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How The Decline In The U.S. Television Ecosystem Could Squeeze Credit Ratings

April 22, 2021

PRIMARY CREDIT ANALYST Key Takeaways Naveen Sarma New York - We expect the rate of subscriber losses for U.S. legacy pay-TV distributors to worsen this + 1 (212) 438 7833 year and next. naveen.sarma @spglobal.com

- U.S. consumers will continue abandoning pay-TV with its steadily increasing prices for SECONDARY CONTACTS less expensive streaming video options. Allyn Arden, CFA - The impact on ratings on the U.S. cable sector from the decline of pay-TV will be muted New York due the strength of its broadband service. + 1 (212) 438 7832 allyn.arden - U.S. media companies will feel the heat on their TV operations, but it's difficult to say @spglobal.com

which companies could face negative rating actions because many have diversified Chris Mooney, CFA businesses. New York + 1 (212) 438 4240 chris.mooney @spglobal.com

William Savage More and more U.S. consumers are choosing direct-to-consumer (DTC) streaming video services New York and opting out of pay-TV video bundles--also known as cord-cutting. S&P Global Ratings views + 1 (212) 438 0259 more cord-cutting and fewer pay-TV bundles as negative for the U.S. television sector's credit william.savage quality. We are updating our U.S. pay-TV video subscriber forecast, which we base on a rollup of @spglobal.com our individual company forecasts. We last updated our forecast in January 2020 (see "Consumers Continue To Cut The Cord, But The Pace Should Slacken," published Jan. 13, 2020). Even though cord-cutting trended downward in the second half of last year compared to the first half, we estimate the rate of legacy pay-TV subscription (sub) losses was modestly worse in 2020 (about 7.9% versus 7.3% in 2019). Here, we update our pay-TV video subscriber forecast and assess how any changes could affect our ratings on companies in the U.S. pay-TV ecosystem.

Legacy Pay-TV Video Cord-Cutting Worsens Before It Gets Better

We expect the rate of pay-TV sub losses in 2021 will return to the higher levels we saw in the first half of 2020 (see table).

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Pay-TV Subscribers Forecast--By Distribution Platform

(%) annual change

Large Midsize Small Total Total Overall cable cable cable cable Satellite Telco legacy Virtual pay-TV

2018a (1.7) (3.4) (3.1) (2.0) (6.8) (1.7) (3.8) -- 0.5

2019a (3.2) (6.0) (8.0) (3.9) (11.5) (6.5) (6.8) 25.1 (3.7)

2020e (3.8) (9.0) (10.8) (4.9) (11.2) (15.9) (7.9) 17.6 (4.7)

2021f (5.8) (10.0) (10.5) (6.6) (10.1) (13.7) (8.2) 15.7 (4.5)

2022f (5.8) (9.9) (10.6) (6.5) (10.0) (38.6) (10.3) 12.3 (6.0)

Small cable results for 2018 include an acquistion, which skews results. Large cable includes Comcast and Charter. Midized cable includes operators with >1 million video subscribers but not including Comcast and Charter. Small cable includes operators with <1 million video subscribers and includes the overbuilders. Satellite includes DIRECTV and DISH. Telco includes Verizon and AT&T (U-verse). Virtual includes SlingTV, philo, Sony Playstation, YouTube TV, fuboTV, AT&T TV (and its incarnations), and Hulu Live. a--Actual. f--Forecast. e--Estimate. Source: Company reports, S&P Global Ratings estimates.

Cable

We expect the rate of pay-TV sub losses for the cable sector to increase to 6.6% this year versus 4.9% last year. The increase comes primarily from the larger cable operators (growing by 200 basis points (bp) to 5.8% from 3.8%) as we're maintaining the rate of video subscriber losses for the small (10.5% versus 2020's 10.8% rate) and midsize (10% versus 2020's 9% rate) companies.

