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By Darren Carter
With many non-investment grade cable bonds trading wide of the market, we see attractive opportunities in the space.
In our view, cable companies have attractive credit profiles, benefiting from asset-rich infrastructure, subscription-oriented business models, and relative insulation from cyclical/inflation/supply chain issues. Notwithstanding these defensive characteristics, the spreads on many cable bonds have widened more than the market, which is different from prior credit sell-offs.
What has changed?
Part of the issue is technical. Cable issuers tend to have termed-out capital structures, and this duration (frequently with low coupons) creates a technical headwind for the bonds. Perceived LBO risk has also contributed to widening in some cable names.
But more relevant is a broader change in market sentiment. Cable has enjoyed a quasi-monopoly in residential broadband service for many years. The aged and inferior copper-based technology of telecom companies has not been able to match cable broadband’s speed and performance, and market share has shifted relentlessly from telecom to cable.
The tide, however, is beginning to turn as telecom operators more actively upgrade their copper plant to fiber. Wireless broadband offerings from mobile operators are also providing a new option for consumers. The trends in cable broadband (which benefited significantly from COVID due to work- and school-from-home) are increasingly being questioned by investors. To put it bluntly, the outlook on cable broadband growth has seldom been more opaque. Nowhere is this shift in sentiment clearer than in the performance of the largest pure-play cable operator in the U.S., whose stock is down 43% from its 52-week high (vs. the S&P 500’s 19% decline).
We acknowledge the growing competitive headwinds that cable could face, especially from fiber, and we believe this change will precipitate higher capital intensity for cable companies. But these changes will happen over a period of years, not overnight. And while we expect an increase in capital expenditures, these investments will improve creditors’ collateral base and potentially “future-proof” the overall business. Historically, cable companies have deployed substantial excess cash flow into share buybacks. From a creditor’s perspective, the reallocation of cash flow from share buybacks to investment in the business is a credit positive. Finally, we do not see substantial LBO risk given current leverage levels and our expectation of higher capital intensity over the medium term.
As a result, we are finding many high-yield cable bonds with above-market spreads to be attractive in this environment.
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