Re: Increasing MSO's Revenues- Digital TV, Cable Telephony, and Cable Modem
Thread- FINALLY something positive about the cablecos. Notice this article has a lot of facts rather than just speculation the negative articles seem to throw out. I was getting sick of all the negative articles coming out generally trashing MSOs(mainly ATT). This article seems to confirm that the MSOs who have upgraded to digital two-way 750mhz HFC plants have indeed made a smart move.
Any Harmonic(sym:HLIT) followers should pay close attention to the Charter figures. I believe HLIT is tied in quite closely to Charter's success.
Antec(sym:ANTC) followers should note the cable telephony optimism shown by the facts stated in the article. -MikeM(From Florida)
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Cashing In On Digital Services
by Mavis Scanlon
Online Exclusive, Nov 20 2000
The new services offered by cable operators – digital, high-speed Internet access and cable telephony – may finally be starting to catch on. Getting those services to register on MSOs’ bottom lines, and in their stock price, is the next hurdle.
In the third quarter, Charter Communications averaged 21,500 installations per week of digital cable – an eye-popping 80% increase in the average weekly install rate over the second quarter. That means the MSO added 279,000 new digital customers in the period. "Demand is exceeding, and continues to exceed, expectations," says Kent Kalkwarf, CFO of Charter. "We think it will continue to drive growth in the future."
But despite Charter's 20% growth in operating cash flow during the quarter, the stock fell 68 cents on the news.
Although the other major MSOs could not boast similar weekly install percentage gains, the rollout of new services is accelerating and is beginning to show signs of getting some respect from analysts on Wall Street. Impressive rollout rates were repeatedly mentioned as the overriding trend that stood out during the quarter by stock watchers.
"We're seeing signs that these products and services that had been talked about a year or two years back are finally starting to make headway to becoming a more broad-based consumer phenomenon," says Russ Solomon, VP and senior media analyst at Moody's Investors Service. "We expect that this trend will continue going forward." The hopes for revenue growth in the $28 billion cable industry are pinned on the rollout of the new services.
The relatively mature basic cable market is fighting increasing programming costs as well as competition from DBS on the video side and digital-subscriber line (DSL) providers on the Internet side. Basic subscribers are growing at the lackluster rate of 1.5% to 2% annually, while rate increases for MSOs have been held in check at 4% to 6%. In addition, the lack of high-profile, heavyweight boxing matches has MSOs turning in weak year-over-year pay-per-view comparisons. It's no wonder that revenue from new services will grow increasingly important in the next several years.
But how much new revenue can actually be wrung out of these new services, and how soon? Even though unit growth in new services is becoming more visible, investors will want to see proof that revenue generating unit (RGU) growth is actually hitting the bottom line, says David Lee Smith, who follows the group at Dain Rauscher Wessels. That means execution – from system upgrades to business plan implementation to stellar customer service – is of utmost importance. Investors have shown time and again they will not continue to pay lofty valuations if they see signs that promises made by cable operators are not being executed.
As a group, the stocks of cable MSO's are down 30% year-to-date. That's far less than the stocks of Internet advertisers, for example, or long-distance companies, which are down 80% and 54%, respectively, as of Oct. 10, but far more than the Standard & Poor’s 500-stock average, which is down 7% year-to-date.
"This is certainly very much of a 'what have you done for me lately' market," Smith says. "That would be a market that wants to see a translation of the RGUs to actual revenue growth." Adds Doug Shapiro at Banc of America Securities, "The reason why the very strong unit growth in the quarter didn't drive the stocks more is because you haven't seen enough of an impact" on the profit-and-loss statement.
But that may change, as early as next year. Both analysts agreed that over the next few quarters, the year-over-year comparisons in revenue generated from new services will begin to make an impact, and that impact will accelerate toward the third and fourth quarters of 2001.
