Its little secret why customers fed up with paying well over 80 per month to watch TV are switching to low-cost streaming sites. Yet, while analysts have trumpeted the threat these cord-cutters pose to pay-TV providers across the developed world, quarterly results at Sky (LSE: SKY) show little ill effect thus far. Certainly, customer churn in the UK increased from 10.1% to 10.7% year-on-year, but this is still below where it was in 2014.
Furthermore, Sky had little issue replacing these departing viewers as it added 177k new customers over the past three months. Critically, these new customers are paying for premium packages and the companys profitable bundles as average revenue per UK user stayed level at 47. Sky rode these good numbers to revenue increases of 5% over the last nine months to 8.7bn. And, while its more expensive to replace customers than keep them, higher churn numbers didnt stop operating margins from rising to 13.1%.
However, there are problems lurking for Sky behind these good numbers. Enticing customers to keep their expensive pay-TV packages has required spending billions on the rights for sports and high-quality scripted dramas. BTs aggressive move into the pay-TV arena hasnthelped by creating bidding wars for many of these sports rights, culminating in Sky spending 4.2bn to broadcast the Premier League until 2019. Paying for these rights means net debt is now up to 6.3bn, or three times EBITDA. While steady revenue streams mean servicing this debt shouldnt be a problem, it does mean significant cash flow will be diverted to debt rather than dividends in the future. And, as a millennial who doesnt know a single person my age willing to pay a kings ransom for pay-TV, I believe cord-cutting will catch up with Sky eventually.
Thinking ahead
Cord-cutting wont be to the benefit of ITV (LSE: ITV) either, but the creator of quality content has had little problem so far finding new avenues to sell its programmes. When new management took overseveral years ago, they set about quickly lessening dependence on terrestrial TV adsand invested heavily in creating higher quality shows. This has paid off as TV adsonly accounted for 51% of revenue in 2015. The remainder of ITVs revenue comes from distributing its own shows and small amounts from pay-TV and online offerings.
Revenue from these non-advert sources rose a full 34% last quarter and dragged total group revenue 14% higher, despite flat adrevenue. The downside to selling high-quality programmes overseas is that theyre quite expensive, especially as ITV has bought many of the small studios that have produced its hits. Despite this, operating margins were just shy of 20% in 2015.
Looking ahead, ITV should be well placed to survive the long transition away from traditional TV to online and delayed viewing as long as it continues to focus on creating high-quality content. However, investors interested in ITVs low 12 times forward P/E and safely-covered 2.7% yielding dividend should remember two things: producing TV shows is a cyclical, hit-or-miss business and more than half of revenue still comes from traditional TV ads, which will be hurt as cord-cutting rates increase.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Sky. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
