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Friday, February 22, 2013 - 08:30
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Friday, February 22, 2013 - 10:24
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Friday, February 22, 2013 - 08:30

It's Time to Sell Cable Stocks

Friday, February 22, 2013 - 8:30am

When Comcast (Nasdaq: CMCSA) shelled out $16.7 billion this month to acquire the half of NBC Universal still owned with partner GE (NYSE: GE), analysts suggested the deal would provide the nation's largest cable company with another path to growth.

Frankly, the deal is not about growth -- but survival.

Some serious clouds are beginning to form over the major cable companies, which will either need to alter their business models radically, or prepare for steady annual sales declines. From Intel (Nasdaq: INTC) to Google (Nasdaq: GOOG) to Netflix (Nasdaq: NFLX), competition is abounding.

Cutting the cord
Investors are already well aware of the threat that Netflix represents. The video-streaming and DVD-by-mail company has been securing the rights to many popular TV shows, realizing that many consumers are willing to cut the cord with cable TV if they can still catch up on the most popular shows from recent years.

Netflix of course has company. Hulu, Amazon.com (Nasdaq: AMZN), Aereo and others are making it so easy for consumers to watch TV shows and movies, that a decision to ditch cable services (and their expensive monthly fees) becomes easier with each passing year.

The Google end-around
To be sure, cable companies are still generating solid cash flow, in large part because of their virtual monopoly on Internet access. Yet the cable executives are nervously watching Google, which continues to test its own citywide Internet access networks in places such as Kansas City, Mo. Google has always been clear about its intentions: Provide low-cost hardware, software and other components to build high volumes on its platforms. For example, providing the Android mobile software platform to Samsung, LG and many others for free enables these firms to build phones that tie right into the Google eco-system. That's why Google's ad business keeps on growing.

Building out a national Internet access network would prove to be very expensive, but Google's efforts in Kansas City need to be seen as the first moves in a longer-term game. Cable companies operating in Kansas City are already feeling the heat, offering profit-sapping price discounts to retain customers. And they dread announcements from Google regarding additional cities.

Here comes Intel
Yet it's a little-noticed move by Intel that might really shake up this industry. Later this year, Intel plans to launch a paid Internet service that runs through devices being tested at the company's Santa Clara, Calif., headquarters. Intel aims to deliver a service that carries the functionality of a set-top box, though it will place slightly more emphasis on Internet-related content than the current cable TV offerings. Intel also sees the device as a way to usher in the next generation of video-conferencing, enabling family and friends to interact virtually, whether they are in the next town, or across the country.

There are many hurdles in Intel's way, so this initiative isn't really an endorsement of Intel's stock. For example, many programming networks may be reluctant to alter their current profitable relationships with cable companies. And Intel has almost no experience in the area of consumer sales and branding.

But regardless of the relative success of Netflix, Amazon.com, Google and Intel with these moves, it is increasingly clear an expanding array of consumer choice will lead to ever greater pricing pressures for cable companies.

Let's take a closer look at Comcast as an example. Years of heavy investments in capital spending have only recently enabled the company to start reaping prodigious cash flow.

Comcast's Impressive Free Cash Flow

Yet it's important to remember that Comcast carried more than $40 billion in short- and long-term debt at the end of 2012. This means robust free cash flow is crucial to help the balance sheet from starting to buckle. (These figures don't reflect the early 2012 acquisition of the remaining stake in NBC Universal though).

Although Comcast's Internet access customer base is stable for now (and not yet seeing any negative effects from Google's modest initiative), it's already possible to see the impact that companies like Netflix are having on the cable TV business. Comcast lost 459,000 video subscribers in 2011 and another 336,000 in 2012. The impending move from Intel into this space surely doesn't help.

Risks to Consider: As an upside risk, a firming U.S. economy may enable all of the companies in the media landscape to raise prices, which would offset some of the customer attrition.

Action to Take --> Shares of Comcast have risen from $15 in early 2010 to a recent $40, giving the company an eye-popping $110 billion market value. In this time frame, shares of Time Warner Cable (NYSE: TWC) have more than doubled, as have shares of Charter Communications (Nasdaq: CHTR).

If you've been fortunate to ride these stocks all the way up, then the looming storm clouds should give you ample reason to lock in profits.

P.S. -- One stock has raised its dividend 33 consecutive quarters. Another has beaten the market by nearly 100 points in the past three years. And another has $9 in cash on the books... but trades for just $20 per share. Together, these stocks and seven others make up Elliott Gue's Top 10 Stocks for 2013. To learn more about all 10 of these stocks -- including several names and ticker symbols -- visit this link.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of INTC in one or more of its “real money” portfolios.