The Latest Attack on Cable

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: The original version referred to the CEO of Time Warner as Glenn Britt. He is actually the CEO of Time Warner Cable. This version has been corrected and Motley Fool apologizes for the error.

Cable companies are under attack. Pay-TV subscribers are leaving in droves, headed to their computers, tablets, and smartTVs to watch streaming videos on Netflix (NASDAQ: NFLX) and Google’s (NASDAQ: GOOG) YouTube instead. A recent study found that 82% of consumers aged 18 to 24 much prefer to watch content online as opposed to television. With the growing support for online streaming, companies providing high-speed household internet connections ought to see the most benefits as video viewing habits shift from cable to the internet.

According to the latest Nielsen report, cable lost 2.7 million subscribers between the third quarter of 2011 and the third quarter of 2012. Meanwhile, satellite subscription numbers were flat. The strength of online video is undeniable. Netflix is by far the most popular use of internet bandwidth, drawing about one-third of all of downstream bandwidth used in the U.S.. YouTube comes in second, utilizing 13%. All-in-all more than half of downstream bandwidth in the states is used to stream video, and that number is sure to grow much to the benefit of internet service providers.

Wait, don’t cable companies provide internet access?

In fact, cable companies provide more than half of all broadband connections in the United States. With the increasing use of internet bandwidth, it would make sense to assume companies like Time-Warner (NYSE: TWX) and Comcast (NASDAQ: CMCSA) would do well raising prices as demand increases.

Comcast, similarly, has seen internet subscriptions continue to climb even as it loses cable subscriptions, adding 287,000 new subscribers in the third quarter of last year. Comcast’s internet subscriber base now tops 19 million, about 22% of all household broadband subscriptions. At least for now, cancelled cable subscribers appear to be sticking with the company for its internet service, which has grown to become nearly 30% of all its residential subscription revenues. (Source: 10-Q)

Time-Warner demonstrated last year that it has the capability to increase the amount of bandwidth served, while increasing the price of service by relatively little (50% vs 10%). Comcast, too, clearly has the capabilities of offering high-speed internet for less as exemplified by its Internet Essentials program where it offers 3 MB/s access for $10 a month to low-income families. However, internet providers have been slow to increase bandwidth. With ridiculously high margins on broadband sales, there’s little reason for these companies to innovate.

We interrupt your regularly scheduled streamcast

Enter Google. Last year, Google began building a high-speed fiber-optic network throughout Kansas City. Dubbed Google Fiber, subscribers are provided 1 GB/s access, speeds about 10 times faster than the slightly higher-priced offering from Time-Warner. What’s more, Google offers a 5 MB/s connection for a one-time charge of $300, no subscription necessary. To put that in perspective, across state, in St. Louis, I receive a measly 1 MB/s for $30 per month from the local cable company. If Google Fiber became available in my neighborhood, I would undoubtedly switch.

This isn’t merely a hobby for Google, either. In the most recent earnings call, CFO Patrick Pichette said, “We really think that we should be making good business with this opportunity, and we are going to continue to look at the possibility of expanding.” In fact, Susan Crawford, author of Captive Audience, says Google is “making money on sign-ups, and not counting on indirect effects.” In other words, the business is profitable all by itself, and doesn’t require an increase in the number of YouTube videos watched or Gmail messages sent to subsidize it.

However, what works in Kansas City won’t work everywhere. 80% of the cost of running fiber is the labor, and not all cities are as densely populated as Kansas City. That’s why Verizon (NYSE: VZ) has selectively built out its own fiber optic network to make its cable-TV and internet service available to just 18 million homes. Verizon has built out its network over the last eight years, investing approximately $23 billion, and has penetration of just 5.4 million customers still. This has led James Ratcliffe, telecom analyst at Barclays to state, “The long-term returns on the FiOS business are still up for debate.”

But Google works smarter, not harder. The biggest cost of FiOS is what’s called “the last mile” - actually running the cable to individual households. That’s why Google requires a pre-requisite number of signups in an area before it starts building out the network. Continuing with this model will allow Google Fiber to expand in the most profitable way possible, while still making the service available to quite a large chunk of the nations 80 million plus broadband subscribers. 

An all-out assault

We’ve heard about the struggles of cable for a long time. YouTube has been around since 2005 and Netflix started streaming movies at the beginning of 2007. As the popularity and content libraries of video streaming companies grow, and more subscribers ditch their cable packages, the internet providers will win.

Google’s efforts in Kansas City originally looked like a project to push traditional cable companies to step up their broadband businesses. However, most cable companies are failing to meet the challenge. Instead, small independent companies have teamed up with local governments and college campuses to put 1 GB/s connections in more cities. Unless cable companies start stepping up their efforts, it won’t be long before they start losing subscribers of another one of their most profitable revenue streams.

Oh yeah, did I mention Google offers a pay-TV option for just $50 extra per month with its Fiber connection? Your move, cable.

adamlevy has no position in any stocks mentioned. The Motley Fool recommends Google and Netflix. The Motley Fool owns shares of Google and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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