It’s 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 company’s 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 it’s more expensive to replace customers than keep them, higher churn numbers didn’t 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. BT’s aggressive move into the pay-TV arena hasn’t helped 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 shouldn’t 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 doesn’t know a single person my age willing to pay a king’s ransom for pay-TV, I believe cord-cutting will catch up with Sky eventually.
Should you invest £1,000 in Tesla right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Tesla made the list?
Thinking ahead
Cord-cutting won’t 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 over several years ago, they set about quickly lessening dependence on terrestrial TV ads and invested heavily in creating higher quality shows. This has paid off as TV ads only accounted for 51% of revenue in 2015. The remainder of ITV’s 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 ad revenue. The downside to selling high-quality programmes overseas is that they’re 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 ITV’s 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.
