In summer 2016, I wrote an article in which I postulated that Comcast (CMCSA) was at the peak of its value and would see a substantial share price decline going forward. Not exactly my finest moment. Despite its recent difficulties, Comcast is still trading at $36.50 a share. That is actually $5 above the (split-adjusted) price it was at when I wrote my bearish article.
In for a penny, in for a pound. I remain skeptical about set-top box revenue growth, the reason for my original bearish thesis. But the changes at the FCC reduce the proximity of that threat at least a little. However, I am also growing increasingly skeptical about Comcast for another reason.
The Other Duopoly May Be Crumbling
A big reason Comcast has managed to ride out the rise in cord-cutting so well thus far is high-speed broadband, which is often bundled in with Comcast TV service. Because satellite providers DIRECTV and DISH Network (DISH) cannot offer high speed broadband, Comcast usually has either a monopoly on such services, or a duopoly with the local phone provider, which in some cases is DIRECTV’s owner, AT&T (T).
In fact, the latest studies suggest that Comcast only loses about a net $5.50 per subscriber per month when TV service is cancelled, since the price of Internet rises so much higher without a TV component bundled in with it. At that rate, Comcast’s 22.4 million video customers account for only $1.1 billion of Comcast’s almost $7.9 billion in net income YTD as of the most recent earnings. While NBCUniversal also accounts for another 28% of EBITDA, it is clear that broadband is now Comcast’s dominant product offering.
I’m starting to think that that duopolistic profit center, like video before it, is not going to last much longer.
Wireless Services Get Better And Better
I always think that in these situations, it is helpful to put ourselves in the mind of the customer as well as the investor. Comcast and Charter (CHTR) usually charge $8-$10 per month in fees just to rent a modem. That is on top of whatever they charge for actual Internet service, which can run anywhere from $40-$80 per month. Generally, it seems safe to peg home Internet service at somewhere between $50 and $85 per month.
Meanwhile, heavy competition in the wireless sector has greatly increased the amount of bandwidth a consumer may access at a reasonable price. While T-Mobile (TMUS) is still the only company to offer unlimited mobile hotspot data at useable data speeds - i.e., either 3G or 4G LTE speeds - Sprint (S) and AT&T are also greatly increasing their hotspot offerings, to 10 GB of full speed data. This is, of course, in addition to full unlimited data on the smartphones themselves.
The change really is remarkable. In 2014 when T-Mobile was just starting to challenge the wireless duopoly, hotspot cost extra and was usually capped at 1 or 2 GB. Verizon (VZ) has a more complicated data plan setup, but its premium Unlimited offering comes with 15 GB of hotspot data.
With all this data now coming standard on wireless plans, investors need to ask themselves: at what point will consumers start to question the need for a second Internet plan, i.e., the home data plan?
Quantifying The Customer
What we need now is an idea of how much data consumers need to satisfy their at-home communications requirements. That actually turned out the be the hardest part of this whole analysis. Data on individual home internet usage is surprisingly rare, and often second-hand or inferred even when it is available. I could not find a single study for 2017, 2016, or 2015 that actually used first-hand reporting of direct sampling of a statistically reliable population.
In light of this, we are going to use Sandvine’s 1H2014 Internet Traffic Report for this article, apparently one of the last it prepared before stopping such surveys. Use of data this dated - pardon the pun - and raises obvious issues, but more about that a bit later. For now, we at least have a reliable sample to use, whatever its age.
A Low-Bandwidth Customer Bloc
I took a look at Sandvine’s report. It splits Internet usage into three groups, a top and bottom 15% and a middle 70%. What really surprised me looking at this was how low the bottom 15% were. According to Sandrine, as recently as 2014, long after Netflix (NFLX) had become a household staple and Internet TV was booming, 15% of North American households were still consuming an average of 4.5 GB per month.
The qualifier here is that I am reduced to using data from 2014. There has obviously been real growth in data traffic since then. But the Sandrine report also makes clear that most of what drives home Internet usage growth, like mobile Internet, is media streaming. Anyone with relatively low home internet usage to begin with probably isn’t streaming much, so the growth in their data usage has probably been relatively low.