This increased pace should continue for the cable industry because the sector is increasingly indifferent as to whether unprofitable customers get their video service from cable companies or a third-party service. To garner maximum market share, cable companies had historically subsidized consumers' bills by absorbing a portion of the programming cost increases imposed by media companies. The small and midsize cable companies were forced to shift away from this practice to focus on profitability instead of unit growth and began to fully pass these higher rates directly to consumers. Comcast Corp. followed suit more recently and its net pay-TV subscriber losses has nearly quadrupled in just two years. Although Charter Communications Inc. was able to buck the industry trend by increasing video subs slightly in 2020, we expect its subscriber losses to increase to 4% in 2021 as broadband subscriber growth normalizes. Longer term, we expect Charter to use "skinny bundle" options to keep its video subscriber losses lowest in the industry.

Satellite

Overall, we expect satellite pay-TV subscribers to decline at a low double-digit percentage rate. While DISH DBS Corp.'s focus on key rural subscribers has slowed its subscriber losses, the sustainability of this trend is uncertain. For starters, DISH may struggle to continue passing along rate increases as life normalizes and demand for in-home entertainment subsides. We also believe churn could increase this year as vaccines become more widely available and consumers becoming more comfortable allowing technicians into their homes to switch providers or resume moving. Finally, while many of Dish's customers have fewer video alternatives in rural markets that lack high-speed broadband options, there is bipartisan government support to increase broadband availability, which will shrink the addressable market significantly over the next

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several years.

We believe DIRECTV's pay-TV subscriber retention woes will continue into at least 2021. We had previously expected that the rate of DIRECTV's subscriber losses to moderate last year as the company cycled through its circa-2017 subscribers that were on deeply discounted plans. However, it hasn't, and the pace of subscriber defections remained at about 15% in 2020. We believe DirecTV's subscriber base skews more toward urban and suburban markets than DISH, making its customers more susceptible to streaming alternatives where broadband availability is more prevalent. The company has also focused more heavily than DISH on promotions in recent years, which could result in lower credit-quality customers defecting as prices increase.

Telco

We believe, the telecom companies, outside of those that offer fiber-to-the-home (FTTH) services will be generally content to let their video customers churn over the next few years. Somewhat countering this, several telco companies have been successfully offering cloud-based TV services. As a result, we expect that video sub losses will accelerate to above 20% this year and remain elevated until non-FTTH video subscribers completely depart.

Strong Growth In Virtual Pay-TV Somewhat Tempers Legacy Cord-Cutting

We don't believe the virtual pay-TV entrants are a long-term solution for the decline of the pay-TV ecosystem. While there was much fanfare when these low-priced, slimmed-down alternatives were launched, these services now resemble a traditional full-size pay-TV bundle and the rapid price escalation (eliminating much of the price difference) has quickly reduced the competitive advantage of these alternatives. Still, for the next few years, these services' subscriber base should grow at a double-digit percentage rate as the price delta will take time to contract. Over several years, these services are likely to be less financially stable compared with legacy pay-TV services. With no contract and no equipment fees, these new services have much greater monthly churn and thus their revenue streams are more volatile versus traditional cable TV subscribers.

We also expect churn and subscriber growth will be seasonal. Subscriber churn will depend largely on consumers' preferences for and interest in major league sports. Until the virtual multichannel video programming distributors, or MVPDs, develop a more stable record (which will only happen over time), we'll view these services cautiously.

Why We Could Be Wrong

Among the reasons why cord-cutting could be worse than our forecast, we highlight the following:

As key sports programming becomes available on streaming platforms, it could, over the longer term, eliminate one of the few competitive advantages of the pay TV bundle. We view sports as a crucial element holding together the pay-TV bundle. Key sports programming, such as the NFL and the MLB and NBA playoffs, has not generally been available on streaming platforms (ViacomCBS's CBS All Access has been the exception). If consumers wanted to watch these key

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sports, they were limited to linear television. This will change shortly as all four NFL broadcast TV partners gained streaming rights under their new contracts. Three of the four will immediately utilize these rights (Comcast's Peacock service, ViacomCBS's Paramount+ service, and Walt Disney's ESPN+ service), which will benefit their streaming platforms, bringing in more new subscribers and significantly growing streaming revenues. Fox doesn't have its own subscription video-on-demand platform, so it can't currently take advantage of these rights. We expect other major sports leagues will follow the lead of the NFL when their current TV broadcast contracts are renewed. Longer term, the availability of key sports programming on both linear TV and streaming platforms could accelerate the decline of the linear TV bundle as consumers now have an option other than linear TV.

