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UBS Says Buy Cable, Bernstein Shouts "Neutral" (= Sell)
Monday, 10 May 2010 06:05
Early Monday May 10, Craig Moffett of Bernstein Research (no relation) "pulled the plug" on cable stocks while John Hodulik of UBS raised Time Warner Cable to a buy because "fears" are "overblown." I'll let these guys argue out how the stock price will move. John is right the D.C. action is weak and will have mnimal real impact on the companies; Craig may well be right that "investor perceptions" will hold down the stock price. I'm not a stock-picker or investment analyst. Both these guys are friends I read closely, but I'm looking at the industry fundamentals, not the psychology that drives stock prices.
      By the time people read the proposal - and looked at the power politics that predict future actions - it was obvious little had changed. The actual net neutrality regulations will prohibit some abusive behavior that was highly unlikely to be common anytime soon. There are loopholes ("managed services") large enough to drive 500 channels through.  Julius is acting like the million-dollar lawyer from Home Shopping Network (which he was) rather than a social reformer like his law school buddy Barack Obama. 

      Moffett's headline is "U.S. Cable: Pulling the Plug... Regulatory Uncertainty Clouds Terminal Growth Rates; Downgrading Sector to Neutral. Hodulik's is "TIME WARNER CABLE: Upgrading to Buy, Fears overblown." Craig puts the bear case 
"We are downgrading the Cable sector, and each of Comcast, Time Warner Cable, and Cablevision, to neutral. Our target prices for each remain unchanged. The bull case for cable stocks is a simple one. Cable wins the broadband wars. But the prospect for broadband price regulation cuts to the heart of that thesis. Notwithstanding the FCC's promises of forbearance, the plan to apply Section 201 (b) - mandating "just and reasonable rates" - opens the door to broader price regulation and thereby fundamentally alters the equation for Cable." His write-up is more nuanced, looking at whether the ruling might impact prices and hence profits literally 15 years from now. He's not particularly concerned with net neutrality, which all of us realize is not a big operational problem. Rather, he fears that the FCC power might prevent cable from raising prices as much as it might given market power as he expects telcos to fade away. 

      That's not a current fear. High speed prices in the U.S. are currently twice as high as England or France, and Julius has been allowing Verizon and Comcast to raise prices. Although not long ago he told the Washington Post making broadband affordable was his key priority, his results are the opposite. He - or possibly the White House above him - specifically vetoed anything in the plan designed to directly bring down high speed prices. The plan essentially is praying that freeing up spectrum might bring in more competition five or ten years in the future.

       Hodulik instead is "Maintaining our bullish stance on the Cable sector. We believe improvements in the economic and competitive environment and the reacceleration of the industry’s two highest-margin product lines—broadband and advertising—bode well for industry fundamentals over the next several quarters. This should lead to better-than-expected financial results and a higher multiple." He goes on "FCC reclassification of broadband access not a game changer. Cable stocks pulled back last week partially due to the FCC’s intention to reclassify broadband access as a Title II (common carrier) service. Even if this move withstands inevitable court challenges, we believe the FCC solution is more industry-friendly than had been anticipated. With the bad news out, we believe investors have another buying opportunity and we expect the regulatory narrative to improve moving forward. .... Title II reclassification overblown. While some worry that the FCC is opening a Pandora’s Box with its move to reclassify broadband under Title II last week, we believe the bulk of the pain from this regulatory gambit has been felt for two reasons. First, the carriers are extremely good at protecting their shareholders’ interests on the regulatory front and the November mid-term elections will likely make their job easier. Secondly, while the FCC strategy unveiled last week was not a good thing, the commission acted narrowly and adopted industry-friendly language in its approach. We believe the FCC’s main focus is the enforcement of net neutrality (in some form) and USF reform.

We believe it is unlikely that this “Third Way” withstands the inevitable court challenges. However, if it goes into effect, we believe it will have only nominal impact on the carriers’ near- and medium-term economics for 3 reasons:

1) The FCC’s watered-down definition of net neutrality: The FCC is now focusing on the more industry-friendly concept of “unreasonable” discrimination in managing network traffic. This will give carriers more flexibility to operate as they see fit;

2) Explicit renunciation of pricing and unbundling re-regulation: FCC filings state unequivocally that regulators have no intention of changing their stance on these major issues, and go so far as to say that usage-based pricing is OK; and

3) Carriers’ ability to offer managed service: The FCC will not prevent carriers from getting into the business of content distribution, QoS guarantees, tiering or other services."