Comcast's (NASDAQ:CMCSA) decision to add Netflix (NASDAQ:NFLX) into its X1 cable box is a clear sign of abdication by the cable company that there's no turning back to the glory days of the fat bundle. In the wake of this decision, I believe other companies such as Time Warner (NYSE:TWC) and Charter (NASDAQ:CHTR) also will add NFLX and/or competing OTT providers into the box to respond to the recent FCC decision of overhauling the cable box, second to partially protect the bundle and mitigate the sluggish TV subscriber trends, and finally, to double down on broadband services, where cable companies will generate the highest ROIC and pricing power in the years to come. I'm bullish on the OTT sector given the shift in viewership from pay TV to online, and NFLX is best positioned for the trend, assuming consistent execution in its original content and international expansion. Besides Netflix, I also like Sony (NYSE:SNE), whose PlayStation Vue is gaining traction as a leading OTT provider in the US (see "Sony: Expect Big Things From Upcoming Investor's Day"). Among the cablecos, I prefer Comcast and Time Warner, whose DOCSIS 3.1 specification allows companies to quickly roll out its broadband footprint and provide 4K services to viewers.
While investors will see this to be a clear positive for NFLX that could potentially gain from higher viewership amid decelerating domestic subscriber growth, I believe the cable companies are also winners in this partnership. The recent FCC decision to overhaul cable boxes is driving competition and lowering the revenue stream that the cable companies generate from cable box rentals as viewers migrate to other set-top box devices from Google (GOOG, GOOGL), Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN). However, by adding NFLX and other OTT providers into their set-top box and offering comparable interface and user experience, cable subscribers are less likely to churn off the network. More important, adding OTT services into the STBs encourages higher data consumption, which ultimately increases the pricing power of the cable companies, since broadband is becoming the key determinant of ROIC in wireline.
Although there's a possibility that some cable subscribers could migrate to a cheaper TV bundle, such as buying a basic cable service and adding on the OTT service, thereby negatively impacting cable company's overall ARPU, the higher internet consumption along with future price hikes in internet services will more than offset this weakness, in my view. At a high level, it appears that telecom/cable companies are shifting their focus to streaming rather than conventional TV bundles. Notably, AT&T's (NYSE:T) recent acquisition of Quickplay was intended to strengthen its network delivery and efficiency to position itself in an OTT/streaming world. I believe TWC/Charter will follow suit by adding other OTT providers in their cable box in the coming days in light of Comcast's decision.
As for implications for NFLX, I see this to be a clear positive given the decelerating sub growth in the US and increasing competitive risk. Although I'm positive on the overall OTT landscape, I'm actually cautious on NFLX given the proliferation of alternative services such as Amazon Prime (see "Amazon 2016 Outlook: Ready For Prime Time"). The partnership with cable companies could be accretive to growth and address a key concern that many investors have on their mind.
The days of fat bundles are gone, and these are being replaced by a bundle of OTT services. Conventional cable companies that continue to rely on pay TV will be at risk, but those that evolve and adapt to the new trend, such as Comcast and AT&T, by modifying their bundles and/or acquiring OTT infrastructure assets are best positioned for this trend given the increasing importance of broadband.
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