Time Warner Cable to Underperform

We are downgrading our recommendation on Time Warner Cable Inc. (TWC - Analyst Report) to Underperform backed by the company’s weak financial guidance for 2013. The company is losing video subscribers without any interruption since 2009. We do not know when this trend will ultimately reverse.

Why the Downgrade

Growing competitive threats from telecom, satellite TV and online video streaming operators along with soaring programming costs are taking heavy toll on Time Warner Cable’s finances. The company estimated that its programming costs will increase by 10% in 2013.

Further, the total amount of high-margin political advertisement will be significantly below the prior-year level. As a result, the company’s operating margin will decline 0.5-1% in 2013.

Management guided that its fiscal 2013 adjusted earnings per share will grow by 10-14%, which is way below the initial Zacks Consensus Estimate of 20% growth. Time Warner Cable currently has a Zacks Rank #5 (Strong Sell).

Other Negatives

The multi-channel video market in the U.S. is almost saturated. Roughly 87% of the total 114 million TV household in the U.S. are at present multi-channel TV subscribers. It is not easy to gain customers from competitors since each and every pay-TV operators are offering innovative packages.

For example, the online videos provide an extremely cheaper source of TV programming unless the customer is very eager to see real-time programs like sports events. This business model is gaining momentum, especially when the economic headwind is still persisting.

Time Warner Cable must change its business model simply as a pure-play pay-TV operator and broadband service provider in the U.S. The company’s closest competitor, Comcast Corp. (CMCSA - Analyst Report), has decided to acquire full control of NBC Universal, which will position the company as a formidable integrated content developer and TV distribution company.

DIRECTV Inc. (DTV - Analyst Report) is significantly expanding its base in the Latin America region beside the U.S., while DISH Network Corp. (DISH - Analyst Report) is trying hard to become an integrated wireless-satellite TV bundled service provider. Despite so many changes in the pay-TV industry’s internal dynamics, Time Warner Cable is lagging as an innovative business model.

Other Stocks to Consider

Other stocks to consider in the U.S. pay-TV industry are Comcast, DIRECTV and DISH Network. While Comcast’s net earnings slightly fell below the Zacks Consensus Estimate in the most recent quarter, DIRECTV handily beat the same. DISH Network is yet to release its earnings results. However, all these three stocks currently have a Zacks Rank #3 (Hold).