Communication services sector: how it makes money and what to watch

Communication services covers the companies that connect people and deliver content: phone and internet carriers, search and social media platforms, streaming services, video game publishers, broadcasters and publishers. It is one of the most mixed sectors in the market, with slow-growing, debt-heavy network operators sitting beside fast-growing, asset-light internet platforms. Understanding which business model a company really has matters more here than the sector label.

What is in the sector

In 2018 the Global Industry Classification Standard (see GICS sectors explained) expanded the old Telecommunication Services sector into Communication Services. The change brought in internet and media companies that had previously been classified in information technology and consumer discretionary. The sector now has four industries.

How the sector makes money

Four revenue models dominate, and many companies use more than one.

• Advertising. Platforms, broadcasters and publishers sell audience attention. Revenue tends to follow user numbers, time spent and the price advertisers pay, and advertisers cut budgets quickly when the economy weakens.
• Subscriptions. Streaming services, cable operators and wireless carriers charge a recurring fee. Revenue depends on the number of subscribers, the average revenue per user (ARPU) and how many leave (churn).
• Content sales and licensing. Studios and game publishers earn from ticket sales, game sales and licensing deals. Results can be hit-driven and uneven.
• Connectivity. Carriers charge for access to networks that cost a great deal to build and maintain, including fiber, towers and licensed radio spectrum.

The subscription arithmetic

Monthly revenue  ≈  average subscribers  x  ARPU
Monthly churn    =  subscribers lost in the month  /  subscribers at the start of the month
Average lifetime ≈  1  /  monthly churn

Example (illustrative numbers)

A streaming service has 10 million subscribers paying an average of $12 a month, so monthly revenue is about $120 million. Monthly churn is 3%, meaning it loses 300,000 subscribers each month and must add that many just to stay flat. The implied average lifetime is 1 / 0.03, or roughly 33 months, and the revenue from a typical subscriber is about $12 x 33, or around $400, before content, marketing and other costs. If churn fell to 2%, lifetime would rise to 50 months and revenue per subscriber to about $600. Small changes in churn have large effects on value.

What to watch

Subscriber and user trends. Growth in subscribers or active users, ARPU and churn. Rising users with falling ARPU may mean growth is being bought with discounts.

Advertising sensitivity. Ad-supported businesses are tied to the economic cycle. See how revenue behaved in past slowdowns and how reliant the company is on one platform or a few big advertisers.

Content and capital spending. Media and streaming companies spend heavily to make or license content, often recognizing the cost over time through amortization. Telecom carriers spend heavily on networks and spectrum. Compare reported profit with free cash flow to see what the spending is really costing.

Debt. Carriers and legacy media companies often carry large debt loads. Check net debt to EBITDA and the maturity schedule, especially when growth is slow.

Competition and technology shifts. The move from traditional pay-TV to streaming, new networks and new devices can reshape the economics of a business within a few years.

Regulation. Governments review competition, privacy, content and pricing rules. The impact is hard to predict and appears in the risk factors section of annual reports.

Ownership and incentives. Several media and internet companies use dual-class shares, which can give founders or families control that does not match their economic stake. Platforms also tend to pay employees heavily in shares, so check stock-based compensation and dilution.

Valuation: use the right tool

No single multiple fits the whole sector. Rules of thumb:

• Carriers: enterprise value to EBITDA, free cash flow yield and dividend coverage, with close attention to debt.
• Internet platforms: price to earnings or price to free cash flow, read together with growth and margin trends.
• Media and streaming: enterprise value multiples and free cash flow, adjusted for content spending and debt.

A sector average hides the fact that the group is made up of very different businesses, so compare each company with others of its own type.

Common mistakes

• Treating the sector as one business. A wireless carrier and a social network share a label, not an economic profile.
• Counting users without checking money. Growth in subscribers or users only creates value if revenue per user and margins hold up.
• Ignoring content and network spending. Profit can look healthy while cash is being consumed.
• Assuming ad revenue is steady. Advertising budgets can fall quickly in a downturn.
• Judging carriers by dividend yield alone. A high yield on a heavily indebted business can be fragile.

Where to see it on StocksXray

You can browse the group on the Communication Services sector page. StocksXray ranks each metric as a percentile within the sector, and since this sector blends carriers, media companies and internet platforms, the peers list on each stock page is a useful way to compare a company with businesses closer to its own model.

Key takeaways

• The sector mixes network operators, media companies and internet platforms, which behave very differently.
• Advertising, subscriptions, content sales and connectivity are the main revenue models.
• Subscriber growth means little without ARPU, churn and margins.
• Content and network spending can create a gap between profit and free cash flow.
• Match valuation tools and comparisons to the company's actual business model.