By the end of next year, for example, the incremental revenue per subscriber generated by these new services is expected to contribute fully two-thirds of an MSO's total projected revenue increase, some analysts estimate.
A closer look at a long-term revenue and operating cash flow model provides a better understanding of the market potential for new services.
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ATT Richard Bilotti, an analyst at Morgan Stanley Dean Witter, projects that pro forma revenue for AT&T Broadband's digital [TV] services can grow to $1.1 billion in 2005, up from a projected $322.4 million in 2000. He projects that revenue from high-speed data and telephony could grow even faster. He projects high-speed data revenue to jump more than $1.6 billion in 2005 from the $326.2 million he projects for this year.
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Charter At Charter, one of Bilotti's top picks, it's a similar story. He projects digital cable revenue to grow to $734.8 million, up from an estimated $66.4 million this year. High-speed data revenue should grow to $562.3 million, up from an estimated $63.4 million this year he projects. Combined, revenue from digital cable and high speed data should total $1.3 billion in 2005 for Charter, according to his calculations, about 20% of his projected $6.2 billion revenue projection for that year.
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Revenue increases from these new services should certainly offset any basic cable subscriber erosion to any new pay TV services, says Solomon at Moody's, "and will likely offset it by a wide margin." Adding to the bullish case for cable operators is an indication of somewhat slowing growth at satellite companies.
Satellite providers grew revenue at a searing pace in 1999, outpacing MSOs by a wide margin. In 1999, combined revenue for satellite providers leapt 55.7% to $5.9 billion, according to Veronis Suhler Associates, an investment bank focused on the media and communications industries. That's an eight-fold increase since 1995. But that growth may be slowing. DirectTV, the satellite unit of Hughes Electronics, whose parent is General Motors, reported net subscriber growth of 450,000 in the third quarter. Although that growth was up about 6% year-over-year, it was actually down slightly from the net subscriber growth of 452,000 the company posted in the second quarter.
Satellite providers, with offerings of greater channel selection and superior picture quality than analog cable, have – to a large degree – provided the MSOs with the impetus to accelerate system upgrades.
The backbone of the new offerings, and the interactive services that are quickly expected to follow, is a fully upgraded network. The always capital-intensive cable industry has become more so in recent years as operators tapped the equity and debt market in a rush to ensure they would have the capital to complete the upgrades. A few operators, including Charter, the fourth-largest MSO and Insight Communications, the eighth-largest MSO, have accelerated the build-outs of their plants to the 750 MHz standard, but nearly all of the MSOs expect to have between 68% and 90% of their plants upgraded to 750 MHz capability by year-end.
That will allow for more aggressive marketing of new services next year. But in some cases, the intense focus on upgrades and implementation of new services causes a less aggressive marketing stance for basic services. Insight, for example, saw basic customer subs slip a bit in the third quarter, to 96,200 from 96,600 in the second quarter.
The decrease was not a surprise, as Michael Willner, Insight's chief executive officer pointed out in an e-mail interview. This year is a transitional year for the company, he said, and that was made clear to analysts and investors when the company went public in last year.
"We determined that because we are so near completion of our rebuild cycle (90% as of December 2000, in our entire footprint), we should not be aggressive at marketing our standard cable fare," he wrote. "We are going to launch our fully interactive digital service throughout the entire company by the end of the first quarter 2001." Overall, operators saw impressive results in the third quarter. Consider some highlights:
+ Cable operators added about 690,000 new high-speed Internet modem customers during the quarter, bringing the number of U.S. cable modem customers close to three million, according to survey released last week by the NCTA.
+ The nation's digital video customer base grew to 7.8 million, with about 700,000 new digital video customers added during the quarter.
+ A record 139,000 cable telephony customers were added during the quarter throughout the industry, bringing the total cable telephony base to about 568,000. As a result of the better-than-expected growth during the quarter, several MSOs upped their year-end target numbers for some of the new offerings.
