Cable’s Yin-Yang State

CABLE’S YIN-YANG

STATE

BY KIMBERLY M. RANDOLPH & LAURA K. SUNISLOE

DESPITE COVID-19, THE CABLE industry continues to experience both a surge in subscriber growth, usage and profitability. At the same time, there’s an acceleration of the already waning traditional multichannel video revenues.

Above all, the pandemic has served to highlight the importance placed on high-quality, dependable home connectivity, particularly given the reliance on broadband networks for remote work, online education and telehealth services. The cable industry has met the challenge as more customers work and learn from home.

However, the economic burden many consumers and businesses are facing, particularly small businesses, is expected to impact the industry.

On March 13, 2020, the chairman of the Federal Communications Commission (FCC), Ajit Pai, issued a call to action to the cable industry to “Keep Americans Connected.” Specifically, he asked broadband and telephone service providers and trade associations to take the so-called Keep Americans

Connected Pledge in order to ensure that

Americans do not lose connectivity as a result of exceptional circumstances surrounding the

COVID-19 crisis.

More than 800 companies and associations have signed the pledge, which waives late fees, expands Wi-Fi hotspots and defers the termination of service to any residential or small business customer due to nonpayment. Many of the pandemic-relief programs introduced by the cable operators include 60-day free access for low-income homes with school-age children. In addition, member companies of the NCTA - The Internet and Television

Association pledged over $100 million in public service advertising for community health education.

According to S&P Global Market Intelligence (S&P), an estimated 1 million high-speed data subscribers fell under a COVID-related relief plan in 2020’s second quarter across three multiple system operators (MSOs), which serve 82% of the cable broadband universe. Of the 1 million subscribers, Comcast Corp. served 600,000, with Charter Communications and Altice USA reporting 386,000 and 54,800 customers, respectively, in that period.

S&P estimates that the incremental revenue potential from this subscriber growth results in a substantial annualized $765.2 million. (Note: This estimate is as of August 2020 and does not take into consideration third-quarter 2020 performance; an updated projection of the incremental revenue was not available at press time.)

In addition to customer additions associated with the relief programs, the pandemic has also resulted in considerable subscriber growth for cable operators. Wireline highspeed data (HSD) subscriptions grew more than 1.6 million in the third quarter, up from 595,000 year-over year, S&P reports. The total number of subscribers, including residential and commercial, reached 112.9 million in the third quarter, up 4.7% from Q3 2019.

Even after accounting for changes in reporting due to subscribers associated with the Keep Americans Connected initiative, the cable industry’s broadband gains signal a continued shift to cable from telco, with total cable HSD customers of over 77 million, compared to telco HSD customers of around 36 million.

In the second quarter, Comcast reported its largest net adds amount since 2007, and

Multichannel providers may be losing video customers, but they’re more than compensating with broadband

revenue. This is the third in a series of stories on the performance of various media sectors.

that is excluding subscribers added under the COVID-19 relief programs.

TELCO LOSSES NARROW

Other third-quarter figures show how the telcos have slightly reversed their overall slip in popularity. Their broadband losses were reversed in the third quarter. They added 207,000 net customers, a gain that was driven primarily by fiber subscriptions. This net gain resulted in a 0.6% sequential uptick after consecutive quarters of subscriber losses.

The larger players, including AT&T and Verizon Communications, reported subscriber growth that overcame legacy fiber-to-the-node and digital subscriber line (DSL) losses for the quarter. In this regard, the smaller telco operators – including Windstream Holdings, Cincinnati Bell and TDS Telecomm – all increased their respective high-speed data customer bases.

Another key trend that has impacted the industry since the beginning of the pandemic, and as shelter-in-place orders became more widespread, is consumers’ desire for higher speeds and increased bandwidth.

Overall, the uptick in broadband usage and demand for higher-speed services suggests a continued trend towards faster, more valuable tiers across the industry.

For the top 10 public cable operators, the subscriber gains and service upgrades helped push EBITDA (earnings before interest, taxes, depreciation and amortization) margins to a record 41.4% in the third quarter and led to a 3.8% year-over-year revenue gain.

The margin uptick was also driven by lower programming costs and a move toward self-installations as a result of precautions related to the pandemic. These factors were offset slightly by underperformance within the group’s residential video services segment.

Advertising revenue, typically a significant contributor in election years, rebounded sharply in the third quarter, after a 30% decline in Q2, driven by political spending and economy reopenings.

