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The picture grows dimmer for cable investors

Fabrice Taylor, CFA, publishes the President's Club investment letter. His letter and The Globe and Mail have a distribution agreement. You can get a free copy here.

Cable stocks bask in the popular perception that they are stable generators of cash flow and dividends. But are they really that safe in a world full of young pirates?

My brother is 30 years old. He doesn't own a TV. He therefore doesn't have cable. But he watches a lot of TV, which, like millions of other people, he downloads from the Internet. He doesn't pay for these shows, to my knowledge, but even if he did – buying them from Netflix or iTunes – he still wouldn't need cable.

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The loss of cable subscribers is called cord-cutting. I brought it up in this space as a potential threat to cable companies about two years ago. The tendency appears to be gathering steam – and it turns out cable companies are also burdened by other irksome problems, particularly the rise of Internet television services from phone companies. Investors should tread carefully.

Perhaps the best example of the trouble in cable land is Shaw Communications Inc. In the latest quarter, revenue, operating income and cash flow all fell at the Calgary company. This was masked by sharply higher earnings per share because of a lot of non-operating "noise" such as a lower tax rate.

The company continues to lose basic cable subscribers, more than 20,000 in the latest quarter compared to about 14,000 in the same period a year before. For the first nine months of the fiscal year the company lost more than 50,000 basic cable subscribers, again higher than last year. This was offset by more digital subscribers but the rate of increase in that area has slowed to a crawl – only 246 new digital subscribers in the latest quarter. Internet customers fell, and phone customer growth is slowing down.

Shaw has been able to mitigate deteriorating fundamentals by playing with its prices – raising them and then discounting. But it has not been able to fix the underlying problem. If it offers discounts, it slows the loss of subscribers but cash flow falls. If it doesn't offer discounts, its cash flow is more robust but the trickle of customers toward the exit resumes.

Where are these subscribers going? Some are presumably dropping cable all together. They download, legitimately or otherwise. They go back to rabbit ears, which carry digital signals now. Some defect to Shaw's phone-company rival, Telus Corp., which, given its subscriber growth, appears to have a compelling Internet TV offering.

Based on the anecdotes I hear, many younger people never get cable in the first place. They often don't even buy TVs because their computers will do just fine for watching movies or shows.

For cable companies, these are not healthy trends. Shaw's free cash flow was down 15 per cent in the most recent quarter and 33 per cent for the first nine months of the fiscal year. At the same time, the company has to invest more to stay competitive.

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Shaw recently lowered its free cash flow guidance for fiscal 2012 by $100-million and thinks it will make the lower target. But that forecast rests, in the company's on words, on "continued overall customer growth; stable pricing environment for Shaw's products relative to current rates; no significant market disruption or other significant changes in economic conditions, competition or regulation that would have a material impact."

Investors can figure out for themselves if those conditions will be met. CEO Brad Shaw put it this way in a call with analysts earlier this year: "As our industry matures, cable, telecom and broadcasting entities are challenged to find ways to grow and differentiate their services."

In the meantime, Shaw's stock price has held up reasonably well despite the ravages of competition and technological change. The dividend helps. So does the belief held by some investors that Rogers Communications Inc. will eventually come along and buy Shaw.

Remember, though, that Shaw's payout is not guaranteed. And Rogers has the same cable issues as Shaw.

Bottom line: Investors should ponder the clouds gathering over the cable industry. It's easy to be complacent given the history of these companies, but complacency can be deadly.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More


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