At Reaves, we invest in companies that provide the most essential services to the modern economy. Our thesis is that the durability of these business models provides steadier earnings and free cash-flow growth than the broader market, with an objective to provide better investment outcomes for our clients over the long term.
The pandemic and ensuing stay-at-home orders put one of our areas of focus — cable broadband networks — under the microscope. As nearly everyone was forced to learn and work from home, it demonstrated three things: a) how essential broadband services have become, b) how strong existing broadband networks are, and c) how entrenched the companies are that deliver them. In short, we believe it validated our long-term investment thesis on cable stocks.
When Peak Demand is Constant
Broadband services are undeniably essential to most families’ daily lives. Since states went under lockdown, networks have supported virtual meetings for parents, classroom lessons for kids, check-ins with the family doctor, and entertainment streaming at night.
This around-the-clock demand from multiple family members is the ultimate stress test for broadband networks. Fortunately for its users, the networks were built for it. Broadband networks were architected to function at peak demand times such as after dinner or in the morning when people are getting ready for work and school. Engineers modeled these “peak periods” of usage and constructed networks with the capacity to satisfy this demand throughout the household. During the quarantine, those peak periods lasted entire days. Designed to manage stress, broadband networks proved their resilience.
Cable Companies Look Well Positioned
The Reaves team focuses on companies in essential services industries that have built strong competitive moats around their businesses. Business models without a clear competitive advantage can be easily disrupted or replicated, making the cash flows associated with the business risky. For the cable companies providing broadband, these competitive advantages weren’t always obvious but have now revealed themselves.
Cable operators built networks for a very specific application – people love TV, and cable networks were historically designed to deliver households hundreds of simultaneous streams of content. As channels proliferated and picture quality improved exponentially, cable operators were forced to invest massive amounts of capital to keep up with the trend. Unfortunately, video is a tough business. Competition from satellite and telecom operators kept pricing in check. The threat of tech companies providing similar services over the internet overhung the industry for years before finally proving reality. What’s more, cable operators didn’t own the content on TV, and too often were on the wrong side of price increases from media companies. The pass-through of these price increases infuriated customers. The resulting narrow margin and high capital spending model didn’t sit well with investors either.
As it turned out, a network built to handle a cable TV-sized load was incredibly well-positioned to lead the U.S. transition to high-speed broadband. More than just a “dumb pipe,” the cable plant has proved fungible, allowing not only for efficient use of different applications, but for increasing amounts of bandwidth to be allocated to both downstream and upstream data traffic. This dynamic helped enable the network resilience that cable broadband users enjoyed during pandemic-induced shut-ins. Most alternative networks simply could not cut it.
Competing Networks Face a Less Certain Outlook
Cable operators’ largest competitors in broadband services are telecom companies. But telecom networks were built for voice calls and thus are ill-equipped to manage large data loads. Despite some significant innovation, upgrades to these legacy networks have been unable to keep pace with cable’s capacity. While fiber networks are a satisfactory substitute, they are very expensive to deploy.
Going forward, telecom companies may look to use a hybrid of wireline and wireless solutions to better compete. The economics of this strategy are questionable today, but certainly may improve with time. For now, cable companies appear very well positioned.
Ongoing business shift from video to broadband well-received by consumers and investors alike
The transition in cable’s business from video to broadband, along with continuing advancements in cable technologies, has led to increasing levels of customer satisfaction. Instead of fuming over high and rising monthly subscription bills for TV channels no one was watching, customers are increasingly associating cable companies with reliable broadband service.
At Reaves, we have long admired the innovation in cable networks. Now that the networks have passed the test of the pandemic by proving essential and reliable, we believe investors will start to admire the transformation as well.
Disclosures:
Reaves Asset Management is an investment adviser registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration does not imply any skill or training. Reaves is a privately held, independently owned “S” corporation organized under the laws of the State of Delaware.
The information provided in this blog does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities and sectors listed. Investors should consider the investment objective, risks, charges and expenses of all investments carefully before investing. Any projections, outlooks or estimates contained herein are forward looking statements based upon specific assumptions and should not be construed as indicative of any actual events that have occurred or may occur.
Past performance is no guarantee of future results.
All investments involve risk, including loss of principal.
All data is presented in U.S. dollars.
Important Tax Information: Reaves Asset Management and its employees are not in the business of providing tax or legal advice to taxpayers. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax adviser.
