Steve Mehs
01-08-03, 04:10 AM
By Doug Shapiro
People prefer when things are black and white. Because they are direct competitors, the rivalry between DBS and cable is usually treated this way. Investors, analysts, regulators, the press and the companies themselves often portray it as a zero-sum game, "us versus them." (Ever notice how SkyREPORT derisively refers to the cable industry as "wired ones," while sister publication CableFAX Daily counters by referring to the DBS industry as "dishheads?")
But does one need to "lose" for the other to "win?" As it regards subscriber counts, the answer is obviously yes, particularly as the multichannel business approaches saturation. With the exception of consumers who subscribe to both services, a sub gained by one is generally a sub lost by the other. But as it regards to a much more important measure – return on capital – we think the answer is no. That’s because the economic structure of the business and the interests of the participants, namely maximizing shareholder returns, weigh heavily against a destructive price war. We think the implication is that, contrary to popular opinion, the investment cases of cable and DBS aren’t mutually exclusive.
There is enough organic growth to support both. In a recent report, we showed an analysis of subscriber growth that suggests cable and DBS can peaceably co-exist. (E-mail me at dshapiro@bofasecurities.com for a copy.) The conclusion was that assuming annual household formation of 1.1 percent through the end of the decade; a modest increase in multichannel penetration over the next several years; and that recent trends in gross addition market share and churn remain steady for both cable and DBS, the DBS business should be able to grow its sub base at roughly a 6 percent compound annual growth rate over the remainder of the decade while cable should be able to grow its sub base at 0.5 percent - 1 percent annually over the same period. DBS doesn’t need to crush cable to keep growing rapidly.
The economic structure of the business discourages aggressive price competition. Some observers compare the multichannel business to the broader telecom industry, suggesting that it must follow the same destructive pricing pattern seen in wireless or long distance services. However, we think the economic structure doesn’t lend itself to this type of pricing for several reasons.
1) It has very high barriers to entry. History suggests that overbuilding cable operations is economically futile and also suggests that, largely because of prohibitively high marketing costs, the DBS business can’t support multiple competitors. (This makes a successful launch by Cablevision, SES Astra or potential new MVDDS entrants of a competitive service seem far-fetched.) So multichannel video seems likely to remain an oligopoly for the foreseeable future. From a game theory perspective, the fewer competitors in a business, the less likely one will pursue irrational pricing that damages everyone’s economics.
2) Multichannel video has little price elasticity of demand. Over the past three decades the cable industry has shown that demand for multichannel video is relatively price inelastic. Because consumers regard it as more of a necessity than a luxury, they don’t tend to disconnect service when operators raise prices. This effectively gives all participants pricing power.
3) It has high variable costs and rising cost inputs. The business is very different from most telecom businesses because it has high variable costs. With gross margins in the 60 percent range and pre-marketing EBITDA margins in the 40 percent range, as much as 2/3 of multichannel video cost is variable programming costs. And programming suppliers have substantial pricing power. To reduce prices in a business with high variable costs and suppliers who have substantial bargaining power is economic suicide.
The upshot: The investment cases aren’t mutually exclusive. The cable investment case is predicated on selling more stuff to existing subs, not on rapid subscriber growth. The DBS investment case is predicated on continuing to grow the subscriber base profitably and starting to harvest the financial benefits of the installed base. With sufficient organic growth in the business to meet these conditions and an economic structure that makes aggressive price discounting unlikely, we think the implication is that both can be successful investments – even if that’s not what most people want to hear.
Doug Shapiro is an analyst with Banc of America Securities.
From SkyReport (http://www.skyreport.com/skyreport/jan2003/010803.shtm#four) (Used with Permission)
People prefer when things are black and white. Because they are direct competitors, the rivalry between DBS and cable is usually treated this way. Investors, analysts, regulators, the press and the companies themselves often portray it as a zero-sum game, "us versus them." (Ever notice how SkyREPORT derisively refers to the cable industry as "wired ones," while sister publication CableFAX Daily counters by referring to the DBS industry as "dishheads?")
But does one need to "lose" for the other to "win?" As it regards subscriber counts, the answer is obviously yes, particularly as the multichannel business approaches saturation. With the exception of consumers who subscribe to both services, a sub gained by one is generally a sub lost by the other. But as it regards to a much more important measure – return on capital – we think the answer is no. That’s because the economic structure of the business and the interests of the participants, namely maximizing shareholder returns, weigh heavily against a destructive price war. We think the implication is that, contrary to popular opinion, the investment cases of cable and DBS aren’t mutually exclusive.
There is enough organic growth to support both. In a recent report, we showed an analysis of subscriber growth that suggests cable and DBS can peaceably co-exist. (E-mail me at dshapiro@bofasecurities.com for a copy.) The conclusion was that assuming annual household formation of 1.1 percent through the end of the decade; a modest increase in multichannel penetration over the next several years; and that recent trends in gross addition market share and churn remain steady for both cable and DBS, the DBS business should be able to grow its sub base at roughly a 6 percent compound annual growth rate over the remainder of the decade while cable should be able to grow its sub base at 0.5 percent - 1 percent annually over the same period. DBS doesn’t need to crush cable to keep growing rapidly.
The economic structure of the business discourages aggressive price competition. Some observers compare the multichannel business to the broader telecom industry, suggesting that it must follow the same destructive pricing pattern seen in wireless or long distance services. However, we think the economic structure doesn’t lend itself to this type of pricing for several reasons.
1) It has very high barriers to entry. History suggests that overbuilding cable operations is economically futile and also suggests that, largely because of prohibitively high marketing costs, the DBS business can’t support multiple competitors. (This makes a successful launch by Cablevision, SES Astra or potential new MVDDS entrants of a competitive service seem far-fetched.) So multichannel video seems likely to remain an oligopoly for the foreseeable future. From a game theory perspective, the fewer competitors in a business, the less likely one will pursue irrational pricing that damages everyone’s economics.
2) Multichannel video has little price elasticity of demand. Over the past three decades the cable industry has shown that demand for multichannel video is relatively price inelastic. Because consumers regard it as more of a necessity than a luxury, they don’t tend to disconnect service when operators raise prices. This effectively gives all participants pricing power.
3) It has high variable costs and rising cost inputs. The business is very different from most telecom businesses because it has high variable costs. With gross margins in the 60 percent range and pre-marketing EBITDA margins in the 40 percent range, as much as 2/3 of multichannel video cost is variable programming costs. And programming suppliers have substantial pricing power. To reduce prices in a business with high variable costs and suppliers who have substantial bargaining power is economic suicide.
The upshot: The investment cases aren’t mutually exclusive. The cable investment case is predicated on selling more stuff to existing subs, not on rapid subscriber growth. The DBS investment case is predicated on continuing to grow the subscriber base profitably and starting to harvest the financial benefits of the installed base. With sufficient organic growth in the business to meet these conditions and an economic structure that makes aggressive price discounting unlikely, we think the implication is that both can be successful investments – even if that’s not what most people want to hear.
Doug Shapiro is an analyst with Banc of America Securities.
From SkyReport (http://www.skyreport.com/skyreport/jan2003/010803.shtm#four) (Used with Permission)