Industry Consolidation Could Benefit Large Cable Players

Industry consolidation can help a company strengthen its position, improve its operating efficiency, and increase economies of scale. In the cable industry, consolidation could improve the bargaining power of cable TV operators against content providers, which have demanded higher prices. Indeed, this is happening right now as both Comcast and Charter Communications join the bidding for Time Warner Cable . After this was announced, Time Warner Cable rose 10% in one trading day, reflecting the market's optimism about the potential acquisition.

The growing operating performances of Comcast and Time Warner Cable
The largest cable operator in the U.S., Comcast operates in five main business segments: cable communications, cable networks, broadcast television, film entertainment and theme parks. The cable communications business was the biggest revenue and profit contributor for Comcast, generating 63% of total revenue and more than 80% of operating income in fiscal 2012. 

In the third quarter of 2013, Comcast's cable communications and cable networks segments experienced decent year-over-year growth of 5.2% and 4%, respectively. The growth in the cable communications segment was due to a double-digit increase in business service and a 7.9% rise in high-speed Internet service. The growth of the cable networks segment resulted from a 5.4% rise in distribution revenue and a 4.6% increase in advertising revenue. 

The cable networks segment is a part of the NBC Universal business, which was acquired by Comcast in 2009. Since then, Comcast has managed to grow its total cash flow by 50% from $10.2 billion to $15.3 billion for the trailing twelve months. In the third quarter, free cash flow rose by 30% to $2 billion.

Time Warner Cable, the second-biggest cable operator, also experienced an improved operating performance. In the third quarter, Time Warner Cable grew revenue by 2.9%, driven mainly by 20.5% growth in business-services revenue and a 14.2% rise in residential high-speed data sales. The company is also quite cash-generative with around $440 million of free cash flow in the third quarter. For the full year, Time Warner Cable expects $2.5 billion in free cash flow. 

John Malone is definitely interested in industry consolidation
If Comcast is successful in acquiring Time Warner Cable, the company could become a larger empire that serves as many as 33 million customers in the U.S., and it would scale up its footprints in the New York and Los Angeles markets. Media guru John Malone, who owns a 27% stake in Charter Communications, has been pursuing industry consolidation to gain cost reduction and better rates from the networks.

I personally think John Malone will definitely join the bidding for Time Warner Cable. If Charter Communications bought Time Warner Cable, its subscriber count would increase from 4.2 million to 15.2 million, making Charter Communications the third-largest player in the U.S. cable industry. Because of the potential antitrust issue, there is a rumor that Comcast might partner with the smaller player, Charter Communications, to split up the assets, customers, and territories of Time Warner Cable and maintain the competition in the industry. However, that would go against John Malone's intent of industry consolidation.

Commitments to return cash to shareholders
Both Comcast and Time Warner Cable have been quite committed to returning cash to their shareholders via both dividend payments and share buybacks. Since the beginning of the year, Comcast has returned $3 billion to shareholders, including $1.5 billion in share buybacks and $1.5 billion in dividends.  Comcast currently offers investors a 1.60% dividend yield with a conservative payout ratio of only 35%. The company still has around $2 billion left in its buyback authorization.

Time Warner Cable gives investors a better dividend yield at 2%, and its payout ratio is just a bit higher than Comcast's at 39%. For the full year, Time Warner expects to generate free cash flow of $2.5 billion. It intends to buy back at least $2.5 billion worth of shares in 2013, which means a total buyback yield of 6.7%. 

My Foolish take
It is hard to tell whether or not a deal involving Comcast, Charter Communications, or Time Warner Cable will occur and who will acquire whom. The ultimate consolidator in the cable industry will certainly benefit greatly from potential synergies, cost efficiency, and monopoly power. In the meantime, income investors can certainly put Comcast and Time Warner Cable into their long-term portfolios because of these companies' leading positions in the cable industry and their decent dividend yields. In addition, investors could also benefit from these companies' commitment to return cash to shareholders via share buybacks as well.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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