One 2016 survey found that 22% of respondents were not using video streaming services. So the integrity of the bottom 15% sample is probably not compromised. Even assuming 5% growth per year in the non-streaming segment, the bottom 15% are probably still at or around 5 GB average.
Some might be inclined to dismiss this as an edge case, one without much relevance to most broadband households and therefore little threat to cable companies. But Sandrine’s report suggests that also would be a mistake. Which brings up the second surprise in the report.
And It Might Not Be So Small
Look at the second column in the report, the middle row of the middle 70% of families. They average 29 GB of data consumption. Certainly more than a typical wireless bundle could provide.
But of course, this is the average. Assuming both measurements correlated to the median of their respective groups - the 50th and 7.5th percentile of data usage - half of the population was using 29GB or less in 2014. Meanwhile the average of the bottom 15% was 4.5 GB. So that would put 42.5% of the broadband households at between 4.5 GB and 29 GB. Assuming the progression was linear, that is approximately 1 GB of additional data consumption for every 1.75 percentage points up the distribution chain. Plus the 7.5% of households who are below 4.5 GB. At that rate, 25% of all broadband households would be below 21 GB.
But actually, there’s more. Remember, we assumed a linear progression. But that is actually impossible. A linear progression would mean that from the 50th percentile to the 92.5 percentile, data consumption rose from 29 GB to 212 GB. And if there were that much data on the other side of the distribution slope, the average of the middle 70% would have been much higher than 29 GB.
Building A Model
The only way this data makes sense is if the median user for the middle group is slanted substantially toward the low-end. That is, the median user uses far less than 29 GB. As for that matter do a lot of even the above-median users. Most of them, in fact.
Assuming two independent linear progressions on either side of the average user, that sum to a total average of 29 GB, some quick and dirty math puts the actual 29 GB user somewhere around the 75th percentile. If 75% of users are using 29 GB or less and 7.5% of users are using 4.5 GB or less, then it takes approximately 2.75 percentage points of movement over the sample population to move consumption a single GB.
That means that 36.5% of all broadband homes were using 15 GB or less three years ago. They could run entirely on Verizon’s More Unlimited plan. Another 16.5% were using 21 GB or less.
Given the high fixed costs of wireline broadband, this is potentially a major competitive weakness for wireline broadband companies. Reducing subscriber counts and revenues by 36.5% will not produce cost reductions anywhere close to the same proportion.
This analysis, constrained by dated information, is of course somewhat imprecise. Doubtless data growth has grown far more substantially in the households which have embraced streaming. And those with sufficient income might well decide they want the high-speed broadband in their home, even if it's theoretically well within reason to go without it.
But before Comcast investors rest too comfortably off that fact, there are also some unconsidered points on the other side. First, remember that many households have more than one person living in them. Such households could pool their hotspot allocations on each of their cell phone lines and stretch their mobile data buckets further.
Second, wireless competition has also now produced true unlimited data for tablets, usually around $20 per month - one-third to one-quarter of home broadband charges. Those screens are far larger than smartphone screens and might well be adequate for the viewing of video content, allowing at least some streaming usage to be shifted off the metered hotspots and onto true unlimited devices.
It is also true that telecoms such as AT&T and Verizon would likewise expect to see some deterioration in their landline business from this effect. But unlike Comcast and Charter, they are actually providing the wireless service that is displacing the home broadband, so they would presumably be at least somewhat less opposed to seeing it happening. Particularly if they could sell more tablet data plans and phone plans with hotspot as a result.
This is a projection on my part, not an empirical declaration. I make no claim that this is happening in large numbers right now, only that the evolution of mobile communications and the economics of the wireless industry have reached a point where it is feasible for it to happen. Being feasible, more consumers, especially those on tight budgets, might be inclined to pursue it.
While I do not expect to see “wire-cutting” reach nearly as far as “cord-cutting,” the increased vulnerability of cable companies to the latter is important to remember. Comcast ducked the worst of the financial damage from cord-cutting precise because it had broadband to fall back on to preserve most of the profit stream from the customer, just providing a different service. If even a much smaller number of customers decide to sever both, the hit to profits could be far larger.
I remain wary of an investment in Comcast, even at the lower stock prices we are seeing in recent weeks. I would avoid the stock.
Disclosure: I am/we are long S.
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.