quarters though executives of these companies have made statements acknowledging the loss of the video customer.

So how are these cable companies still profitable if they are losing a large video subscriber base and facing continuously more expensive content licensing/broadcasting fees? There have been positive metrics in two key areas. The first area I cannot go into great detail on as it is outside the scope of this article since it pertains to an increase in business accounts. Nearly all of the major cable companies are now able to deliver much needed high bandwidth connections to businesses from the standard coaxial to 10 Gbps symmetrical fiber connections; their coaxial connections are a great value compared to a traditional T1 price, but the fiber will bring you into a whole different pricing range. Overall the business customer accounts have been increasing annually and in double digits for some of the companies. The other positive metric for profitability can be also be found simply in residential internet connections which has more than doubled as you can see in figure one below.

Figure 1 Video and Internet Subscribers - in Millions (CMCSA, TWC, CHTR, CVC, T, DISH, & DTV) Pre 2008 Video w/Satellite does not include DTV. Pre 2007 Internet Subscriptions does not include AT&T.

The chart contained in Figure 1 makes a number of valid points. The number of purely video subscribers for the cable companies has been on a down trend for the past 7 years. This loss of video customers can be described as the equivalent of losing the entire population of the San Francisco, Oakland, and Hayward Metro area (according to the 2010 Census) as a customer. As a second point the chartists among the audience might find the 5-year channel range of video subscribers inclusive of satellite subscriptions to be interesting; to me this shows the indecisiveness of customers who purchase/invest in the video delivery services of these companies. The third point is that high-speed internet subscriptions are rapidly increasing. Fourth is that the disparity between cable television and satellite subscription rates continues to increase annually.

According to the US Census an additional 11.2 million households were created from 2000 to 2010 and an additional 25.454 million people were added to the population base over the age of 18 in the same time period. The total number of residential and commercial addresses serviceable by cable providers also increased by tens of millions during the same period as additional fiber, coaxial, and copper backbone was laid across the country. Utilizing rational logic this should translate into additional customers for the video segments of the cable industry, but these additional subscriptions have not materialized - a fact that does not shine brightly on the future of the content providers who seem to be losing demand as displayed by a shrinking penetration rate as compared to the total population.

The Content Provider

CBS being the content provider on the other hand does not quite realize what it has been losing. If we cannot account for where those subscribers or additional eligible 11.2 million households are going, how can CBS, NBC, or any of the major networks? Right now there are still enough people paying for video demonstrating that demand exists; but, the number is slowly dwindling when you look at the loss of subscribers and quickly dwindling when you consider the potential subscribers they have never captured. You would not realize this by looking at CBS ratings (they are the number one network) nor would you realize this by looking at their profits because they increase prices and create new fees annually. Cable and satellite companies continue to engineer ways to pay for the content and pass the expense on to their customers; or they were engineering ways until Time Warner Cable said CBS demands were steeper than the price Time Warner customers are willing to pay.

CBS and the rest of the major network providers are walking down a very dangerous road in my mind. Time Warner Entertainment (NYSE:TWX) (not to be confused with TWC), the owner of Turner, HBO, Warner Bros, and Cinemax networks in a recent annual release alluded to the fact that content delivery methods, specifically speaking of HBO Go, will change in the future only when it is economically in their best interests. A rough translation is that they have not developed their streaming business enough to make it profitable to have this available without a cable subscription - or in simpler terms: they have not changed with times and are in no rush to. All of these companies have their hands deep into the pockets of their customers and virtually none of them are paying attention to the change in the end user. There is one thing that CEOs, officers, and boards of these companies seem to forget from time to time as they strive to deliver future visions and solid earnings - the consumer, in the end, is the one who signs all checks.

