Cablevision Shareholders Win Big

The Dolan family's decision to finally sell

After several years of spin-offs and asset sales, Cablevision has gotten back to its roots. The firm serves about 3 million customers across a service territory that includes 5 million households, primarily in the New York metro area. Cablevision benefits from many of the same network advantages as other U.S. cable companies. The firm upgraded its networks aggressively around the turn of the century, providing it with a platform to deliver television, Internet access, and phone services. The architecture of the network has also enabled the firm to upgrade its capabilities at low incremental cost.

Given the high level of wealth and population density of this technologically progressive market and Cablevision's early emphasis on Internet access and phone services, the firm is exceptionally well entrenched, with industry-leading market penetration rates. While high penetration rates lead to strong network utilization and returns on capital, Cablevision's easy growth is behind it.

High population density and attractive demographics are also an invitation to competition. In addition, Cablevision has the unfortunate position of competing nearly exclusively in Verizon VZ territory. Verizon has been the most aggressive of the local phone companies in the residential market, investing heavily in its network to offer topnotch services. Verizon FiOS reaches more than half of Cablevision's territory, a far higher percentage than is typical for the larger, more geographically diverse cable companies. We expect Verizon will exert consistent pressure on Cablevision's market share over the decade to come.

New York Presence a Double-Edge Sword Narrow-moat Cablevision shares several traits with larger, wide-moat peers Comcast CMCSA and Time Warner Cable TWC. The firm's networks are capable of meeting the vast majority of customers' demands today, enabling the provision of digital television, phone service, and Internet access at speeds of 100 megabits per second or more. Cablevision should be able to steadily improve network performance at relatively modest cost. It has increased Internet access speeds at a steady clip in recent years while spending minimally on incremental network assets. Explicit network upgrading spending has totaled about $150 million over the past five years, or less than 1% of revenue. Spending on other network equipment has totaled less than 5% during this period. New technologies, notably DOCSIS 3.1, promise to leverage Cablevision's existing infrastructure further, meeting customer demand far into the future.

Cablevision has also benefited from its nearly singular presence in the New York City market, where customers tend to enjoy higher incomes and the desire to adopt new technologies relatively quickly, and management's early focus on the Internet access market. The firm reached 40% penetration of Internet access service in 2006--a mark that Comcast and Time Warner Cable have yet to reach. Cablevision's Internet access penetration currently stands at 54%, demonstrating that it is the clear market leader. This scale enables the firm to naturally earn better returns on capital as more of its network assets are actively generating revenue. High market share also generally discourages competitors, primarily the phone companies, from investing in their networks, as winning back customers otherwise satisfied with their current services is challenging.

However, the nature of the New York market is a double-edge sword. Verizon, the primary phone company serving the area, has been the most aggressive of any local phone company with respect to network upgrades. Its FiOS network is the gold standard in local data networks, using fiber optic cable exclusively to serve customers. Because of the attractive demographics present in New York, Verizon has invested heavily in its network across the region: Cablevision estimates that Verizon FiOS is available to more than half of its service territory. By contrast, larger, more diversified cable operators Comcast and TWC face FiOS competition in around 15% of their territories. Because of the high cost of deploying FiOS, Verizon has been disciplined with its marketing and promotional efforts, but the presence of this competition will put constant pressure on Cablevision over the next decade or more and creates the potential for irrational competition at any point in the future. Cablevision also faces significant competition from Frontier FTR in Connecticut.

Finally, Cablevision's small size is a detriment, especially in negotiating for content rights. The large volume of high-value local content, especially sports programming, in New York also works against the firm. We estimate Cablevision spends about half of television revenue on programming rights, a figure that is comparable with peers. We suspect that Cablevision has enjoyed relatively strong negotiating leverage despite its size, thanks to its dominance in New York. However, as the firm loses market share to Verizon and other alternatives, we expect it will struggle to control programming costs. Pushing future cost increases onto consumers is likely to be especially difficult for Cablevision as lower-cost Internet video services emerge.

Risks Include Technological and Regulatory Changes General risks facing the cable business include technological change, shifting consumer demands, unexpected competitive pressure, and unfavorable regulatory policy adoption. We expect that Cablevision's network will enable it to meet customer needs far into the future, but some industry participants are pushing Internet access speeds far in excess of current norms. If services develop to take advantage of very fast speeds, Cablevision could be forced to invest heavily in its network to keep pace with Verizon's FiOS. Conversely, if the Internet access market evolves slowly, Verizon could decide to undertake a price war to drive FiOS adoption. Finally, regulatory policy around net neutrality and the provision of Internet services is currently under debate. Regulators and legislatures could choose to exert significant control over this business.

If the Altice transaction fell through for some reason, Cablevision shareholders could face significant losses. We increased our fair value estimate to $33 per share from $16 to reflect the terms of the deal, in which Altice will pay $34.90 per share in cash. We expect this transaction to close without issue in early 2016, though we haircut the deal price slightly to reflect the time value of money. Our prior $16 fair value estimate was based on our expectations for Cablevision as a stand-alone company under the Dolans' leadership.

Sale Improves Our View of Stewardship Cable pioneer Charles Dolan founded Cablevision in 1973, following his creation of the first cable system in Manhattan in 1961 and HBO in 1971. He has served as Cablevision's chairman since 1985, the inception of its current incarnation. The Dolan family is deeply rooted in the company. Six sons and daughters currently serve on the board, including Cablevision CEO James Dolan. James' spouse, Kristin Dolan, also serves on the board and holds the COO position. In total, 10 of 18 board members have direct ties to the Dolan family and 6 of the 10 hold operating positions in the company. Given this deep entrenchment, we were surprised by the decision to sell. With Cablevision now sold for a great price, we've moved our stewardship rating to Standard from Poor.