Factors That Could Potentially Trigger Movement In Time Warner Cable’s Stock Price

-3.12%
Downside
210
Market
203
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TWC: Time Warner Cable logo
TWC
Time Warner Cable

Pay-TV operator and Internet Service Provider Time Warner Cable (NYSE:TWC) has been doing well in recent times. The company reported extremely strong numbers in its last quarter. Time Warner Cable (TWC) added 315,000 high-speed data subscribers in what was the company’s best quarter in terms of subscriber additions since Q1 2007. [1] The company also registered its first quarterly increase in its pay-TV subscriber base since the Q1 2009. Additionally, Time Warner Cable experienced their best quarter ever in terms of net subscriber additions in residential customer relationships, residential triple play and voice.

TWC also announced recently that it has entered into a definitive agreement to merge with Charter Communications (NASDAQ:CHTR). [2] TWC shareholders will be paid $195.71 per share, comprising $100 in cash and the rest in shares of a new public parent company (tentatively called “New Charter”), for each TWC share outstanding. The newly formed company would represent 21% of the high speed internet market, becoming the second largest internet service provider behind Comcast (NASDAQ:CMCSA). [1] [3] In the pay-TV market, New Charter would account for 17% of the market. [4] (Related – Our Thoughts On The Time Warner Cable-Charter Merger)

If the merger receives regulatory approval, we expect TWC’s price to rise to around 195 (the price offered by Charter) as investors will try to book arbitrage profits. However, if the merger does not go through, we believe that there are certain other triggers and plausible developments that can move the stock price significantly in the next couple of years. Specifically, we believe that a rapid erosion of the overall pay-TV subscriber base and introduction of a streaming service are some of the catalysts that can trigger stock price changes for better or worse.

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Our price estimate for Time Warner Cable stands at $183, implying a premium of about 3% to the market.

See our complete analysis for Time Warner Cable

Pay-TV Subscriber Losses Could Accelerate Rapidly (~13% Downside)

Pay-TV market has become saturated over the past few years. Even though total TV households in the U.S. have inched upwards, increasing from 114.2 million [5] in 2012-13 to 116.3 million [6] in 2014-15, the number of pay-TV subscribers has remained stagnant at around 100 million for the past few years. [7] Top pay-TV providers are currently losing a combined 100,000+ subscribers per year, having lost around 105,000 [8] and 125,000 [7] subscribers in 2013 and 2014, respectively. This rate of erosion has allowed the pay-TV providers to remain profitable as the loss of subscribers is more than offset by rising subscription fees. In our base scenario, we believe the pay-TV subscriber base will shrink by 100,000 subscribers every year and just dip below 100 million by the end of our forecast period, resulting in a pay-TV penetration of just under 85%.

However, the rate of erosion of subscriber base could potentially accelerate to a point where the pay-TV industry might lose more than one million subscribers per year. TiVo recently released a white paper which estimates that approximately 1.5 million customers plan to cut the cord of their pay-TV service. The rise of alternative platforms, such as online streaming services, can also hasten the subscriber losses for the pay-TV industry. Streaming giant Netflix already has a thriving subscriber base and other content providers such as Dish Network, Sony, Apple, HBO, CBS, and etc., are also launching their own streaming services. These services will be priced considerably lower than the subscription fees charged by traditional pay-TV providers. This could lead to a mass exodus and the pay-TV market could drop down to 90 million in the next six to seven years, resulting in a pay-TV penetration of around 75%. This turn of events will also have a detrimental effect on the TWC’s market share, which could potentially drop down to around 9%. The company will also not be in a condition to raise prices as it will be competing against cheaper streaming alternatives. All these developments could bring down TWC’s price estimate to $160, which would be a 13% correction to our current estimate of $183.

Introduction Of Streaming Service (~10% Upside)

The streaming market is ripe with potential. As mentioned earlier, content providers are increasingly opting to broadcast their programming through the internet. These streaming services are priced according to the amount and demand of content they carry. On the low end of the spectrum, Netflix offers its services at $9 a month while Hulu does so at $8 a month. [9] On the other end, Sony’s Playstation Vue service is priced at $50-70 and broadcasts around 85 different channels. Other streaming options such as Dish’s Sling TV ($20 monthly for 20 channels) and Apple’s streaming service ($25-$35 monthly for 25 channels) are priced somewhere in between.

TWC currently provides a free streaming service called TWC TV® to its pay-TV subscribers. The subscribers can access up to 100 channels of live TV programming through the TWC TV® service. TWC could potentially convert its streaming service into a paid service and could price it somewhere in the $20-$25/month region based on the amount and quality of its content. Rival pay-TV provider Dish Network’s streaming service Sling TV offers 20 channels including ESPN and has attracted around 250,000 paying subscribers from the start of February to the start of June. [10] Keeping this in mind, we believe that TWC could potentially have a customer base of around 500,000 by the end of its first year of offering. If this customer base reaches 7 million by the end of our forecast period, it can add $2.3 billion in incremental revenues and $850 million in incremental gross profits. The streaming service will cannibalize some of TWC’s pay-TV subscribers but we expect this loss to be minimal. The additional revenue brought in by the streaming service will push TWC’s average revenue per subscriber higher. In our base assumption, which does not include revenues secured from the streaming service, we believe that average revenue per U.S. subscriber will be around $68.50 in 2015 and will eventually grow to $81.40 by 2021. This figure increases to $69.60 for 2015 and reaches $101.50 in the next six to seven years in our optimistic scenario. Consequently, the introduction of a streaming service will result in a potential upside of around 10% to our price estimate.

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Notes:
  1. Time Warner Cable’s SEC Filings [] []
  2. Charter Communications to Merge with Time Warner Cable and Acquire Bright House Networks, May 26, 2015, Time Warner Cable Press Release []
  3. NEARLY 1.2 MILLION ADDED BROADBAND IN THE FIRST QUARTER OF 2015, May 15, 2015, Leichtman Research Group, Inc. []
  4. MAJOR PAY-TV PROVIDERS ADDED ABOUT 10,000 SUBSCRIBERS IN 1Q 2015, May 14, 2015, Leichtman Research Group, Inc. []
  5. NIELSEN ESTIMATES 115.6 MILLION TV HOMES IN THE U.S., UP 1.2%, May 7, 2013, Nielsen []
  6. NIELSEN ESTIMATES 116.3 MILLION TV HOMES IN THE U.S., UP 0.4%, May 5, 2014, Nielsen []
  7. MAJOR PAY-TV PROVIDERS LOST ABOUT 125,000 SUBSCRIBERS IN 2014, March 3, 2015, Leichtman Research Group [] []
  8. Major Multi-Channel Video Providers Lost About 105,000 Subscribers in 2013, March 14, 2014, Leichtman Research Group []
  9. Sony Unveils Pricing, Availability of Vue Online TV Service, March 18, 2015, Wall Street Journal []
  10. Sling TV’s Web TV Subscriber Numbers Keep Growing, Now Around 250,000, June 5, 2015, re/code []