A fundamental shift in cable industry competitive dynamics in recent years has been accelerated by the COVID-19 pandemic. Americans increasingly rely on fast internet connections to watch TV, conduct virtual business meetings, interact socially, and educate online.

The pandemic will eventually end, but we believe the shift toward higher-speed broadband will persist. COVID-19 served only to accelerate these inevitable trends. Cable is best positioned to capitalize on it because about 70% of the U.S. lacks competition capable of delivering comparable, or better, speeds.

Shifting technology and consumer preferences affect our view of industry fundamentals. We have identified which companies we believe are best positioned to capitalize on these dynamics.

We view the mix shift toward broadband and away from traditional video as positive overall for the cable industry.   Cable earnings and cash flow predictability has improved significantly because broadband is not nearly as competitive as video. In video, all cable operators face direct competition from satellite TV providers Dish Network Corp. and DirecTV, as well as a plethora of new online entrants.

Importantly, as the industry has migrated away from the more competitive video environment, overall earnings have increased with high-margin high-speed data (HSD) revenue growth. We believe cable's broadband competitive advantage over other high-speed services such as those offered by incumbent phone companies will only be magnified in the coming years. Consumers will demand more bandwidth, increasing penetration as well as higher average revenue per user (ARPU) as they move to faster speed tiers. This equates to more predictable earnings because the costs to deliver broadband are fixed (and largely sunk) and don't depend on cable operators raising prices faster than the media companies raise theirs. Therefore, we view favorably a larger, more stable pool of earnings in broadband despite higher concentration in a single and less differentiated service.

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Cable operators have a significant competitive advantage in the internet era.   Their networks were designed to carry video across the fatter pipe of coaxial cable. Competing phone companies carried voice traffic over thinner copper wire. Therefore, it is affordable for cable companies to upgrade electronics in the network to increase speeds. For example, Charter Communications Inc. upgraded equipment in the head-ends to the latest technology standards (known as DOCSIS 3.1)--enabling speed of 1 gigabits per second (Gbps)--for $9 per home passed. Conversely, the best option for wireline phone companies is to replace the copper network with fiber-to-the-home (FTTH), which is very expensive and only economical in densely populated markets that account for about 30% of the U.S.

In the rest of the country, incumbent cable providers compete with legacy digital subscriber line (DSL), satellite broadband, or fiber-to-the-node (FTTN) technology with far inferior speeds, typically maxing out at 25-100 megabits per second (Mbps). We believe operators in less densely populated markets generally face less fierce competition.

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Technology enhancements within the cable network enable adequate capacity to handle rising internet traffic without materially increasing capital investments. Most cable operators have been driving fiber deeper into the network, splitting nodes, moving to digital video signals, and benefitting from video customers exiting the ecosystem. This frees more capacity to be allocated to broadband. While the pandemic has increased focus on upstream speeds and capacity, most residential usage is still used for download. However, there are relatively low-cost options for cable operators to reallocate more capacity within their networks to upstream, if necessary, such as changing amplifier filters. Charter management indicated it is capable of 1 Gbps uploads and downloads under DOCSIS 3.1, with a path to 10 Gbps symmetrical speeds with the next iteration of DOCSIS technology (not likely for 3-5 yeas).

Scale is now less important because its benefits are skewed primarily toward video distribution.   Smaller cable providers are more disadvantaged than larger nationwide satellite TV providers--Dish and DirecTV--for video customers because their competitors' greater scale provides improved programming cost benefits. Satellite competitors have more flexibility in pricing and value proposition than small cable operators given their lower programming cost per subscriber (which small cable operators can partly offset by bundling high-margin broadband with video). Satellite's programming advantage is much less important now because cable providers no longer rely as heavily on video subscribers. In fact, most small cable operators generate very little, if any, earnings from video today because rising programming costs have eroded profit margins.