THE STREAMING FACTOR

The pandemic has accelerated the shift away from traditional multichannel and the adoption of streaming video, particularly broadband-delivered subscription on-demand services. In addition to consumers’ changing video consumption preferences, specifically over the last decade, the shift away from multichannel is driven in part by a decline in affordability for these services.

Net gains of broadband-only homes more than doubled in the second quarter, with S&P estimating that U.S. households not subscribing to traditional multichannel services reached 38.2 million, or 29.5% of occupied U.S. households at the end of the second quarter. That is an 8.5% increase

Public MSOs — Revenue and EBITDA Margin

$32

EBITDA Margin (%)

$31

Revenue ($1B)

$30 $29 $28 $27 $26 $25 $24

Q1’17 Q2’17 Q3’17 Q4’17 Q1’18 Q2’18 Q3’18 Q4’18 Q1’19 Q2’19 Q3’19 Q4’19 Q1’20 Q2’20 Q3’20

SOURCES:Industry data; Kagan estimates

Public MSOs — Revenue and EBITDA Margin

$32

EBITDA Margin (%)

$31 Revenue ($1B) 42% $30 41% $29 40% $28 39% $27 $26 38% $25 37% $24 36%

Q1’17 Q2’17 Q3’17 Q4’17 Q1’18 Q2’18 Q3’18 Q4’18 Q1’19 Q2’19 Q3’19 Q4’19 Q1’20 Q2’20 Q3’20

SOURCE 35%S:Industry data; Kagan estimates Data compiled November 2020. Includes Altice USA, Atlantic Broadband, Cable One (Sparklight), Charter, Comcast, GCI Liberty (Cable consumer + business), Mediacom, Shentel, TDS (Cable) and WideOpenWest. 42% 41% 40% 39% 38% 37% 36% 35%

Data compiled November 2020. Includes Altice USA, Atlantic Broadband, Cable One (Sparklight), Charter, Comcast, GCI Liberty (Cable consumer + business), Mediacom, Shentel, TDS (Cable) and WideOpenWest.

35%

MSO Index 25

Comparing Index Values (January to November 2020) Comparing Index Values (JanuaryS&P 500MSO Index to November 2020)MSO 100 Day Moving Avg

S&P 500 100 Day Moving Avg

S&P 500 MSO 100 Day Moving Avg S&P 500 100 Day Moving Avg

15

5

-5

-15

-25

-35

SOURCE:S&P Capital IQ

Jan 2020Jan 2020 Jan 2020Feb 2020

Feb 2020 Mar 2020Mar 2020 Apr 2020 May 2020May 2020Apr 2020 Jun 2020 Jun 2020 Jul 2020 Jul 2020 Aug 2020Jul 2020 Aug 2020Sep 2020Sep 2020 Oct 2020 Oct 2020 Nov 2020 Nov 2020

Mar 2020Mar 2020 Apr 2020 May 2020May 2020Apr 2020 Jun 2020 Jun 2020 Jul 2020 Jul 2020 SOURCE:S&P Capital IQ Sep 2020Sep 2020Aug 2020Aug 2020Jul 2020 Oct 2020 Oct 2020 Nov 2020 Nov 2020

MSO Index includes AT&T, Altice USA, Cable One, Charter, Cogeco, Comcast, DISH Network, GCI Liberty, Shenandoah, TDS, Verizon, and WideOpenWest.

over first quarter 2020 and a 32.1% increase year-over-year.

Given the economic impact of the pandemic, it’s likely that U.S. households were looking to cut expenses. At a monthly $100-plus average cost, traditional multichannel services probably stood out as no longer affordable to many subscribers.

S&P projects that cable’s traditional multichannel segment will experience a 5.7% decline in its compound annual growth rate (CAGR) from 2019 through 2024. Overall, the cable industry accounts for 58.3% of traditional multichannel market share.

The downward trend also extends to the direct broadcast satellite (DBS) sector, which accounts for approximately 30% of the total traditional multichannel market share. S&P projects this sector’s CAGR will dip 15.9% from 2019 through 2024. Overall declines in the subscriber pool for the DBS segment are further exacerbated by expensive hardware and installation and satellite’s limited broadband bundling options.

As evidenced by the cable sector’s performance in the public markets, the subscriber gains and consumer upgrades to more expensive packages have largely offset the weak growth and declines in video service.

