TORONTO – BMO Capital Markets has downgraded its investment rating on Shaw Communications from outperform to market perform, based on the growing competitive threat from Telus, which could eventually capture one third of the B.C.-Alberta TV subscription market, says the bank.
“We are growing increasingly concerned with Shaw’s ability to withstand competitive pressures from Telus, specifically its Optik TV service,” writes Tim Casey, cable and media analyst at BMO Capital Markets, in his note to clients.
He cautions that Telus has the financial scale and strategic incentive to remain aggressive with marketing promotions this year and next, particularly since Shaw is not expected to launch a wireless service until 2012. In the longer term, Casey believes both Shaw and Telus would best served by a more “benign competitive environment.”
“Given Shaw’s industry high operating margins and valuation metrics, we think a neutral rating is warranted until the competitive situation, and Shaw’s ability to respond, clarifies,” writes Casey.
He also notes that:
• The latest results from Telus indicate an all-time high quarter for television subscriber additions of 48,000.
• Promotional activity appears to be robust from Telus and reflects material financial incentives for consumers.
• Telus has the financial scale and momentum in wireless to remain aggressive in 2011 and 2012, when Shaw expects to launch a wireless product.
• Given these challenges, “we are concerned Shaw can maintain ARPU growth and industry leading margins and protect its subscriber base,” says the analysis.
Also, a review of the U.S. experience regarding cable and telco video competition provides some insight into what may happen north of the border, writes Casey. For example Verizon launched FiOS, a fibre-to-the-home (FTTH) terrestrial IP-based video-data-voice platform in 2005 and now has 3.5 million television subscribers against an addressable footprint of 15 million homes – which is expected to reach 17 million homes by year-end.
U-verse is a similar IPTV product from AT&T but is less fibre intense, which has 3 million subscribers over a 27 million home footprint (target 35 million).
Of the cable companies in the U.S., Casey believes Cablevision, Comcast and Time Warner are the most representative companies for Canadian operators given they operate in urban markets, operate high-capacity, two-way systems with triple-play service offerings and have attractive balance sheets.
“Therefore, we believe something in the 30-35% for market share seems a reasonable target for Optik, implying television subscribers in the 700k to 750k range compared to the installed base of 314k. At a run rate of 120-150K subscriber additions per year, it will take about three years to reach this scale. Assuming 2% new home growth within the Optik footprint implies roughly 40k new potential subscription television homes per year. That still leaves significant potential losses for Shaw,” writes Casey.
Telus seems well positioned to attracted 125,000–150,000 subscribers per year in a footprint with new home growth of 40,000. Non-Optik territories would seem to offer new home growth of 20,000.
BMO also expects Shaw to be very aggressive in the 700 MHz auction in late 2012. A material cash outlay – in the half billion dollar range – for Shaw should not surprise investors in 2013.
Another pressing issue are fees for sports channels. Current rates for Sportsnet are roughly $1.15 per month per subscriber and TSN is at $1.40, but both are unregulated now, says the investors’ note.
“We expect sports channels will continue to pay escalating prices for sports rights given the extreme loyalty of viewers, the PVR-proof nature of the product and its appeal to higher-ARPU HD customers. Moreover, sports has historically driven take-up in new platforms and wireless seems an obvious area for this trend to continue,” writes Casey.
Shaw shareholders are relatively more exposed to this trend given Shaw doesn’t own a sports channel, thus the company’s application for one.
“We think the primary hurdle to Shaw’s sports aspirations will be rights acquisitions. We understand national rights to NHL games are not available until 2014 and Sportsnet recently acquired regional cable rights for the western-based teams in Vancouver, Edmonton and Calgary for ten years. Given that Rogers owns the Blue Jays, baseball rights landing at Shaw seems unlikely. Finally, TSN has grown its exclusive CFL broadcast package to record viewership in recent years and seems unlikely to lose it (but not without significant fee increases itself),” writes Casey who also noted that the downgrade is not is a condemnation of the vertical strategy at Shaw as the CanWest deal did prove to be well-timed and well-priced.