Rural cable providers stand to benefit the most, as the primary competitive advantage shifts from video scale to internet speed available.   Given the high barriers to entry, most small rated operators have no FTTH competition in 70%-80% of their footprints. We do not expect a significant change, although competing FTTH penetration is likely to increase modestly over time. Three incumbent phone companies announced plans to pass about 5% of U.S. homes with fiber over the next 5-10 years:

• Frontier Communications Corp. could pass 3 millon-5 million more homes over the next 10 years.
• Windstream Holdings Inc. could pass 1 million-2 million more homes with fiber by 2026.
• Consolidated Communications Inc. plans to pass 1 million-2 million more homes with fiber by 2025.

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AT&T Inc., the largest incumbent phone company in the U.S., could also increase its FTTH penetration from 14 million homes (25% of its footprint) as the company drives fiber deeper for wireless backhaul. Still, in less densely populated areas with fewer wireless small cells, the economics will likely remain challenging to extend fiber all the way to the home. AT&T has guided to building out about another 2 million fiber homes in 2021. This is down from a peak buildout of 3 million-4 million homes per year from 2016-2019, but up from 1 million in 2020.

For reference, Verizon Communications Inc. is the largest FTTH provider in the country at 16 million homes. Its build is largely mature, so we do not expect a significant change to the competitive landscape any time soon. Furthermore, AT&T recently announced it will no longer market DSL, typically the only alternative to cable providers in rural markets, positioning cable well to boost its customer base in the coming years.

We believe an inflection point is approaching for more rural providers that have historically lagged in penetration due to less favorable consumer demographics.   Small cable providers often operate in lower-income markets, which has contributed to lower HSD penetration rates than those of larger diversified peers such Comcast and Charter (which operate in both urban and rural markets). We believe rural markets tend to lag in high-speed internet adoption in part because DSL and satellite video were adequate to meet connectivity needs. The trade-off for faster, more expensive internet may not have been that attractive to a demographic that skews older, with lower income and lower-than-average data requirements.

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However, we believe the coronavirus pandemic has accelerated the structural shift to high broadband connectivity throughout the U.S., which should drive higher HSD subscriber and penetration rates. We believe DSL and FTTN competitors offering 25-100 Mbps may no longer be sufficient for many households given the increased importance of having a fast and reliable broadband internet connection for distance learning, telemedicine, and work-from-home arrangements. Furthermore, as satellite TV becomes more expensive, we believe the plethora of streaming TV alternatives could push rural consumers to switch to high-speed cable and save on their TV bills.

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A Democratic government brings opportunities as well as threats to cable operators.   We believe there is bipartisan support to increase broadband availability in unserved markets (about 10% of the U.S.). The Rural Digital Opportunity Fund (RDOF) will allocate up to $20 billion in grants over 10 years (starting in 2022) to winning bidders to extend into rural markets. This presents an opportunity for cable providers to fill in portions of markets or edge out into new adjacent markets that historically could not justify satisfactory stand-alone investment returns. For example, Charter Communications was recently awarded $1.2 billion to cover 1 million unserved homes in Phase I of the auction with speeds of 1 Gbps. Phase II of the RDOF auction, which could award up to $11 billion to cable and telecom providers, will cover underserved homes and those that did not receive funding in Phase I.

There is the potential for incremental broadband subsidies beyond RDOF, particularly with Democrats gaining control of the U.S. Senate. For example, the Moving Forward Act, passed by the House of Representatives in 2020, provides a potential preview of Democratic priorities by proposing to allocate $100 billion to broadband. Most of the proposed funding was for grants to expand service in unserved and underserved markets, but also included a proposal to introduce low-income consumer subsidies to make broadband more affordable.

Incremental funding could introduce competition in mid-tier cable markets (less than 1 Gbps speeds), which we view as a manageable risk because funding priority is given to unserved and underserved markets. Most rated cable operators have upgraded their networks to allow for 1 Gbps speeds across most of their footprints. Of course, the timing and amount of any incremental funding above RDOF is uncertain, subject to negotiation, and may not materialize.