OUTPERFORMING THE S&P

Of the 12 publicly traded MSOs in the U.S., six outperformed the S&P 500 through the most recent year-to-date period (Jan. 1 to Nov. 23). MSO performance was bolstered in large part by Charter Communications and Cable One, which cited 31.5% and 29.1% increases, respectively. Their growth was driven by sizable subscriber gains (some of which were attributable to additions under COVID-19 relief programs).

Taken as an index, MSOs’ growth eclipsed 24.5% whereas the S&P 500 saw just a 9.8% rise over the year-to-date period. However, not all MSOs fared equally, with three of the 12 companies included in the index showing a significant decline in share price ranging from -15% to -26%.

Prior to the pandemic (as of Jan. 1, 2020), MSOs averaged an enterprise value (EV), or EBITDA, of 8.48x, which is slightly higher than the current EV/EBITDA average of 8.31x (as of Nov. 23, 2020). With increased demand and subscriber upgrades, these multiples are projected to increase.

In comparison, forward EV/EBITDA multiples for the MSO index averaged 8.58x prior to the pandemic and have since returned to a current average of 8.63x. The relative stagnation in these multiples contrasts sharply with the MSOs’ ability to outperform the market. This may suggest hesitation by investors to pay a premium in a volatile industry despite growing share prices.

As was true for other sectors, multichannel operators experienced a sell-off late in the first quarter. Share-price declines ranged from 10.0% (Charter) to 43.6% (DISH Network Corp.) over the period from Dec. 31, 2019 to March 31, 2020. Overall, MSO shares performed better than the S&P 500, which declined 20.0% during the period.

The MSO industry has typically proved to be resilient in economic downturns, given the subscription-based business model, which provides stable revenue and cash flows. For example, the recession that took place from December 2007 to June 2008 had a limited impact on the industry’s financial performance. In fact, total multichannel revenues increased 14% from 2007 through 2009, according to S&P.

The industry did not, however, escape the sell-off during the dotcom bust in 2002; stock price declines ranged from 41% to 88% during this period. It is worth noting that the multichannel sector has experienced significant changes in recent years – notably, the increase in streaming services and decline of traditional multichannel video.

Despite its current headwinds, the cable industry has fared well relative to broader market and is on pace for a record year – both with regard to public company performance and deal volume.

M&A ACTIVITY SPRINGS BACK

THE CABLE MERGER AND ACQUISITIONS (M&A) LANDSCAPE RECEIVED A boost in the second half of 2020 after a slow start to the year, with significant private equity deal making and activity among broadband providers.

A few of the notable transactions include: ■ San Francisco-based investment firm GI Partners announced its partnership with industry veteran Rich Fish to acquire Vast Broadband. Vast serves over 60,000 residential and business subscribers in South Dakota and Minnesota. S&P estimates the deal value at $418.9 million, or an estimated 11.1x projected forward EBITDA. ■ SDC Capital Partners LLC acquired a 48% stake in ALLO Communications for $197 million. ■ Cable One purchased a 45% stake in Mega Broadband Investments Holdings from

GTCR for $574.1 million in cash. ■ Wren House Infrastructure Management acquired all of residential and commercial provider i3 Broadband. ■ Stonepeak Infrastructure Partners announced the acquisition of Astound Broadband, the sixth largest U.S. cable and broadband provider, from private equity firm TPG

Capital LP for $8.1 billion. Astound had previously acquired RCN Corp. and Grande

Communications. At $8.1 billion, Stonepeak’s purchase is the 12th largest cable M&A of all time according to S&P. It pushes the cable industry year-to-date deal volume as of Nov. 1, 2020 to an estimated $9.59 billion.

In addition, AT&T has renewed or continued its efforts to sell DirecTV. At press time, it was in talks with private equity companies to sell a significant minority stake in its DirecTV, AT&T Now and U-Verse pay-TV businesses, according to CNBC and The Wall Street Journal.

Under the terms of the proposed deal, AT&T would retain majority economic ownership of the business and would maintain ownership of the U-Verse infrastructure, including plants and fiber. The buyer would control the pay-TV distribution operations and consolidate the business on its balance sheet.

It is estimated the deal would be worth less than $15 billion to $20 billion, per the Wall Street Journal and CNBC.

Kimberly M. Randolph is managing director and Laura K. Sunisloe is vice president at the valuation advisory Stout. They can be reached at krandolph@stout.com and lsunisloe@stout.com, respectively.