How Long Can Comcast Squeeze Blood from a Stone?


On Wednesday, Comcast reported another quarter of strong year-over-year profit growth. Adjusted EPS came in a little ahead of expectations at $0.65 . Meanwhile, the company's NBCUniversal media segment continued to improve (excluding the effect of the 2012 Summer Olympics) with operating cash flow up more than 20 %.

However, performance in the core cable business is still mixed. While Comcast continues to add high-speed Internet subscribers at a good clip, the video business lost customers again. As I pointed out back in September, this could be a significant long-term threat to Comcast and other cable operators. If the video business continues to decline, it could undermine the whole company's growth.

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Comcast lost 129,000 video subscribers in the third quarter, slightly more than the 117,000 subscribers it lost in Q3 2012. Over the last 12 months, Comcast's video subscriber count has dropped from just over 22 million to 21.65 million: a 1.6% decline. However, video revenue actually grew 2.9% .

Comcast attributed the increase in video revenue to price increases and a higher number of customers paying extra for HD or a DVR . This more than offset the decline in the subscriber base.

The biggest contributors to the cable communications segment's growth were high-speed Internet and business services. Comcast has added more than 1 million high-speed Internet customers in the past year, driving 7.9% revenue growth, while Comcast's sales to small and medium businesses soared 26.4 %.

Providing Internet service (and voice and TV, to a lesser extent) to small and medium businesses is clearly an important growth driver for cable companies. Comcast's top competitor, Time Warner Cable has also been growing its business services revenue by more than 20% annually . By contrast, the sustainability of growth in residential high-speed Internet is more questionable.

Is residential revenue growth sustainable?
While some customers use Comcast for high-speed Internet service but not TV, the biggest driver of growth in high-speed Internet customers is Comcast's "triple play" strategy. Like most other providers of video, Internet, and voice service -- including Time Warner Cable and AT&T -- Comcast tries to get customers to subscribe to two or three different services, rather than just one.

Comcast has been quite successful in increasing the penetration of double play and triple play bundles. Two years ago, 70% of residential video customers had at least one other service, and 36% had all three . At the end of last quarter, this penetration had risen to 78% with at least one other service and 43% with the "triple play ".

However, this bundling strategy faces an uphill battle going forward, simply because so many Comcast customers are already bundling video and Internet service. Moreover, if the number of video subscribers continues to fall, the addressable market will shrink. Much of Comcast's recent growth on the cable side has consisted of squeezing more and more money from a relatively fixed base of subscribers. This business model does not seem sustainable.

Video turnaround?
Comcast's management team does not believe the situation is quite that bad. On the company's conference call last week, multiple executives attributed the loss of video subscribers to an increase in competition: particularly from AT&T. AT&T has been aggressively growing the number of locations eligible for its "U-Verse" service as part of its Project VIP. AT&T plans to expand U-Verse availability by 8.5 million customer locations between 2013 and 2015 .

Comcast executives described a "tale of two cities": the company is gaining video subscribers in many markets, but losing subscribers in areas where AT&T (or another competitor) has recently entered. However, the company expects to stabilize its losses and even win back customers in areas where it is currently losing share to AT&T .

Given that AT&T is only one year into its U-Verse expansion, Comcast needs to start winning back video customers soon. The first step will be to end the recent run of video subscriber losses. This is the most important metric for shareholders to track; if the video subscriber base continues to erode, it will quickly undermine growth in Internet and voice service.

Foolish conclusion
One of Comcast's biggest growth drivers over the last decade has been its drive to convert more and more customers to double play and triple play bundles. Today, it has nearly as many high-speed Internet subscribers as video subscribers. As a result, Comcast's revenue per subscriber has risen continuously.

However, the video subscriber base has been falling for several years now, while the percentage of video subscribers taking a double play or triple play bundle is inching ever closer to 100%. This is a dangerous recipe that could cause Comcast's growth to stall out in a hurry. Comcast needs to prove that it can stabilize its video subscriber base, and I will remain wary of this stock until it does so.

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