Why Big Media Isn't So Worried About Cord-Cutting

When Disney, Time Warner and Fox report earnings next week, investors will watch closely to determine whether viewers and advertisers are accelerating their move away from TV and to mobile.
By Leon Lazaroff ,

Just how bad is this cord-cutting thing?

We may soon find out. Big media companies like Disney (DIS) - Get Report , Time Warner (TWX) and 21st Century Fox (FOXA) - Get Report will be reporting third-quarter earnings in the coming week. And one of the things investors will be watching for is how much the historic shift of viewers and advertisers to the Internet is hurting traditional TV viewing.

Media stocks plummeted in early August after Disney CEO Robert Iger told investors that subscriber rolls at ESPN were experiencing a "modest" decline. The fear among investors was that if ESPN was losing customers, every other broadcast and cable-TV company must be losing subscribers as well.

From indications this past week from Comcast (CMCSA) - Get Report and Time Warner Cable  (TWC) , the country's two largest cable-TV operators,  things might not be as bad as feared.

Last Tuesday, Comcast said it lost 48,000 cable-TV subscribers in the third quarter, beating a projected decline of 66,000 video customers. The country's largest broadband network operator also added 320,000 Internet subscribers, reflecting the increase in U.S. household growth, through rentals and ownership, as well as the proliferation of "cord-nevers," mostly young people who aren't getting a pay-TV contract at all.

Time Warner Cable had even better numbers. The New York-based operator, which is near to merging with Charter Communications (CHTR) - Get Report , lost 7,000 video subscribers, better than a forecasted decline of 113,000, the average of two analysts surveyed by Bloomberg Business. Similarly, Time Warner Cable added 232,000 Internet customers in the quarter, surpassing a projection of 146,000.

As for the pace of cord-cutting, Bruce Leichtman, director of the Leichtman Research, a broadband and media consultancy based in Durham, N.H., says pay-TV subscribers have actually declined by less than one million from the industry's peak of about 100 million in the first quarter of 2012.

More importantly, the picture of cord-cutters ending their pay-TV subscription and never coming back is a false one, he says. About 5% of current pay-TV subscribers would have been called cord-cutters at some point over the past two years.

"'Cord-cutters' implies a degree of permanence," said Leichtman. "That they've cut it and they're never coming back again -- and the reality is that's not true."

The big difference between today and 2005 is that there's much more content available through the Internet, either free, or through a subscription service from Netflix (NFLX) - Get Report or Amazon (AMZN) - Get Report Prime, and as of Thursday, YouTube Red, the new ad-free video service from Alphabet's (GOOG) - Get Report Google.

And that, of course, is the rub. Media stocks in August traded down on mounting investor concern that traditional broadcast and cable-network owners will be unable to sustain their current level of programming costs if they're incrementally losing ad sales and viewers.

Media programmers and distributors contend that the traditional bundle remains large and profitable. Indeed, Comcast had 22 million pay-TV subscribers at the end of June, while Time Warner counted 11.3 million; Charter was at 4.3 million.

And despite the meteoric rise of Netflix (NFLX) - Get Report , the pay-TV business -- cable, satellite and TV through traditional telephone operators AT&T (T) - Get Report and Verizon (VZ) - Get Report -- generates about $100 billion in revenue a year; Netflix is at $4 billion.

"It's important to look at the big picture and not get caught up in the hype over cord-cutting," Leichtman added. "Look at where the market is, not some ten-year-out prediction that may or may not happen."

To protect the core of their traditional pay-TV business, media companies such as Disney are putting more of their networks, including ESPN, on services such as Dish Network's (DISH) - Get ReportSlingTV. Disney is also participating in Charter's new "custom" or "skinny" bundle called Spectrum and launching a streaming service in the U.K. next month called DisneyLife.

Likewise, Time Warner has its online offering HBO NOW and CBS (CBS) - Get Report has an Internet standalone for its premium channel Showtime.

Investors next week will want to get a status report on these new online offerings to determine whether large media companies are keeping pace with viewers preference for mobile, commercial-free platforms such as Netflix and Amazon Prime.

"Right now, these aren't adding up to much at all," Craig Huber, a media analyst at Huber Research Partners in Greenwich, Conn, said in a phone interview. "They're doing it for the long term in case cable and satellite distribution falls off significantly, and they'll have more of their programming on broadband."

As usual, investors will also be focused on ad sales and the fees pay-TV providers pay programming creators such as Disney, Time Warner and Fox to carry their networks. A slip in subscribers means lower carriage fees, as they're known.

A drop in either ad sales or carriage fees usually means a lower operating cash flow. Comcast shares fell on Tuesday after the owner of NBCUniversal reported a mere 2% rise in ad sales in the third quarter at its cable network unit, leading to a 3.9% decline in its operating cash flow. Shares dropped despite a spectacular showing by Universal's movie business, which reported a 64% revenue increase to $1.95 billion.

"If you start seeing cash flow down, that's a a huge negative in investors' minds, particularly given that we're not in an official recession," Huber added. "If you see a down-tick in profits or advertising revenue growth, that's not going to be well received."

According to media measurement firm Standard Media Index, TV advertising revenue fell 4% in September compared to the same period a year earlier. The drop, said SMI, came "despite a much-hyped programming lineup that included high-profile new late-night TV presenters. All television sectors saw declines."

Just how to gauge cord-cutting remains a source of great debate within the industry. Huber argues that the trend is clear, and that the business model beneath traditional media is eroding.

"A big overarching issue is the movement of eyeballs and advertising dollars to mobile,"  he said. "It's a huge net negative for the broadcast/cable network industry."

Next week, investors will get a better view at just how bad it is.

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