Does a cable operator in the US with 13.5 million customers, and around 45,600 employees, which turns over revenue of almost $16 billion, and generates around $4.5 billion of cash a year, have any future?
When put like that Time Warner Cable appears impregnable, and rather worth owning. So why is it exactly, that Time Warner has been convinced that it should separate from the business and give up ownership of TWC?
Well of course the $11 billion dividend has something to do with it, with over 80% of that going to Time Warner, but just as we have with Comcast in the past, there is a little matter of asking just how much damage the US telcos have to do to business as usual for TWC to no longer have these impressive statistics?
First off take a look at capital expenditures? Last year TWC spent $3.4 billion on capex, almost all of its operating free cashflow, racing ahead of the two previous years when it spent $2.7 billion and $1.8 billon respectively. A company that feels a need to increase its capex so aggressively, is perhaps a company that has an old network.
TWC picked up 3.3 million subscribers when Comcast and TWC carved up the decaying corpse of Adelphia, a large cable conglomerate that was in bankruptcy, after fraud was discovered in its management. So many of these were analog subscribers, because for the three years previous Adelphia was pre-occupied with other issues, than upgrading its plant.
Today TWC has $13.3 million cable customers, of which 8.3 million get at least some of those channels digitally and 7.9 million have high-speed internet, with 3.2 million as Digital Phone customers. A year ago that would have been 13.4 million cable customers, with 7.7 million digital, 7.2 million with high speed internet, and just 2.3 million with digital phone.
That amounts to a loss of 100,000 customers in a year, but gains of just 600,000 in digital customers since last year, and at this rate it would take over 9 years before its entire customer base was converted to a digital offering; and roughly the same rate to convert its entire high speed internet base, at a rate of just 700,000 a year. But voice is the key issue, with 900,000 being the annual rate at which TWC takes VoIP customers away from other operators. All of that looks fairly rosy for TWC, gaining customers in digital cable, internet and VoIP faster than it is losing basic cable customers.
But we have to accept that in order to do that, the company has to build out its network further. VoIP cannot be offered to customers that do not have digital CMTS systems and which do not have Packetcable and at least DOCSIS 2.0, if not DOCSIS 3.0 for very high speed internet lines.
So with the emergence of at least one telco rival operating in core markets such as New York, California and Texas, we expect all these growth numbers to begin reducing and for the capex to continue for the next 8 or 9 years, both to make its network entirely digital and to upgrade it through the gears to DOCSIS 3.0 for even higher speed internet offerings. So really the cash that the business throws off is around $1 billion after essential capex, and that capex needs to continue for the foreseeable future. If it gives back $1 billion to shareholders each year, it would be standing still financially.
TWC has around $13.2 billion of long term debt, which is strangely close to its currently revenue ‘ owing a year’s revenue is always a scary thing, but considering the cash that is needed to continue not only to upgrade the plant to digital, but to continually upgrade it, it will be a long time before real cash piles are thrown off. The Comcast ratios are much the same with 24 million cable customers, of which 14.7 million are digital cable, 12.9 million high-speed internet customers, and 4.1 million voice customers, and Comcast was recently pilloried by Wall Street for its capex plans.
Debt at Comcast is around $30 billion, again perilously close to its annual revenues, and although the impression you get from following this industry is that Comcast is in better shape than everyone, and gets its programming practically for free (negotiating power), it’s still not in good enough shape to enjoy a decent share price, so much so that even Comcast is thought to be looking to sell about 400,000 to 500,000 of its customers, having hired investment bankers to shop around some of its smaller systems to other cable groups. The idea seems to be to convert some customers into cash, and use the cash to get more of the capex work done that needs to be done to drive ARPU.
Even the valuations for the two companies are in line, with $64 billion for Comcast, versus $28.8 billion for TWC, more or less twice revenues, with perhaps TWC on the low side which seems to us about right or even slightly optimistic.
We don’t think anyone believes that a separate Time Warner Cable is a stronger operation than one merged with Time Warner, what they think is that the Time Warner content businesses are stronger on their own than potentially being dragged into the triple play price war that is engulfing all US communications operators.
The truth is that within the timeframe that the US telcos complete their IPTV rollouts across the US, TWC will still be investing heavily in plant. It will have little chance to catch its breath before being beset on all sides by what by then are likely to be declining average customer expenditures, an increasing tendency to get programming over the web, and without the buying clout that Comcast retains.
The one light at the end of the tunnel is that TWC is still small enough to actually acquire other cable operators, rather than worry about controlling too great a percentage of the US public for the FCC’s liking, as Comcast does.