Despite Blackout, Time Warner Sails Through Quarter

Despite its troubling subscriber losses, Time Warner Cable was able to push higher last week on the back of a generally impressive earnings report. The company is getting more out of its customers and building a bigger and more profitable business-services segment. For investors, the data may seem compelling and, coupled with a reasonable 2.2% dividend yield, is indicative of attractive returns in coming periods. On a fundamental level, though, there is more to consider. Time Warner Cable has issues beyond the financial statements that aren't factoring into its stock price. Before you hit the buy button, consider the long-term trends in this business.

Earnings recap
For Time Warner Cable's recently ended quarter, the company bumped up its adjusted EPS by a sizable 20% to $1.69 per share. Driving the bottom-line gains included a more than 20% gain in business services revenue, a 14% climb in residential data revenue, customer ARPU up 2%, and lower interest expense.

Broadband Internet services in homes along with the growth of voice and wholesale transport in the business services are the most pure forms of growth for the company -- "pure" growth meaning a material gain in subscriber counts instead of price increases or financial statement creativities. For residential wideband high-speed data services, the company actually doubled its subscriber count to 719,000.

As mentioned above, investors and analysts considered the quarter an outperformer, and kept the stock on its upward trajectory that it has steadily enjoyed since mid-2009.

More important than short-term financial results are the industry's long-term concerns, and TWC's seeming reluctance to address them.

When TWC blacked out CBS and its various properties for a period of one month, the company lost 300,000 subscribers. Residential service revenue saw a 4.5% drop in video and a 6% drop in voice. The segment booked an overall gain, but it was because of the high-speed data service and home automation business.

Time Warner's core cable business is suffering, and management doesn't seem too eager to address this. Industry veteran John Malone, chairman of Liberty Media and a 25% stakeholder in Charter Communications, has long called for the consolidation of the industry. He's set his eyes on a TWC-Charter team-up as an early effort. Time Warner can't forever raise prices to compensate for falling subscriber counts -- that is not a sustainable strategy. Moreover, the company needs leverage over the broadcasters and content creators to avoid issues like the CBS blackout. Even though Time Warner, like Comcast, is a huge player in the industry, it lacks the scale to effectively negotiate content costs and carriage fees. This is the central point of Malone's argument, and why he believes streaming services like Netflix will prevail if nothing is done.

The data supports Malone. Even if Time Warner is buoyed by its business services and still finding attractive growth in high-speed data, it won't be enough to compensate for its core business crumbling in the long term.

For long-term investors, the best thing to have happen at this point is for Charter and Malone to make an offer for the company (likely at a decent premium to today's price), or for the company to make a more concerted effort to address its core business, beyond asking for more in every month's cable bill.

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