Cable vs. Telco: The Battle Heats Up

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From Standard & Poor's RatingsDirect

The cable sector's traditional video product is nearing maximum penetration, yet the industry is still able to post low-double-digit revenue gains because of increasing sales of digital services, digital video recorders, high-speed Internet connections, and voice service. It remains to be seen whether cable can continue to thrive amid aggressive competition from satellite TV providers DirecTV and EchoStar, which have higher growth rates and are promoting price and additional high-definition programming, and from video offerings from the telephone companies. In a report card on the telecom industry published Oct. 6, 2005, Standard & Poor's predicted that first-mover advantage would go to cable in the battle between telephone and cable but that phone companies could start to reassert their position with their video products in two to three years. That time has arrived.

To be sure, nontraditional cable-delivered services still have a considerable upside: digital TV, digital video recorders, cable telephony, and cable modems have yet to reach their peak penetrations. But for cable companies that are further along the advanced services curve, the ability to sustain annual double-digit revenue growth is less certain. While there is still revenue to be harvested from the introduction of high-definition TV and more video on demand, cable operators at some point will face moderating growth. With some cable operators already posting average revenue per user well above $100, customers may be less willing to tolerate price increases when enticed by more competitive offers from telephone companies.

We see a similar situation in wireless in the next few years, when penetration will begin to peak in a tight pricing market dominated by four major national carriers. The timing for wireless maturation may be a little longer than for cable because the U.S. penetration rate, estimated at 80% by industry association CTIA, lags behind the 100%-plus penetration in some European and Asian markets. We note, however, that the financial policy for three of the four national carriers, AT&T Mobility, Verizon Wireless, and T-Mobile, is part and parcel of their parent entities' financial policies.

Some Likely Casualties

For most pure wireline players, including CenturyTel (CTL) (BBB), Citizens Communications (CZN) (BB+), Embarq (EQ) (BBB-), Qwest Communications International (Q) (BB), and Windstream (WIN) (BB+), the prospect of flat or declining revenues is not just a future possibility but a current reality. Given continuing wireless substitution and cable's inroads into the residential telephone business, growth prospects for their core businesses are minimal at best, as reflected in our mostly negative outlooks for the pure wireline companies. The pressure to satisfy equity investors lessens their ability to reduce debt to offset challenging business prospects.

Liquidity has always been a key rating factor, but in times of uncertain capital markets, it takes on even more importance. Overall, the telecom and cable sectors haven't demonstrated any particularly troubling liquidity issues due partly to recent opportunistic refinancing activities.

Many companies took advantage of favorable market conditions through the early part of this year to extend maturities and establish revolving credit facilities with good availability and limited covenant pressure. Issuers that completed such refinancings include Charter Communications (CHTR) (B-), Bresnan Communications, and Level 3 Communications (LVLT). In addition, financing related to M&A activities have bolstered liquidity at some companies with speculative-grade ratings, including PAETEC Holding (PAET) (B), NuVox (B-), Integra Telecom Holdings (B-), and Time Warner Telecom (TWTC) (B).

While it appears that telecom and cable companies will generally have access to cash, the cost of credit will be a concern. Standard & Poor's will monitor adequacy of liquidity at each company and, especially for weaker credits, the impact of the potentially higher cost of maintaining sufficient liquidity under current market conditions.

Siderman is an analyst for Standard & Poor's Ratings Services.