CBS has gone a step further in the recent battle and blocked their streaming web content from all people who use TWC as their ISP. As a consumer if I were blocked by CBS from content, a website that is provided for free to every other internet user in the world and to my neighbor who had AT&T DSL instead, I would question the legal right of any company to exert targeted censorship over the content I am allowed to view simply because of who my ISP is. To make matters even more complex DirecTV customers who widely use TWC internet due to wholesale agreements are also blocked. It appears that these two companies are taking their inability to conduct business in a professional manner out on the customers they are vying for when it comes to ratings, viewership, and service subscriptions - with CBS taking the lead by driving a stake through the heart of its loyal viewers. As a consumer I have a long memory over issues like this - especially when I pay a price for a set of services. I would also have no qualms, in this case, about finding a work around to reach the censored site if I truly desired to view the content. According to a report on this is what CBS had to say about the whole thing:

If Time Warner Cable is a customer's internet service provider, then their access to CBS full episode content via online and mobile platforms has been suspended as a result of Time Warner Cable's decision to drop CBS and Showtime from their market. As soon as CBS is restored on Time Warner Cable systems in affected markets, that content will be accessible again.

This still doesn't change the fact that my neighbor could have any other ISP and no video service and still view this content.

The Consumer

The consumer who watches television has been studied like a cancer cure in a lab rat. Many companies such as Nielsen, SNL Kagan, GFK, and others publish the statistics about consumers, their viewing habits, the technologies they own and use, and almost every other conceivable thing you could want to know. It was not until the past year or two that these companies began to acknowledge two groups who are silently delivering their own message to the content and network providers - these groups have been dubbed the "cord cutters" and the "cord nevers."

The cord cutters are people like myself who for one reason or another have stopped subscribing to cable. Deloitte in its 2013 Predictions Report believes this is a socio-economic phenomenon and to a degree they might be correct. In the report they also state that there are four pillars of broadcast TV, or four types of TV that people are willing to pay for and watch: news, sports, first run dramas, and reality television. The report overall while it did teach me a few things, seemed to be very narrow minded and written more for the sake of company executives than as any realistic prediction of market forces.

I know a number of people like myself who could pay the extra $1600+/ year for cable television, but it offers little to nothing that is rewarding enough to justify that price. I am among a minority that could care less about sports, dramas, and reality television. Even if I were interested in viewing drama or reality television many of the shows are available on the network websites for free after some delay. News is the only offering of true value to me, but then the news that you get with standard or even enhanced cable television usually covers a narrow geographic region that is too small and targeted while the news itself is often more biased than a simple report needs to be; not to mention, it is often very delayed to keep ratings and viewers in the slots where the media companies need them (tune in at 6 for more information). Instead I can pick up my iPad at any time in the day and read news from almost any country and in a language familiar to me; this news is available 24 hours per day for free (or almost free), spans the globe, is up to date (to the minute in some cases), and offers fresh perspective with little political motivation behind the articles. I know many people who use their smart devices in a similar way. With this in mind there is no entertainment that is worth the $1600+ on an annual basis. No matter how much the networks try to convince people that the programming is worth their hard earned money the number who disagree are growing rapidly - probably faster now considering the backhand CBS just gave to its end customers.

The cord nevers are a different category. The cord nevers are a group of people that range in age from 18 to roughly 30, live on their own, and have never had a cable bill. There is not much more to say about cord nevers, except some people think that they simply cannot afford the service and will come around when they can. I believe if executives continue with that mode of thinking they will quickly find their vast empires growing inversely to the population at a very fast rate. If this group has not yet been wooed into paying a gigantic bill for something they do not use, they likely will not be wooed anytime soon. In fact it is this age group who is routinely credited with developing, adapting, or adopting new technologies and new uses for old technologies.

The data is all out there and without paying the steep price for some of the "professional reports" we can arrive at our own conclusions about what the consumer has been trying to tell the network and content providers. The image above is a search on Google Trends that demonstrates the power of the word torrent out in the world as compared to CBS, Time Warner, cable TV, and Netflix (the number one streaming site). Though general in context, this image speaks volumes. Torrents are one of the ways file sharing happens online and the largest way in which pirated movies and television shows are distributed to internet users.

