Cable's Growth Worries Take a New Twist

Year-over-year basic subscriber growth reported by the industry has sunk from 0.5% in the fourth quarter of 2000 to negative 0.2% in the first two quarters of this year, says Bazinet. But if cable operators built systems at the same pace of new household formation, they'd actually be losing subscribers at a rate of nearly 2% a year.

A particular troubling element of the penetration falloff, says Bazinet, is that the pace accelerated in the first half of this year. That runs counter to many investors' expectations that industrywide system upgrades, nearing completion, would stabilize the decline.

The declining penetration accompanying cable system expansion raises at least two worrisome questions for cable investors. One, how long will operators, facing competition from direct broadcast satellite service, be able to build their way out of steep subscriber losses? And two, are the new potential customers reached by plant expansion worth the cost of reaching them?

"If the only way you can grow your customer base is by doing line extensions," says the short-seller, "that implies you're losing customers on your base network. If that trend continues, where you have less and less customers per mile of plant, over time your operating margins will come under pressure."

Or, using an example from the food-service industry, the short-seller says, "If McDonald's (MCD Quote) has to keep opening new stores to sell the same number of burgers, that's going to eat into their profitability."

Subsiding Subscriber Growth How Slower System Expansion Affects Growth Rate for Basic Cable Service

Source: J.P. Morgan report "(No) Growth, But at What Cost?," Aug. 19, 2002

Challenges

The questions surrounding penetration spotlight major ongoing challenges to the cable TV industry. As DBS services such as EchoStar Communications' (DISH Quote) Dish Network eat into cable TV's traditional customer base, the question remains whether cash generated by a new generation of advanced cable services will offset a slowdown in demand for basic cable.

Over the past year, in fact, cable stocks have slid as investors have grown increasingly uncertain that the billions plowed into cable system upgrades in recent years will result in payoffs from advanced services as large and as timely as they previously expected.