Video on Demand Will Boost Cable Earnings

The performance of the large cable stocks like Comcast (CMCSA Quote), Time Warner (TWX Quote) and Charter Communications (CHTR Quote) has been dismal over the last 12 months, with the group losing over 4% in value while the S&P 500 has gained 6.7% for the same period.

Judging by the stock performance and the lack of progress in growing EBITDA margins and average revenue per user (ARPU) as a proxy, it would be easy to assume these operators are content with the declining basic cable businesses and don't really care about shareholder value. But the cables have made a concerted effort to keep up with the times, sinking billions of dollars into upgrading networks to bring high-speed, cutting-edge interactive video and data services to the end-users.

This investment will drive higher average selling prices and lead to bigger market share gains, and it is indicative of the cable companies' vision of growth. Given the underperformance of the stocks in this sector, we believe opportunities abound in the stocks of equipment makers and cable operators.

We had the opportunity to sit in on a presentation by Comcast CEO Brian Roberts where the case for video on demand (VOD) was made clear. VOD is light years beyond pay-per-view, both for the user and the operator. VOD applications are geared toward segmenting the television viewing market and that will drive premium advertising dollars. That is why so much money is going into research and development to increase storage capabilities, increase video libraries and create proprietary programming.

Comcast's VOD menu is a screen of channels broken down into a constantly evolving growing list of genres. For instance, Comcast rolled out its on-demand television dating service in September. This service allows users to enter criteria for a possible match and then watch a video, in digital form, of the potential date. In its first month in a small Philadelphia rollout, there were 100,000 streams. And the company's NFL replay allows on-demand users to see archived, 8-to-10-minute highlight reels of each game with audio from the local market's radio broadcast, and comes with digital video recorder (DVR)-like fast-forward and rewind functions. The service has had 3 million streams since the start of the season in early September.

To put that in perspective, DirecTV's (DTV Quote) Sunday Ticket, which plays all of the week's games, has only 1.5 million total users. Satellite is unable to offer VOD because it requires a two-way, interactive platform, which is only available from cable. Maybe that is why DirecTV just reported on Tuesday that it is spending more to acquire customers and churn is increasing.