Stocks of cable television operators have been among the top performers in the market over the past three years, but now may be the time for investors to cut back, according to one prominent analyst.
Craig Moffett, regularly the top-ranked cable analyst by large investors for the past decade, stripped his “buy” rating from Comcast (CMCSA), Time Warner Cable (TWC) and Charter Communications (CHTR) this week, saying it was time to “take some chips off the table." In an 18-page report, Moffett outlined increasing risks to the sector from the likely regulation of broadband Internet service, as well as declining viewership and advertising trends.
“With the stocks having largely achieved our target prices, with cord cutting risks mounting, and with regulation clouding the path forward in broadband, it seems to us to be time to reduce exposure,” Moffett wrote.
The major risks could combine in ways investors have not anticipated, Moffett added. Cable companies might want to increase prices on Internet service as customers drop television service, but the new Federal Communications Commission rules give regulators the power to block such a counter-move, he said.
Over the past three years, Comcast’s annual total return to investors, including dividends, averaged almost 28%, 10 percentage points a year better than the S&P 500 Index, according to Morningstar data. Time Warner Cable, which Comcast is seeking to acquire, had a total return of 26% a year and Charter returned over 40% annually.
But now the FCC is preparing to classify broadband Internet service as a business, subject to the kind of utility-style regulation imposed on telecommunications carriers. The agency says it wants only to ensure that all traffic flows freely without discrimination, consistent with the principle of “net neutrality.” At the same time, viewers are turning away from traditional cable TV programming, hurting revenue from subscriptions and advertising.
Investors aren't worried... yet
Still, Moffett appears to be ahead of the curve among Wall Street analysts. Of those who follow Comcast, 83% rate the stock a “buy” and 17% rate it a “hold,” according to FactSet. Charter received 69% “buy” ratings and 31% “hold.” Time Warner Cable, which largely trades in line with Comcast because of the pending merger offer, is rated “buy” by 43% and “hold” by 57%. No analyst has a “sell” rating on any of the three stocks, according to FactSet.
And cable investors have shown little fear of the impending FCC rules so far. Although cable stocks sold off on Nov. 10, after President Obama issued a strong call for new rules to protect net neutraility, the stocks have more than recovered their losses. FCC chairman Tom Wheeler, himself a former cable lobbyist, is expected to put forth a formal proposal.
Analysts have emphasized the strong opposition to the FCC, with lawsuits likely to tie up any new rules for several years. The agency is also promising not to impose any price regulation as part of the net neutrality plan, they note.
"We expect that Wheeler's (path) post-FCC vote will not be an easy one," says Evercore ISI analyst Vijay Jayant, who has a "buy" rating on Comcast, Time Warner Cable and Charter. Once the FCC approves rules, they must survive opposition by the Republican-led Congress and a legal challenge in an appeals court that has struck down prior FCC net neutraility efforts.
Moffett thinks investors may not be considering regulators' longer-term moves. “It would be naive to believe that the imposition of a regime that is fundamentally about price regulation, in an industry that the FCC has now repeatedly declared to be non-competitive, wouldn’t introduce risk to future pricing power."
On the cord-cutting issue, Moffett points to the recent moves by TV and movie producers like CBS (CBS) and Time Warner’s (TWX) HBO to offer Internet-only services that don’t require a cable subscription. At the same time, ratings are dropping for many traditional cable channels.
Many investors believe cable providers will be able to make up for revenue lost from cord cutters by increasing rates on Internet service, either by charging consumers more or by extracting fees from content providers like Netflix (NFLX). Moffett's concern is that under the FCC’s new rules, the companies won’t be able to make that shift.
“The obvious risk is that carriers’ ability to monetize traffic (through either of the above mechanisms) will never be permitted,” he writes.