Pay-TV excels in 1st quarter, stocks undervalued?

A visitor stands in near of a wall of television screens during the MIPCOM, the international film and program market for TV, video, cable and satellite October 4, 2004.

NEW YORK (Reuters) -Cable and satellite companies may be worth more than their current share prices suggest, as surprisingly strong subscriber growth during the first quarter shows their resilience despite tougher competition and a weak U.S. economy.

Most analysts had assumed the slowdown in the U.S. housing market, coupled with key inflationary factors such as rising gasoline and food prices, would see cable companies losing customers during the period. They also forecast tepid growth for satellite and telephone companies.

Instead, big publicly traded pay-TV companies have so far added more than 700,000 subscribers between them.

The subscriber additions and an increase in average revenue per subscriber (ARPU) raises questions about whether cable and satellite TV company stocks are properly valued and whether a more severe economic slowdown will have as significant an impact as many projected.

"I think the economic downturn got overplayed," said Kaufman Bros analyst Todd Mitchell.

In the first quarter, Time Warner Cable Inc, Mediacom Communications Corp and Cablevision Systems Corp added a total of around 59,000 subscribers.

Phone companies AT&T Inc and Verizon Communications Inc added 411,000 TV subscribers, while satellite TV operator DirecTV added around 275,000 during the quarter. All outperformed analyst expectations, with the exception of DISH Network, which added a very weak 35,000 subscribers compared with 310,000 a year-ago.

Although the largest U.S. cable operator Comcast Corp lost 57,000 subscribers from its 24 million base, it sold hundreds of thousands of new digital video, phone and Internet services and outpaced analysts' forecasts.

ECONOMIC RESILIENCE

In previous downturns, investors viewed cable stocks as economically resilient in the belief that subscribers would only cut their cable TV service under the most dire of circumstances.

That view fell out of favor as competition mounts from new entrants and as monthly bills rise ever higher from consumers taking a "triple play" package of TV, phone and Internet services.

But a surprisingly strong first quarter has convinced some to revert to conventional wisdom.

Both Comcast and Time Warner Cable's shares have risen around 11 percent since April 29, when Time Warner Cable was the first to beat analyst expectations by adding 55,000 subscribers.

Sanford Bernstein analyst Craig Moffett said cable stocks are still attractively priced with room for growth.

"This could be a positive catalyst for the cable stocks if only because it serves as a reminder that these businesses are a lot more durable than anyone gave them credit for," he said.

Comcast's enterprise value (EV), or its market capitalization plus debt minus cash, currently trades at 6.5-times its estimated 2009 earnings before interest, tax, depreciation and amortization (EBITDA), while Time Warner Cable trades at 6.4 times, according to Reuters Estimates.

Bernstein values both stocks at a higher multiple of 8 times EV to EBITDA.

The optimism is driven by early signs of an overall expansion in new subscribers as U.S. consumers become more aware of the digital TV switchover slated for February 2009, when the analog broadcast signal will be switched off.

Moreover, competition between cable, satellite and phone companies for TV subscribers inspired rivals to spend more heavily on marketing, which analysts said also helped boost pay-TV subscriber numbers in the first quarter.

Verizon, for instance, lured new subscribers by offering free flat-screen high-definition TV sets. Some cable operators were offering steeply discounted promotional rates to new customers.

But those tactics catch up with them. While cable valuations have declined from a buyout boom a year ago, Standard & Poor's analyst Tuna Amobi says the stocks might in fact still be overvalued, especially if competition continues to tighten.

"I still feel there's some downside there because increased competition is going to force majors to increase discounting which will put pressure on their ARPU," said Amobi.

Reuters/Nielsen