Cord-Cutting to Accelerate, But No "Doomsday" for Cable Financials, Analyst Says

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Wells Fargo's Jennifer Fritzsche boosts her subscriber loss forecasts, while highlighting that the financial impact "is fairly limited" even in “extreme stress” scenarios.

The rise in unemployment due to the novel coronavirus pandemic led to a new record in pay TV subscriber losses in the first quarter of 2020, and one pay TV analyst on Thursday predicted cord-cutting would accelerate further.

"We see cord-cutting as a secular trend that likely will kick into high gear during and on the other side of COVID-19," Wells Fargo's Jennifer Fritzsche wrote in a report. "With this belief in mind, we have moved our estimates for residential video subscriber losses lower across our cable coverage" to be "worse than Street for 2020 and 2021."

For example, she still projects Comcast to lose nearly 1.79 million pay TV subscribers in 2020, followed by 1.37 million in 2021, up from her previous estimate for a loss of 1.00 million users. For Charter, she predicts a 660,000 loss this year, wider than her previous forecast for a drop of 490,000, followed by a loss of 725,000 subscribers in 2021, up from her previous 520,000 estimate. The analyst also increased her video subscriber loss forecasts for the third cable firm she covers, Altice. 

She then ran "stress tests" with various scenarios to assess the financial impact on companies, concluding that the impact to earnings before interest, taxes, depreciation and amortization (EBITDA) along with free cash flow was "fairly limited — even in 'extreme stress' scenarios — given the substantial margin differential between broadband (60 percent) and video (15 percent-20 percent)." Her conclusion: accelerated cord-cutting "does not spell doomsday."

After all, "the cord-cutting trend only reinforces the need for a faster broadband pipe, which should drive further upgrades to higher-speed tiers (and provide average revenue per user benefits)." And she noted that pay TV companies, such as Cable One, that have de-emphasized video in favor of broadband "show the accretive margin trade-off between these segments."

Comcast remains Fritzsche's top cable stock pick with an "overweight" rating, with the analyst arguing that "its offensive stance in maintaining customer touch points (i.e. Flex, Xfinity Mobile) will allow it to lower churn on the more profitable broadband product."

Here is a look at the Wells Fargo analysts's three stress test scenarios. In scenario one, which she calls "baseline" or "status-quo," she estimates that annual residential video subscriber losses will be around 3 percent-5 percent on average across the three cable operators, saying that would be "a modest acceleration from trailing subscriber losses, which are in the 1 percent-4 percent range over the past three years."

Scenario two, which Fritzsche calls "bad," assumes that the five-year compound annual growth rate of video subscriber losses accelerates to about 10 percent. "We have also adjusted our broadband average revenue per user estimate upward ... to account for the modestly higher price that broadband-only subscribers pay vs. bundled customers for Internet," she wrote. Overall, this scenario would provide a 100-130 basis points [meaning: one hundredth of one percentage point] hit to cable revenue, but only a 20-40 basis points hit to adjusted EBITDA and free cash flow.

Finally, scenario three, which the analyst calls "really, really bad," the subscriber losses rise to about 20 percent, "or a four to six times faster clip than scenario one." In it, by 2024, "the residential video sub bases would be around 60 percent smaller than they were at the end of 2019," Fritzsche said. "The headwinds are 50-60 basis points for adjusted EBITDA and 70-100 basis points for free cash flow."

But she also highlighted: "We do not view this as a likely scenario, as we believe there will always be a solid core of video subscribers that highly value live content (i.e. news and sports) and are unlikely to migrate to a broadband-only offering."