We believe the risk of pricing regulation is low over the next 2-3 years but still presents a long-term overhang.  Most cable markets are still deemed competitive with two carriers able to offer the U.S. Federal Communications Commission's definition of broadband (25 Mbps downloads/3 Mbps uploads). With the new administration, the FCC will likely restore cable operators as "common carriers" under Title II of the 1996 Telecom Act to enforce net neutrality principles of no blocking, no throttling, and no paid prioritization of traffic. The reclassification to Title II also reintroduces the potential for price regulation through the general conduct standard, which provides leeway for the FCC to regulate what it deems to be unfair or unjust practices.

We view the reclassification to "common carriers" under Title II as less of a threat to cable operators because it will be time-consuming to draft an order, it will likely be appealed, and a future FCC administration can flip back to the lightly regulated Title I designation. Additionally, over the next few years we believe the FCC will be more focused on increasing broadband availability and affordability through consumer subsidy programs. By introducing price regulation, it could discourage network investments at a time when expanded broadband access is a key focus of the government. Furthermore, when internet service providers (ISP) were classified under Title II during the Obama administration, the FCC did not regulate broadband pricing but rather focused on a free and open internet. Today, there appears to be more government focus on large tech players around censorship and data protections than on cable infrastructure companies.

Congress could handle net neutrality by enacting a law to prohibit prioritization practices. Theoretically, Congress could go a step further and introduce a framework for pricing oversight and regulation. While this would be a more permanent solution to the ongoing debate, it is unclear where this ranks among priorities, so we view this as a lower probability.

Individual states could introduce rate regulations, but the avenues for successful achievement are unclear. Historically, the FCC has classified telecom service providers as interstate carriers, which precludes states from regulating rates. In fact, the last time ISPs were classified under Title II, states were preempted from regulating broadband. Still, state public utility commissions and legislators could attempt to gain more authority. But we believe this would be costly and time-consuming, likely being tied up in the courts for years.

Longer term, the implementation and enforcement of government-mandated price caps represents one of the biggest threats to the industry, in our view. We believe as penetration rates increase and ARPU rises, cable operators could come under increasing regulatory scrutiny.

We view substitute technology from 5G fixed wireless as a manageable risk to cable.   There is significant uncertainty around the ability for wireless carriers to demonstrate technology at scale, whether signals will be fast and reliable enough for most consumers, and whether it's logical to allocate so much wireless capacity to in-home broadband traffic loads. Still, at the margin, competition from 5G fixed wireless could put some pressure on cable earnings in 3-5 years if wireless carriers successfully execute communicated strategies, which vary by operator:

• T-Mobile US Inc. has committed to build out to at least 50% of the U.S. population by 2025, with a goal of capturing 10 million in-home broadband customers. It will use mostly low- and mid-band spectrum with speeds of at least 100 Mbps.
• Verizon plans to capture 6 million-9 million customers over the next 5-8 years using mmWave spectrum, passing 30 million homes with speeds of up to 1 Gbps, an extended timeline compared with initial plans.
• AT&T has not quantified its plans, but CEO John Stankey recently commented he does not think fixed wireless is the most ideal in-home broadband solution given consumer behavior trends toward more data usage.

We do not believe the number of cable broadband subscribers will be lower in five years, but 5G fixed wireless could slow the pace of growth. Assuming wireless companies achieve their subscriber targets, 5G fixed wireless customers would eventually account for about 20 million-25 million homes (about 20% of current U.S. homes). We believe many potential 5G fixed wireless customers may reside outside the cable ecosystem today. For starters, in-home broadband penetration in the U.S. is only 83%, which we expect to eclipse 90% gradually, likely adding at least 8 million–12 million in-home broadband customers to the market. Furthermore, new home formation of 1%-2% per year could add another 6 million–12 million broadband homes by 2025. Finally, speed and reliability challenges may limit wireless market share gains to 15 million-20 million lower-value cable customers or customers who have slower copper-based service provided by incumbent wireline phone companies.

