The Evolving Broadband Landscape

Several developments over the past two months have shed more light on the potential long-term threats and opportunities facing cable operators. AT&T Inc. announced plans to accelerate its fiber-to-the-home (FTTH) rollout, Verizon Communications Inc. updated its 5G fixed wireless ambitions, and the Biden Administration introduced a massive infrastructure plan that includes funding for broadband access. Taken together, we believe cable operators could face incrementally more competition longer term, but incumbent operators are still well positioned to grow earnings for the foreseeable future, particularly given the massive government funding being allocated to broadband.

Increased fiber buildouts could limit cable companies' market share gains from telco operators' DSL

AT&T management recently indicated the company plans to expand FTTH to 50% of its wireline footprint, roughly 30 million homes--up from about 14 million today. This is more than we previously expected, although there is uncertainty around the timing and ability to achieve this milestone given the cost to build per home passed will increase as the buildout moves to less densely populated markets and AT&T has competing investment needs. For reference, Verizon is the largest FTTH provider in the country at roughly 16 million homes and its buildout is mature at about 25% of its footprint. Still, if AT&T continues to build out 3 million-4 million homes per year, we believe it could meet its goal by the end of 2025, representing an increase in viable competition for incumbent cable operators.

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However, we expect fiber buildouts over existing copper wire would mostly offset digital subscriber line (DSL) losses to cable, rather than result in overall growth in telco subscribers. Therefore, we expect cable to maintain its existing share in these markets, with fiber buildouts serving to protect telco companies' existing customer base. To be clear, this increase in competition will reduce cable's future growth rates relative to our previous expectations.

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Although it will take years for fiber to capture its full market share, successful fiber overbuilds typically achieve about 40% penetration of homes passed, roughly splitting the market with the incumbent cable provider. We believe it will be challenging for new fiber buildouts to achieve penetration levels higher than what Verizon Fios has achieved (about 40%) for the following reasons:

• Cable operators have invested heavily in their networks, with the ability to offer comparable speeds to fiber, with a relatively affordable technology path to keep pace. Therefore, absent sustained pricing discounts from new fiber providers (that would further challenge economics of fiber buildouts), the incentive to switch from cable to fiber is low as internet speeds are comparable.
• Cable operators are differentiating their service with technology investments and bundled offerings. Most cable video offerings have improved dramatically in recent years, with better user interfaces, search and functionality, voice remotes, digital video recorders, and video on demand titles that can help sell broadband. In particular, Comcast Corp.'s Flex service allows for seamless integration of streaming video applications on its broadband service. Comcast, Charter Communications Inc., and Altice USA Inc. all offer affordable wireless services for broadband customers. We believe bundled cable subscribers are less likely to switch to an alternative provider given the inconvenience of doing so, with little improvement in service capability. This locks in the more-profitable higher average revenue per user (ARPU) customers, leaving the lower-value customers for the telcos to pick up.
• Smaller fiber providers are unlikely to surpass Verizon's 40% penetration mark given they lack brand recognition, premium wireless bundle offerings, and scale.

Rural markets present a significant growth opportunity for cable

We believe there is still room for substantial cable subscriber growth in nonfiber markets, which we estimate will still account for the majority of homes in 2025. These typically rural markets have historically been underpenetrated because of lower-income levels and less data usage than consumers in urban and suburban markets. As we recently outlined in "Cable Providers Can Rock On High-Speed-Data Roll," we believe cable operators are poised to significantly increase their market share in the coming years. In fact, we believe cable market penetration could approach 65%-70% over the next four to five years from about 40% today in these more rural markets. Therefore, we project significant growth in nonfiber markets coupled with maintenance of existing share in new fiber markets, will result in industrywide cable high-speed data penetration approaching 58% by 2025 from about 51% today.

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Fixed wireless will primarily target DSL and lower-value cable subscribers

We believe consumer behavior plays to cable's strength, as exponentially rising data usage requires fast, reliable internet connections. However, Verizon management recently increased its target addressable market for fixed wireless broadband service to 50 million homes by 2025, up from previous guidance of 30 million following the purchase of C-band spectrum licenses (with a goal of at least 20% penetration). T-Mobile USA Inc. also continues to target 7 million-8 million customers by 2025 while AT&T will not be aggressively deploying fixed wireless.

While the updated strategy from Verizon poses incremental risk to cable, we continue to view fixed wireless as a manageable risk to cable for the following reasons:

• Fixed wireless may be an inefficient allocation of spectrum resources. There is a clear trade-off between speeds offered to customers and the number of customers that can be served per cell site and the more lucrative business model is in mobile applications, which can be monetized at a substantially higher rate per bit. To the extent a wireless carrier is spectrum constrained, a single residential customer could crowd out traffic of many mobile customers. This could confine fixed wireless to niche locations, such as an outer suburb with good spectrum resources but lower mobile demand.
• Fixed wireless speeds may not be sufficient, particularly for T-Mobile, which is offering speeds of at least 100 Mbps. We believe that five years from now, this may be limited to primarily taking share from DSL customers.
• Fixed wireless service may not be as reliable, particularly for Verizon, which is using a higher-frequency spectrum that may face interference from trees, hills, etc.

