Cable Operators Present Enticing Wager

Cable-TV operators have talked about expanding ad-sales businesses as a way to juice growth. Luckily for them, they haven't made much progress. Ad-dependent TV stocks have been crushed this year, as revenue has plunged. But subscription-based cable stocks have mostly outperformed the broader market. It's a truism that no matter how bad things get, Americans won't stop watching television. That has helped cable operators outperform in past recessions and should be the case this time around. Not that they will escape unscathed. Time Warner Cable Inc. warned earlier this month that it was seeing a slowdown in some of its premium video services, prompting a selloff. But investors shouldn't overreact. Cable companies are likely to continue posting revenue and cash-flow growth next year, albeit at a slower rate than the 8% or higher projected by Time Warner Cable and Comcast Corp. for 2008. Slowing premium services, such as digital video recorders, account for only a small portion of revenue. Much of the growth in recent years has instead come from high-speed Internet service, which now accounts for more than 20% of revenue for big operators and is probably more recession-resistant than video service. Another big source of growth has been cable's entry into the phone business. That business is vulnerable to belt-tightening, as people rely solely on cell service. But most cable operators are adding phone customers so quickly that they can withstand some wireless defections. Consider these numbers. Comcast, the biggest cable operator by subscribers, reported average monthly revenue per subscriber of $110.71 for the third quarter, 8.8% higher than the year-earlier number. Video accounts for about $64 of the number, up $3.20 from a year earlier, with $35 coming from Internet access and phone combined, up nearly $6. Video growth will decelerate as companies sign up fewer new customers for DVRs, high-definition TV and pay-per-view movies. But the impact shouldn't be overstated: Only about $4 of per-subscriber monthly revenue at Comcast comes from DVR and HD revenue, estimates Sanford C. Bernstein analyst Craig Moffett, while pay per view contributes less. Potentially vulnerable are subscriptions to premium-movie channels such as HBO and Showtime, which account for about $6 of monthly per-subscriber video revenue at Comcast, Mr. Moffett estimates. HBO subscriptions dipped slightly in the 1991 downturn, according to research firm SNL Kagan. But that was before HBO became famous for its programming. As these services can substitute for a night at a movie theater for many people, any dip should be small. In contrast, Internet access, where cable has been boosting market share over phone companies, is likely to keep expanding. Phone, too, should keep expanding, but at a slower rate. Comcast finished the quarter with 6.1 million digital-phone subscribers, up from 3.8 million a year earlier. Net additions were 29% lower. But even if net additions dropped by half, Comcast still could add close to a million customers next year. A drop in phone sales also would boost free cash flow short term, by reducing upfront capital investment. Investors will pay a premium for this resiliency. Comcast is trading at about 13.6 times Bernstein's estimated 2008 free cash flow per share, while Walt Disney Co., which has held up better than other media names, is at 11.4 times fiscal 2008 free cash flow. That isn't an excessive premium to pay for a steady performer.