We believe the largest risk from 5G fixed wireless could be in limiting cable margin expansion, through pricing pressure. Cable will have a speed and reliability advantage over fixed wireless. But it could offer pricing discounts, given the cheaper last-mile deployment costs, particularly if wireless operators view 5G fixed wireless as necessary to subsidize investments to support 5G mobile. More competition could make it more difficult for cable to monetize increasing data usage, especially if there is a cheaper option available with service speeds good enough for many consumers.

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However, there is still uncertainty regarding the ability of wireless operators to demonstrate this technology at scale. Verizon could have trouble covering 30 million homes using mmWave spectrum. This high-frequency spectrum doesn't travel very far and may face interference from trees, hills, etc. T-Mobile's speeds of at least 100 Mbps may not be as competitive. It is also unclear whether a wireless network can handle the traffic generated in the home, which is above 600 gigabytes (GB) per month for the average nonvideo customer, according to Charter. That figure is rising rapidly (at a normalized rate of about 20% per year). Initial plans for 5G mobile users are throttled at a fraction of this amount, including 50 GB for Verizon's and T-Mobile's top-tier plans and 100 GB for AT&T's, virtually eliminating 5G mobile as a substitute risk. While this doesn't necessarily indicate fixed wireless usage limitations, we recognize the more lucrative business model is in mobile applications. To the extent a wireless carrier is spectrum-constrained, a single residential customer could crowd out traffic of many mobile lines. This could confine fixed wireless to niche locations, such as an outer suburb with the same spectrum resources but much lower mobile demand.

Depending on C-band auction results, wireless carriers' strategies around fixed wireless could change. However, given the new use cases likely to emerge from 5G technology, we believe most C-band capacity will be allocated to mobile usage to support emerging machine-to-machine technology.

Cable Ranking Exercise

We continue to rank the largest cable providers at the top because scale allows for greater geographic diversity, programming procurement benefits, financial resources for investments in technology, and the ability to offer new services.   For example, Comcast has leveraged massive investments in its X1 video platform to also offer leading over-the-top (OTT) app integration through its Flex service. Charter is reportedly developing a similar app-integration interface. Ultimately, we believe this helps differentiate its broadband service, especially in more competitive markets. This could become increasingly important if fixed wireless technology gains traction as a way for cable to differentiate itself from emerging wireless broadband providers.

Separately, Charter Communications has bucked the industry trend by expanding its base of video customers slightly in 2020. It has a variety of "skinny bundle" OTT offerings that may not be profitable without scale. Both companies also entered the scale-intensive mobile wireless industry through wholesale relationships, which can help attract and retain profitable broadband subscribers through product bundling.

Finally, the scaled provider's video gross margins are about 40%, compared with our estimate of about 15%-20% for most smaller operators. Video is still profitable for larger operators while it's roughly break-even after factoring in overhead for smaller operators.

We still view Comcast as a slightly better business than Charter.   While both companies embrace a connectivity-first strategy and have similar product suites (including using wireless as a retention tool), Comcast has taken a more expansive view and leveraged its significant technology investments to focus on the customer experience to strengthen its connectivity offering. It has more clearly embraced the idea of being the aggregator of aggregators through its Flex service. We believe Flex allows Comcast to differentiate its broadband service and create other avenues for future monetization, such as through advertising. Comcast's business diversity could allow it to leverage its technology platform, media assets, and relationships across media and streaming across the U.S., and increasingly across the world. Still, we view NBCUniversal Media LLC and Sky Ltd. less favorably than Comcast's cable business, which weighs on the ratings thresholds to some degree.

Comcast's strategy has resulted in stronger customer and profitability metrics largely stemming from a greater emphasis on bundled customers (60% vs 55%), which boosts Comcast's profitability versus Charter. Comcast also has better monetized services such as advertising, business services, home security, and technology licensing.