New Companies/Technologies in the World

In the world of today we are becoming increasingly used to having what we want, when we want it, with no waiting. Communication across the globe can happen in an instant and a nearly unlimited repository of knowledge is at our fingertips and accessible literally at the speed of light in many cases. The technologies that drive these possibilities are increasingly being built upon and delivering new applications. In the past decade or so we have seen a vast number of Video on Demand companies enter the market and even though a good number of them have failed, they have all collectively contributed to changing the rules of this game. The fourth perspective to consider in this war over your hard earned money and your priceless spare time is from companies that have and will harness these technologies. Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN), Hulu, Roku, Google (NASDAQ:GOOG), Aereo, Eros Entertainment (LON:EROS) (OTC:EOITF), RedBox, and many others across the globe are moving into this category and paving the way for the future. The companies that adapt successfully and deliver what the consumer wants, when the consumer wants it, at a price worth paying will likely become the leaders of tomorrow. Recently in my article titled Google, Chromecast, and the Future I covered in more depth what I believe the future landscape of entertainment delivery will look like when technology and entertainment are further integrated.


There is no reason why we should be playing by rules created 60 years ago when it comes to entertainment. Nor is there a reason why there should still be a waiting period between when a movie is retired from the theater to when it is available on some service like Netflix, Hulu plus, Amazon Instant, or the even the almost outdated DVD/Blu-ray. Why is there a waiting period between when seasons of shows make it to the same media? Why are there geographic restrictions placed on shows streamed from Canada, the UK, and Germany among other countries? If the entertainment giants of today would like to learn the lesson easily they will begin to change by removing their entrenched hands from the depths of a few pockets to stick them lightly into many pockets at the same time; according to some studies this would also reduce piracy and gain them more paying customers at the same time. The longer it takes these companies to learn that the world has already changed around them the more it will cost them as new companies emerge desiring to create viable alternate solutions in what is a very lucrative industry. Even though I am still bruised by the actions of Netflix a few years ago I have to admit they have figured something out - the consumers' loyalty only goes as far as this season of shows; by creating exclusive content Netflix can slowly wean customers from those businesses who reward their loyal viewers with blocked content.

My outlook over the next few years for the entire industry:

  • Entertainment networks such as CBS, NBC, Fox, TWX, and others will likely learn some very difficult lessons and this will probably be reflected in the bottom line and forecasts. Anyone invested directly in these companies should be prepared to offload or hedge their investments when trouble strikes.
  • Cable/Internet Companies - if they can minimize the impact created by the loss of video subscribers they will remain profitable and valid players since they deliver the internet to most business and consumers from coast to coast.
  • Satellite Providers - this is the only area that has seen an increase in video subscriptions lately. The numbers are not strong in the United States, but the trend exists. If upon closer examination this is a sustainable trend I would consider investing in these. In Latin America DTV specifically has experienced exponential growth in video subscriber count since 2007.
  • Streaming Content Providers - Including Netflix, Roku, Amazon, Hulu, Google, Eros Entertainment and similar companies. The public companies that fall into this category will be good investments provided they can make it past all the content licensing hurdles and retain customers as the major entertainment networks start flopping around like fish out of water in the new technological environment of today. Look for more partnerships that try to bring the world closer together like the HBO and Eros partnership for potential strong long-term investment opportunities.
  • Alternative Providers - There will be more companies that provide/develop legal services utilizing technology in new and innovative ways such as Aereo did. Keep an eye out for investments here, we already know the demand exists and opportunity will likely grow.

Based on my research and outlook I recommend the following actions to safeguard and grow your portfolios with respect to this portion of the industry: Act as if all major entertainment content providers were downgraded to a maximum status of Hold and watch them closely. Begin looking for entry points over the next 18 months for all major ISPs that provide residential service (TWC, ATT, VZ, CMCSA, CVC, CHTR, GOOG, and others) - demand for the internet that these companies provide is only going to increase as will the bandwidth in the orders that consumers place. Look for a solid DTV entry point - it unlike the rest of the cable, internet, and satellite companies has grown at an amazing rate; the foreign subscriber base increased from 3.8 million in 2007 to 10.9 in 2013. And finally keep your eyes open for new or existing content streaming companies that are breaking the paradigm and delivering the content consumers want in a relationship that consumers will appreciate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.