The American cable industry, which Cogeco Cable and the Canada Pension Plan Investment Board are each planting a flag in, is littered with small players who are waging fierce battles for market share at the same time that technology threatens to turn the sector on its head.
More than 1,150 cable companies are battling south of the border for about $98-billion (U.S.) in annual revenue, in a market that is relatively light on regulation. It's a highly fragmented industry, and one where scale matters. The cost of acquiring programming and media content in the U.S. is on the rise and bigger players have more negotiating power with studios and other providers.
These are some of the reasons the market is panning Cogeco's deal while giving a tentative thumbs up to CPPIB's foray. CPPIB has bought a much larger player, has ensured that the company's senior executives will stay, has the financial muscle to invest further in technology or acquisitions, and has a long-term horizon that will allow it to be patient through a period of industry upheaval.
Cogeco's management team says that the culture and the infrastructure it is buying into look a lot like those its familiar with in Canada. But analysts beg to differ. The five largest companies in Canada's communication industry, including both cable and telecom, captured 83 per cent of the industry's $57.4-billion in revenues in 2010. The top 10 players have cornered 92 per cent of the sales, according to Canadian Radio-television and Telecommunications Commission data.
The market fears that Cogeco has fallen into a trap with its $1.36-billion (U.S.) purchase of Atlantic Broadband, the 14th largest cable company in the U.S. The problem is this: Players such as Atlantic Broadband need more scale in the U.S. to thrive there, but Cogeco's investors will not support any further acquisitions south of the border until Cogeco proves it can make a success of this one.
"With this acquisition they are a small player," Desjardins analyst Maher Yaghi said. "The smaller guys are having some issues with containing the inflating costs of media content, so they're being squeezed. And they need to deploy more capital into their networks to improve them as the telecommunication companies encroach on their territory. So it becomes a bit difficult for the small guy to compete."
As a result, many in the industry expect that a number of U.S. cable companies with values around $1-billion to $5-billion could be acquired in a round of consolidation. But the market will punish Cogeco's shares if it seeks to do further deals in the U.S. before making this one work, analysts said.
Mr. Yaghi said the company's money would have been better spent in Canada, whether it was returned to shareholders via buybacks and dividends, or used to fund expansion or small acquisitions here. He noted that telecom rivals Bell and Telus are in the midst of launching Internet Protocol TV here at home, and shareholders are already a bit nervous.
"Unlike CPPIB, which has a lot more assets at its disposal, a medium-sized public company in Canada only has a certain amount of cash it can deploy," he said. "By putting a lot of capital in the U.S. market, if they had to for some reason become more aggressive about defending their own territory in Canada, will they be forced to make certain decisions?"
The company that CPPIB has teamed up with European private equity fund BC Partners to buy, which operates under the name Suddenlink, is the seventh-largest cable company in the U.S.
In an e-mail to clients, Bank of Nova Scotia analyst Jeff Fan said that Suddenlink is six times larger than Atlantic Broadband, with a network that passes 3 million homes as opposed to Atlantic Broadband's roughly 500,000. Suddenlink's subscriptions, revenue and earnings before interest, taxes, depreciation and amortization are also rising more quickly, Mr. Fan said.
Mr. Fan reiterated the notion that, in the U.S., size matters. "Without scale to acquire the right content for all platforms (linear and digital for non-traditional devices such as tablets, PCs and smartphones), we believe smaller operators are facing the risk of margin compression or subscriber cord cutting/shaving," he wrote.
Cogeco's executives have suggested that they will look to grow further in the U.S., labelling the deal a unique opportunity to enter the market. "The idea I think is to combine this acquisition with other acquisitions down the road to become a bigger player," said Mr. Yaghi. "But that will require shareholders to be very, very patient and will take a long time."
Time is something that CPPIB has the luxury of, sheltered as it is from the pressures that a public company faces with quarterly updates to shareholders. Cogeco saw its shares drop nearly 15 per cent Wednesday after the deal was announced and nearly 4 per cent further Thursday, as investors signalled their displeasure with this acquisition.
BMO analyst Trevor Bateman drew up a list of eight reasons why he doesn't like Cogeco's deal, including the leverage involved, the distraction it poses for management just as IPTV rolls out in Canada, and his skepticism about Atlantic Broadband's ability to compete in the "hyper-competitive and structurally different" U.S. market.