Cable & Satellite: Jason Kim

Sector View:

We have a Neutral coverage view on Cable & Satellite. Despite ongoing cord-cutting concerns, cable operators have continued to gain share in broadband, commercial and now mobile segments. We expect an acceleration in core cable fundamentals from CHTR and CVC/CEQUEL next year as they complete merger integration (CHTR) and cycle through tough margin comparisons (CVC/CEQUEL). That said, we believe investors will keep a watchful eye on (1) the fate of the announced S/TMUS merger, which is going through a regulatory approval process and will likely have large lateral implications on the cable/pay-TV sector as well from an M&A and potential partnership scenarios standpoint; and (2) continued roll-out of fixed wireless 5G broadband from VZ. The FSS industry’s competitive environment remains tough yet relatively unchanged. The biggest catalyst in the sector remains the C-band monetization opportunity.

Our top trade ideas in the sector are: (1) Buy DISH 7.75s of 2026s at 9.8%. It is an out-of-consensus call as we believe the core DBS business will fare better than market’s pessimistic expectations and (2) Buy INTEL Jackson 9.75s of 2025s at 9.0% as we see a visible catalyst on the horizon given our estimate that $3.0 bn or higher in C-band repurposing proceeds will enable INTEL to meaningfully improve its cap structure.

Trade Idea 1: Buy the DISH DBS 7.75s of 2026. We believe that DISH’s core DBS business will have a longer tail and fare better than overly pessimistic market expectations. This, in turn, can help break the negative feedback loop that DISH DBS credit has experienced for over a year that has made the bonds one of the worst performers in our coverage - deteriorating fundamentals, diminishing time to reinvigorate strategic options, resorting to priming and/or completely separating DBS from rest of DISH Network.

More rational linear-TV competitive environment: We expect linear pay-TV trends to remain difficult. But over the past 2-3 quarters, we have seen emerging signs that DISH’s competitors are finally starting to act more rationally in this secular backdrop - managing for profitability as opposed to market share gains through aggressive promotions. We believe this bodes well for DISH because it has been the only operator managing its business this way since 2015, which has resulted in significant satellite-TV subscriber losses. We also think that DISH’s subscriber base is in a cleaner shape and less likely to churn than many other pay-TV distributors given that DISH has been pruning its less profitable subscriber base since 2015.

YoY comps remain easy: DISH DBS’ pre-SAC margins started to decline notably in 2Q17 driven by the subscriber-related expenses line. Since lapping the yoy impact (2Q18), margin trends have been much better and we expect several more quarters of yoy EBITDA benefit from easy comparisons.

8-10% is the key inflection point for the DBS credit: If the DBS EBITDA decline rates are better than -8-10%, then the credit can absorb the impact as FCF generation offsets the lower EBITDA. We project DISH DBS net leverage to go from 4.4x at the end of 2018 to 4.2x in 2020.

Risks to our view: Downside risks include weak core TV trends combined with a loss of the value of spectrum without adequate compensation to DBS bondholders.

Trade Idea #2: Buy the INTEL Jackson 9.75% 2025s. We believe the developments since mid-2018 surrounding the C-band process and cap structure transactions have greatly derisked the INTEL credit story. Based on our expectations for INTEL’s core FSS business, we believe that $3.0bn or higher net proceeds from C-band repurposing monetization to the credit would make the structure sustainable over the medium term. We view those levels ($3.0bn or higher net proceeds for INTEL) as relatively undemanding scenarios.

C-band valuation scenarios: In order to obtain $3.0bn of net proceeds for INTEL, the implied valuation on the C-band would be around $0.16/MHz/PoP. This is the same level that the 3.4GHz spectrum auction cleared in the UK earlier this year. Spectrum valuations in the US have historically traded at large premiums to UK auctions of similar bands. For example, the 600Mhz broadcast auction in the US in 2017 cleared at $0.91/MHz/PoP vs. the auction in the 800MHz auction in the UK cleared at GBP 0.38/MHz/PoP - at today’s exchange rate, that implies a 87% premium for the US spectrum.

More conservative commentaries around pro forma balance sheet: Should net proceeds exceed $3.0bn for INTEL, the company in theory can start to distribute the excess proceeds to shareholders via restricted payments under the INTEL bond covenants. Management’s recent comments that it believes the company’s leverage should be below 6x (which would require net proceeds of $4.0bn or greater and used to repay debt) to the extent proceeds are large enough give us more comfort that INTEL’s credit profile can benefit beyond the minimum requirements dictated by its debt covenants.

Risks to our views: Downside risks include the FCC not ruling in favor of the satellite operators’ market-based approach, re-acceleration in pricing pressure in network services and less transponder demand from media customers that are coping with streaming competition.