Time Warner Cable: Doing It The Microsoft/Comcast Way

Sep.13.13 | About: Charter Communications, (CHTR)

Time Warner Cable (TWC) is a company that brought a new television viewing experience to the U.S. in the past and is carrying on that tradition. Currently it is trying to enhance the TV viewing experience by investing into technology. First, the company is into the development of technology relating to cloud based navigation software in order to provide the next generation of TV viewing. This technology will enable Time Warner's subscribers to access videos from multiple devices. Secondly, the company launched an app to enable its viewers to access TV from their Xbox.

In this research, we are taking a closer look at these two initiatives, which will provide Time Warner with growth in the future. Additionally, Time Warner has resolved a fee issue with CBS, overcoming a major threat.

The tough time is over

Time Warner has been in the cable business for decades and has been through plenty of rough patches. One recent rough patch was the long-standing fee dispute between Time Warner and CBS that ended with Federal Communications, or FCC, intervention. The dispute ended in a fee increase per subscriber from around $0.56 per month to around $2.00, signaling a percentage change of around 250%. The prolonged dispute may have caused some Time Warner customers to migrate to its competitors like Verizon Fios and DirecTV (DTV). The increase in the fee per subscriber is expected to put pressure on Time Warner's margins. The blackout affected around 3.2 million viewers. If we assume the fee increase on this subscriber base, it would result in Time Warner increasing its payment to CBS by around $55.29 million per year. Though the end of the dispute creates margin pressure for Time Warner in the coming quarters, it averts a major threat of losing subscribers in the long run.

The next generation carrier

In collaboration with Microsoft (MSFT), Time Warner Cable launched an app in August this year to enable television viewing through the Xbox console. We believe app interface is a necessary step for cable television as more and more consumers are shifting to on-demand streaming services. This deal will give Time Warner access to Xbox Live customers in the U.S., and the company will provide a maximum of 300 live channels to them. This will enable it to generate revenue from the subscribers by providing video services.

This initiative should attract multitasking viewers since viewers have shifted away from passive TV viewing. For example, a person playing a video game can easily switch to watching TV by running this app. This app will help Time Warner increase viewers' television watching time. According to NextMarket Insights, the TV app market in the U.S. will reach $14 billion in 2017 from $4.5 billion last year. This app will help the company grow its television viewing business.

Microsoft has entered into this deal with Time Warner because it wants to gain a major share in the entertainment industry. Microsoft has always tried to position its Xbox 360 as a total entertainment solution. This deal is step in that direction. A major driving force of this deal could be that Microsoft wants its Xbox Live subscribers to spend large amount of time with the Xbox device. The entertainment division, which manufactures Xbox, is one of Microsoft's business divisions performing strongly. In the fourth quarter ending in June 2013, Microsoft registered revenue growth of 8% in its entertainment division quarter over quarter. Xbox Live customer revenue, which increased 20%, was the primary growth driver. We believe this app will further strengthen Microsoft's revenue from Xbox Live subscribers.

A valuable pact

This year Time Warner Cable formed a joint venture, with Comcast (CMCSA), named RDK Management LLC. The Reference Design Kit, or RDK, was initially designed by Comcast to create a platform in the set-top boxes that enables all types of devices to access and play videos. RDK is a software package that will enable it to carry out these video services. With this software, cable companies can reach more video playing devices like phones and tablets. Since the beginning of licensing last year, the software has gained around 100 subscribers among the cable industry and has become a source of revenue for Comcast. As the subscriber base of this software grew, it became necessary to manage and develop the software.

According to the contract, Comcast will transfer all the assets pertaining to RDK to the newly formed JV. This JV will licence the cloud-based X1 channel guide software to cable companies, computer-chip manufactures, and others as well as continuing to develop the software. X1 platform is an entertainment operating system integrating a collection of videos with social media features, interactive apps, and allows users to watch and record programs simultaneously. RDK software will enable televisions to stream videos over the net at high speeds, store videos in the cloud, and allow operability in multiple interfaces. According to Multimedia Research Group, the cloud based TV service is expected to grow to $1 billion in 2017 from around $120 million in 2013, and the JV will help Time Warner Cable capitalize on this opportunity. Also the JV will help Comcast and Time Warner share the developmental cost, reducing the cost burden for both of them.

We are bullish on Comcast. Read: Comcast: Should You Add More Of Its Stock At These Levels?

So is the future bright?

Company

P/E

Forward P/E

Time Warner Cable

15.09

14.36

Click to enlarge

Source: Yahoo Finance

As we discussed, Time Warner has averted a serious threat by resolving the subscription fee issue, but the increase will affect the company's revenue. However, a prolonged battle may have caused the company to lose customers in the long run. Time Warner's pact with Microsoft and Comcast on the technology frontier will make it suitably positioned among its competitors. The TV app for Xbox is a necessary enhancement of its cable services due to the behavior of its television viewers. Also, the development of software with Comcast for watching videos on multiple platforms will give the company a greater push for growth. The technology enhancements will also enable Time Warner to better compete with the increasing demand for online streaming, and it will help the company to retain its customer base. This is evident from Time Warner's forward P/E for the company being lower than the current P/E, a clear sign of future growth.

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.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.