Infrastructure spending expands broadband availability into more rural areas, finally making streaming options available to those underserved consumers. Many rural customers cannot subscribe to streaming services because they lack reliable broadband data services and thus are limited to only pay-TV for their video service. The Biden administration has committed to spending over $100 billion to expand broadband coverage to these underserved areas of the country. We believe cord-cutting could accelerate as consumers in these areas can finally subscribe to streaming services.

What Does This Revised Forecast Mean For Credit Ratings On Pay-TV Operators?

Cable companies

We don't believe there will be any rating actions resulting directly from our revised forecast because cable companies can manage what we believe will be modest earnings and cash flow losses due to decreased video sub losses. First, video makes up a shrinking percentage of total operating income for large providers. It's roughly cash flow breakeven for most smaller operators. Second, cable's broadband service provides a powerful pricing counterbalance. By charging a premium for stand-alone broadband, and then inducing a portion of cord-cutters to buy faster broadband tiers, cable operators can minimize the impact from cord-cutting on earnings and cash flow.

DBS satellite operators

The growing disparity between DISH's and DIRECTV's operating performances is material to our view of the two companies. We view DISH as better positioned than DIRECTV because of DISH's lower price, which makes its service less vulnerable to cord-cutting; DISH's greater dependence on rural customers, which have lower churn rates because of fewer video service options; and DIRECTV's dependence on heavily discounted pricing promotions, which ultimately roll off and cause churn rates to accelerate. However, the rating on DISH DBS hinges largely on the risk of cash upstreaming to the parent to fund wireless ambitions as the company has built ample downside cushion over the past year.

Wireline telecom operators

The legacy wireline telecom operators' interest in offering their own pay-TV services has waned

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over the past few years because of the high cost, low margins, and technology challenges in offering video over legacy low-bandwidth copper infrastructure. We expect the telcos' pay-TV subscribers who get their service via older network infrastructures, will continue to decline faster than the overall pay-TV industry while those who are overwhelmingly on FTTH infrastructure will likely decline at the industry pace. Still, our credit ratings on the wireline telcos are largely unaffected by this trend because pay-TV is only a small percentage of their revenues and cash flows.

The Impact On The Television Sector Is Negative But Company-Specific

The TV media sector is quite diverse, ranging from the TV broadcast networks, cable networks, premium networks, regional sports networks, and local TV stations, all of which have different competitive dynamics. Cable networks can be further subdivided into general entertainment, children, lifestyle, news, and sports. We view the current rate of cord-cutting as negative for the entire television media sector's credit quality, though the impact varies by TV subsector. TV broadcast networks and local TV stations are core elements of any bundle (and they have over-the-air optionality).

On the other side of the spectrum, regional sports networks, which depend on broad distribution to overcome steep sports rights fees, and premium cable networks, which face cannibalization from streaming services, are most vulnerable to cord-cutting. The ultimate impact to individual companies' operating and credit metrics depends on the specific media company. This assessment isn't uniform because most large media companies have diverse business operations, including growing streaming DTC services that benefit from the decline in legacy television.

Relevant Research

- Cable Providers Can Rock On High-Speed-Data Roll, Feb. 9, 2021

- 2021 U.S. Telecom And Cable Outlook: Rising Leverage Overshadows Economic Resilience, Jan. 15, 2021

- Consumers Continue To Cut The Cord, But The Pace Should Slacken, Jan. 13, 2020

This report does not constitute a rating action.

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