Federal Funding

Government subsidies support cable growth in the near term

Recent COVID-19 relief packages already signed into law include a substantial amount of federal stimulus money that should help support high-speed internet. These relief bills focus mainly on internet affordability, which is a positive for cable operators as it will allow lower-income consumers to pay for fast internet. While these programs only provide temporary cable upside (expiring on the first June 30 a year from when the Secretary of Health and Human Services terminates the COVID-19 public health emergency declaration), certain elements could be incorporated in longer-term legislation. More specifically, the following funds will help cable operators grow earnings over the next year or two:

• Emergency Broadband Benefit Program ($3.2 billion): Signed as part of the December 2020 Consolidated Appropriations Act, it provides low-income consumers with $50 monthly subsidies plus a one-time payment of $100 for a connected device.
• Emergency Connectivity Fund ($7.2 billion): Signed as part of the March 2021 American Rescue Plan, it provides extra E-Rate funding for connectivity for schools and libraries. While the Federal Communications Commission (FCC) is still working out details, which are likely to be finalized in the next month or so, a key advantage of this fund is that it can be used to pay for services that E-Rate has not traditionally covered. Historically, E-Rate would provide funding for connections to the schools and libraries but as the lines between school, home, work, and the library have blurred, this funding will subsidize connections for teachers and students off campus, which is a positive for cable providers as it can help increase subscribers.
• Coronavirus Capital Projects Fund ($10 billion): Signed as part of the March 2021 American Rescue Plan, it will provide money to states for construction directly enabling work, education, and health monitoring in response to COVID-19. While most of this money will not be allocated toward broadband, it's possible that some could be used to subsidize broadband infrastructure upgrades for cable providers.

Biden's infrastructure proposal is mixed for cable

President Biden's American Jobs Plan, which calls for $100 billion for broadband funding, includes the following language:

• Build high-speed broadband infrastructure to reach 100% coverage, prioritizing support for broadband networks owned, operated by, or affiliated with local governments, nonprofits, and cooperatives.
• Promote transparency and competition, including by lifting barriers that prevent municipally owned or affiliated providers and rural electric co-ops from competing on an even playing field with private providers, and requiring internet providers to clearly disclose the prices they charge.
• Reduce the cost of broadband internet service and promote more widespread adoption. While the president recognizes that individual subsidies to cover internet costs may be needed in the short term, he believes continually providing subsidies is not the right long-term solution.

On the surface, this proposal sounds negative for cable as it highlights the need for increased competition with an emphasis on funding noncable providers. However, presidential policy statements may not translate into enacted policy, as this proposal is in the very early stages of negotiation and lacks specific details. Republicans recently unveiled a counter proposal that would allocate $65 billion to broadband compared with $100 billion offered by President Biden. We believe this potential source of substantial government funding could have both positive and negative implications for cable, with less downside under the $65 billion proposal than the $100 billion proposal (which may include money for overbuilding).

Increased 'availability' funding presents significant upside for cable

We believe the most expensive part of the potential package would be to increase availability to unserved and underserved markets, which appears to have bipartisan support. Without more precise broadband maps (which the FCC is in the process of updating) it's difficult to determine the cost of subsidies for network buildouts. However, in a 2017 report, the FCC said it could cost up to $80 billion to bring high-speed internet to the remaining 14 million unserved homes that do not have access to 25 Mbps download/3 Mbps upload speeds. Even if this amount is overstated, it provides a sense for the magnitude of capital required to provide high-speed internet to very rural communities. We believe this is a significant opportunity for cable operators to expand their footprint and addressable market size given the ability to offer fast internet over a hybrid fiber/coaxial cable network. However, there is no material risk if money is allocated to other providers given cable operators do not currently offer service to these markets.

Overbuilding threat is modest to cable providers

We view the probability of government-funded competition in cable markets as low given it will be more politically divisive and challenging to pass into law. We believe Republicans have little appetite to spend money that would discourage free-market network investments. Furthermore, given the sheer amount of money required to provide access to unserved markets, which we believe will be the priority, there may not be much money left for increasing competition in "underserved" markets, particularly if the $100 billion proposal is reduced to a lower amount. However, even if some money is allocated to municipal broadband providers, their past operating record has been relatively poor as they often lack the scale, scope, and expertise to compete effectively. Therefore, we view the potential for subsidized overbuilding as a low risk to cable, both legislatively and in the marketplace.

Regulatory Risk

Near-term rate regulation risk remains low, but probability has increased

We believe the risk of rate regulation has increased modestly with President Biden's view that Americans pay too much for internet coupled with his commitment to reduce internet prices. We continue to view government-mandated price caps as the biggest long-term threat to the cable industry. We expect the increased importance of high-speed internet to continue to increase both cable penetration rates and ARPU. If this occurs, we believe cable operators will come under increasing regulatory scrutiny as the case for price caps will continue to be strengthened, particularly in rural markets with less fierce competition.

