The grudge match between media titans Time Warner Cable and CBS continues, with the two sides unable to agree on the network’s demands that Time Warner Cable pay it more to send its programming to customers. And so as Friday dawned, the Great CBS Blackout of 2013 entered its eighth day. For a second straight weekend, Time Warner Cable subscribers won’t be able to watch Tiger Woods play golf, or Bob Schieffer grills guests on Face the Nation.
When two sides who stand mutually to benefit from an agreement are unable to do so, it’s either because one side is irrational and impossible to deal with—like, say, the House Republicans—or because one or both parties have so much riding on the outcome that they can’t afford to give an inch. And that’s increasingly what it looks like here. But contrary to what many observers might believe, it’s not the 20th century fuddy-duddy television network business that is in trouble. Rather, it’s the 21st century cable business.
The stock charts and the company’s earnings certainly don’t back up the story. Time Warner Cable’s very impressive five-year chart shows the stock has risen more than four-fold since the spring of 2009. So far this year, it is basically matching the S&P 500.
So what’s the problem? In a nutshell, Americans are cutting their cords. They’ve been cutting the cords on home-based telephones for years and switching to mobile phones. And just now they are starting to cut the cord on cable service to the home. Combined, these trends are overturning the business model of cable companies. In time, they also will upset their balance sheets. Time Warner Cable is finding that its core business is under assault.
For the last many years, cable companies have proved that distribution can be king. Those fat pipes they built to deliver television reception to American homes, it turned out, could also deliver premium television channels, on-demand events and content, as well as high-speed Internet service and telephone service. To the modern family, these services are utilities no less important than electricity or water. And people with means are willing to pay up for premium products. So Time Warner Cable, and many of its colleagues in the information distribution business, had the best of both worlds. They had the reliable recurring revenue streams of a utility and the growth associated with innovations.
But that was last decade’s story. This decade’s story is a little different. It’s very difficult for Americans to replace the water and electric utilities. Sure, you can build a well or put in solar panels, but these expensive propositions don’t guarantee reliability. But getting television programming from other providers is possible—often at a lower cost. You can put a satellite dish on your roof. Phone companies offer their own form of cable service. Or, as an increasing number of people do, you can forgo an expensive smorgasbord of cable programming and instead curate your own viewing experiences through the internet—Hulu, Roku, Apple TV, Amazon Prime, Netflix, iTunes, etc. The viewing experience in these other venues might be different—you may watch on a small screen instead of a big television, you sometimes have to wait for buffering. But it’s a pretty good substitute. And it’s much cheaper and generally hassle-free. People don’t have to wait for Hulu to come to the house and install service.
Young people are particularly prone to cutting the cord. And so the same thing is happening to cable business as is happening to CBS Evening News. Every month, a chunk of its audience dies off, and new consumers come of age who have no experience with the product and no intention of trying it. Of course, CBS and its competitors can respond by selling its products through these alternate distribution channels. When your business is owning, maintaining, and repairing the distribution channel, you have fewer options. And you have a lot more expenses. Creating content is actually quite cheap—companies might spend a few bucks on a viral video, or a few hundred thousand dollars to commission a book, or tens of millions of dollars on a sitcom. But cable companies have to spend billions to build out their networks, and then billions more to maintain them. Much of that investment is financed with debt.
The combination of a shrinking core business, high fixed costs, and high debt obligations can be deadly if it persists over a long period of time. That’s what did in General Motors, Chrysler, and the city of Detroit. While Time Warner Cable is nowhere near big trouble, a look through the company’s last several earnings reports reveal signs of decay are starting to pop up in its business model.
The company has a bunch of sources of revenues: it sells ads, it sells voice, data, and cable to businesses, and it sells voice, data, and cable to consumers in their homes. But the main show at Time Warner Cable is the residential video business. It accounts for about half of the company’s revenues. And that business is slowly going away.
In each of the last five quarters, Time Warner Cable has lost a significant number of residential video subscribers. In the second quarter of 2012 (PDF), the number of residential video subscribers fell from 12.468 million to 12.299 million, a decline of 169,000. In the third quarter of 2012, it lost 140,000 more. In the fourth quarter of 2012 (PDF), it lost 129,000. In the first quarter of 2013 (PDF), it lost another 119,000. And in the second quarter of 2013 (PDF), it lost 191,000. This is repetitive, I know. But the numbers illustrate a clear trend. In five quarters, the company lost 748,000 cable subscribers, about 6 percent of its total. In the second quarter of 2013, residential cable revenue was off 4.4 percent from the year before.
The company has compensated for these losses in part by steadily increasing the number of high-speed Internet subscribers, who now number more than 11 million. But that’s a much less lucrative business than cable. Meanwhile, voice—i.e., landline telephone service—also seems to have peaked. In the past two quarters, Time Warner cable has lost 81,000 voice subscribers.
There’s a good case to be made that those lost subscribers aren’t coming back. Cord-cutting, it turns out, is a real phenomenon. As Variety reported in March, the pay-television industry notched its first-ever 12 month period in which the total number of subscriber fell in its history. Between March 2012 and March 2013, according to the Leichtmann Research Group, the 13 largest satellite, cable, and telecommunications companies providing residential video service lost 80,000 subscribers. More recently, again per Variety, Moffett Research reported that America’s pay-television industry lost 316,000 customers between June 2012 and June 2013.
Time Warner Cable is facing a tough challenge. It has $26.4 billion in debt. It spends about $350 million each quarter on interest. It spends a lot of money to maintain its systems. The company’s capital expenditures—at $827 million in the second quarter and $1.6 billion in the first half of the year—are rising at a double-digit clip. It needs to spend that money whether it has 11 million subscribers or 10 million subscribers.
For companies, a dollar saved, or not spent, is the same as a dollar earned. As cable companies find it more difficult to earn dollars from their core customers, they are going to focus with increasing intensity on spending fewer dollars on their core ingredients. That’s why Time Warner Cable has been so leery of acceding to CBS’s demands for higher carriage fees. If it sets a precedent, pretty soon it will find itself deluged with requests for higher fees—without the rising revenues to help pay for them.