Table 1

We continue to view overbuilders less favorably than incumbents, but they are still beneficiaries of shifting industry dynamics.   Overbuilders are disadvantaged by scale when competing for bundled video customers, which tends to limit their addressable market primarily to broadband-only homes. Overbuilders continue to operate in very competitive markets, and they must invest more than incumbents, which translates to lower margins and free cash flow generation. In addition, for many years, most overbuilders aggressively pursued a strategy that deemphasizes low-margin video, which should limit margin improvement through mix-shift given already low video penetration rates. Although overbuilder competitive positioning is more dissimilar than incumbent providers, the structural shift to high speed connectivity driven by the pandemic is still a positive, particularly as more households become broadband-only.

Rating Actions

As part of this review, we are taking the following actions:

Loosening our upgrade and downgrade thresholds for Charter by 0.25x.   This reflects favorable industry dynamics and Charter's slightly more rural, and somewhat less competitive, footprint than Comcast's, which should allow for stronger near-term earnings growth. Charter has made significant progress in expanding its subscriber base, which is key to maximizing return on investment. We believe Charter has adopted a tactical strategy of emphasizing unit growth over profitability. We believe this will enable it to increase ARPU when subscriber growth eventually plateaus years down the road.

Placing the ratings on Altice USA on Credit Watch with positive implications pending a more comprehensive review of financial policy and governance.   Management reduced Altice's cost structure, improving its profitability and reinvesting savings into the business. When evaluating operating efficiency, Altice is at the top of the list by EBITDA per home passed and EBITDA per customer. Still, the company operates in the most competitive incumbent footprint, which results in below-industry average earnings growth, underpinning the tighter threshold differential compared with Charter.

Loosening the upgrade trigger for Midcontinent, which results in a one-notch upgrade.   This reflects the strength of the business relative to incumbent peers that operate primarily in rural territories. Midcontinent's operating efficiency, evaluated by EBITDA per customer, ranks above that of Charter in part because of its favorable programming agreement with Comcast. Still, it operates in one of the more competitive incumbent footprints, with overlap coming primarily from FTTN overbuilders.

Revising the outlook on Cable One to positive from stable and loosening the upgrade trigger to 3x.   This reflects the increased likelihood the company's broadband penetration rate reaches 35% on mid-single-digit percent broadband subscriber growth over the next 12 months, which would reflect an improved business risk profile. Although we recognize broadband penetration rates will continue to trail those of most incumbent peers, EBITDA margins continue to lead the industry on favorable product mix and low competitive overlap with FTTH.

Loosening the upgrade trigger for the stand-alone credit profile (SACP) of Cogeco Communications (USA) Inc. (dba Atlantic Broadband, ABB) by 0.75x, resulting in a one-notch upward revision to the SACP.  This reflects the strength of the business relative to incumbent peers. ABB's operating efficiency, evaluated by EBITDA per homes passed, ranks above that of Midcontinent but below that of Cox. It's in part driven by less competition in its footprint than larger providers. In addition, we believe ABB could materially improve this metric by pricing its video product more aggressively. ABB has the highest video penetration rates in the industry. However, we believe the company generates no earnings from video, because it did not adopt a strategy that emphasizes broadband like many smaller incumbent peers.

Over the past year, we also reflected on a more favorable industry view in the following rating actions and will not be adjusting thresholds on these companies:

• We upgraded Mediacom Communications Corp. to 'BBB' on Aug. 21, 2020.
• We loosened the upgrade and downgrade triggers for Cox Enterprises Inc. on Feb. 18, 2020. We view Cox's stand-alone cable business as on par with that of Altice USA's, but its overall business is dragged down by the more cyclical automotive segment.

Table 2

Related Research

• Charter Communications Inc. Rating Triggers Loosened On Secular Shift Toward Broadband; 'BB+' Rating Affirmed, Feb. 9, 2021
• Altice USA Inc. Ratings On Watch Positive On More Favorable Business , Feb. 9, 2021
• Midcontinent Communications Ratings Raised To 'BB'; Outlook Stable, Feb. 9, 2021
• Cable One Inc. Outlook Revised To Positive From Stable; 'BB' Rating Affirmed, Feb. 9, 2021
• Cogeco Communications (USA) Inc. 'BB' Rating Affirmed On Revised Stand-Alone Credit Profile, Feb. 9, 2021