Still, there is a high degree of uncertainty around the approach and ability for President Biden to achieve the broader goal of reducing the cost of broadband, which can either take the form of increasing competition, providing consumer subsidies, or regulating price. Consumer subsidies are being provided today but President Biden has indicated he does not believe this is a viable long-term solution. This leaves the door open for potential rate regulation, although the impact to cable providers may vary depending on how any potential regulation is enforced.

While it is not clear whether Democrats will focus more on average consumer broadband costs or access to affordable entry-level pricing, we believe the more likely outcome of any initial price regulation could be to mandate access to lower-speed tiers for low-income consumers. For reference, New York state recently became the first to pass a law requiring all internet service providers to offer a $15 a month plan to qualified low-income consumers, with a cap of $20 for high-speed broadband for speeds up to 200 Mbps. We view this kind of regulation as largely neutral to cable operators because:

• On the positive side, it could broaden the addressable market by encouraging consumers to sign up for a service they otherwise wouldn't have been able to afford. There could be opportunities to strengthen this relationship and move customers to faster speeds over time (although these customers may be more susceptible to churn).
• A negative could be some margin pressure by a mix shift toward low-priced packages that have rate caps.

In fact, many operators have increased the availability of low-priced plans over the past year, with 77% of Americans now having access to plans of $60 or less per month (after promotions) with minimum speeds of 25 Mbps download and 3 Mbps upload, up from 50% just a year ago, according to BroadbandNow Research. While caps could be set at levels below current offerings, we view potential price caps on low-income consumers as a manageable risk given that broadband is a very high-margin business with low operating costs, so any price caps on low-income consumers will not materially affect profitability or cash flow for these lower ARPU customers.

Separately, if the focus is on average broadband costs, the risk to cable providers is highest. This risk could increase if the FCC redefines "broadband" to levels that the competing phone company is incapable of delivering. Currently, the FCC defines broadband as 25 Mbps download/3 Mbps upload, which two companies can offer in the vast majority of the country. However, many competing copper-based telecom companies struggle to offer download speeds of 100 Mbps (depending on many technical factors) so if the FCC were to redefine broadband to higher levels, the argument for rate regulation could be strengthened if the cable company is the only capable provider of offering "broadband" speeds in a higher number of markets.

However, we believe there are hurdles to the implementation of sweeping price caps, which will face stiff opposition from Republicans. While it is unclear how high broadband regulation ranks among Congressional priorities, it's unlikely that Democrats could use a reconciliation (requiring only a simple Senate majority as opposed to 60 votes) to pass a bill implementing price caps even if it gains more momentum because this process is reserved for taxes, spending, and the debt limit.

Outside of Congress, the FCC could reclassify providers under Title II of the 1996 Telecom Act this year as way to implement rate regulation, but we view this as less of a threat to cable operators. This is because it will be time consuming to draft an order to determine parameters of regulation including speed, latency, data caps, among other items; it will almost certainly be appealed and may be overturned in the courts; and a future administration can revert back to the more lightly regulated Title I regime. Furthermore, we view Title II reclassification as the primary means to enforce net neutrality principles (no blocking, no throttling, and no paid prioritization of internet traffic) as opposed to a way to regulate rates, and it's possible there could be a forbearance on price regulation under such reclassification, which occurred under the Obama Administration.

Still, even if a framework for pricing oversight and regulation is introduced, we believe enforcement of price caps that could hurt cable profitability near term would be low for the following reasons:

• Rated incumbent cable operator industry penetration rates average about 50%, with telco services and/or cable overbuilders capturing roughly 30%-35% of the market (roughly 15% of homes do not have broadband), evidence of competitive marketplace conditions.
• Average price per household of about $60 per month, which is lower than many other utility-like services.
• The cost per bit in the U.S. is relatively low compared with that of global peers, indicating good consumer value despite higher levels of ARPU.

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Whatever approach is chosen, we believe the potential for increased regulatory scrutiny could slow the pace of cable price increases over time. Still, we believe the majority of ARPU growth over the next several years will come from customers moving up-market to faster speed tiers and less from rate hikes on existing service.

Room To Roam

Market growth will drive cable subscriber increases

We believe overall broadband penetration in the U.S. will approach 95% over the next five years, from about 85% today, as government-funded programs increase access in rural markets and improve affordability nationwide. For reference, pay-TV penetration peaked at about 90% and clearly internet usage is becoming more critical in the lives of consumers than TV ever was. Many consumers today opt for wireless-only internet access to save money. We believe that increasing data usage requirements will make this strategy more challenging in the future and increasing government assistance programs could accelerate overall market penetration rather quickly. In fact, 43% of households earning less than $30,000 a year are not connected to internet nationally and this number drops to only 8% for households earning $75,000 or more, according to New York state data.

Overall, this supports our forecast that incumbent cable operators can grow to at least 85 million homes over the next five years, from about 71 million today, factoring in the following assumptions:

• 25 million new FTTH buildouts achieve 40% penetration
• Cable achieves significant penetration (about 70%) of DSL subscribers in nonfiber markets
• Verizon achieves 20% penetration in its 50 million fixed wireless home footprint
• T-Mobile achieves its goal of 7 million-8 million fixed wireless homes
• Overall in-home broadband penetration approaches 95%
• New home formation of about 1.5 million homes per year

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Related Research

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