+ Philadelphia-based Comcast Corp. increased its year-end target for digital customers by 100,000, to 1.35 million. Comcast added 190,000 digital customers during the quarter, or about 14,600 per week. It also saw enough net additions in its high-speed data products to raise its targets for data customers for year-end to 375,000 from 350,000.
+ Atlanta-based Cox Communications added 123,000 digital subscribers, or about 9,500 per week. Salomon Smith Barney analyst Niraj Gupta estimates that at the end of next year, Cox's digital penetration will approach 24%, based on digital growth of 139% this year, to 839,000 subscribers, and 80% growth next year, to 1.5 million subscribers. Cox had 683,000 digital subscribers at the end of September.
On the telephony side, Cox was adding 3,000 customers a week by September. More than 200,000 homes, or nearly 10% of the homes in which digital telephony is available in Cox's footprint, were taking the service. Gupta at Salomon expects that number to jump 91% to 491,500 by the end of next year.
And, of course, Charter saw blistering growth in its digital offering. Granted, Charter's "Summer Sizzle" promotion, a digital package of 200 channels priced at $49.95, helped boost customer sign-up. But even Charter's high-speed modem install rate during the third quarter, at 2,700 a week, was about 200 more installations per week than the company projected earlier this year. Charter ended the third quarter with 184,600 data customers, a 24% increase over the second quarter.
As operators become more aggressive in rolling out services, the question becomes one of the penetration levels these new services can achieve. The question is difficult to answer, and should be looked at service by service. Analog cable, for instance, will naturally evolve to digital cable as analog boxes are swapped out or replaced by digital in coming years, says Shapiro at Banc of America. Telephony "is going to be the slowest of the three services," says Thomas Eagan, first vice president at UBS Warburg. "It's all a matter of where do [the operators] focus their installers." Several MSOs are hanging back to see results of IP, or packet switch, tests. IP is generally considered a more efficient and economical telephony option, but to date is not as reliable as the current circuit switch standard.
Still, simply by virtue of the fact that cable operators have the ability to offer several services on one physical infrastructure, giving them lower capital and operating costs, they have the ability to pass through savings to consumers. That's a benefit the MSOs have over local carriers, says Shapiro at Banc of America.
In addition, pricing for local phone service is set statewide, and an incumbent carrier would have to undercut itself across a state to beat a price in one market, and they’d be reluctant to do that. Those benefits "suggest that cable can get to decent levels of penetration," Shapiro says, citing as an example Cox's telephony penetration levels of up to 40% in certain markets.
Cox's pro forma telephony revenue grew 107% in the third quarter, to $51.7 million, up from $25 million in the third quarter of 1999. When looking at the total market opportunity for high-speed modems, you have to look at how many homes are online, Shapiro says. Internet usage is jumping. At the end of 1999, more than 40 million households had access to the Internet, a 41.6% increase over 28.6 million in 1998. Spending on Internet access totaled more than $9.4 billion in 1999, according to Veronis Suhler.
Some estimates predict the number of Internet homes may eventually grow to more than 60 million, Shapiro says. And even with the use of DSL and a large base of narrow-band users, cable high-speed modems could likely capture about 50% of the market, which would give it a penetration rate of 30%.
"Our products follow beautifully those escalations" in PC ownership and Internet usage, says Maggie Bellville, EVP of operations at Cox Communications.
"We are in the home, and that's key," she added. "We got in the home early when we could create that barrier to entry, and now we have the opportunity to layer on more products."
In coming quarters, more data will be available for projections. Meanwhile, some analysts are already revising their projections for cable modem users for this year. Bilotti at Morgan Stanley upped his 2000 year-end estimates for cable modems subscribers at the eight largest MSOs to 3.4 million, up from 3.2 million, as he detailed in an October report.
The NCTA expects an even higher number – 3.6 million – by year-end, which would be more than double the 1.6 million cable modem customers at the end of last year.
Driving the acceleration "is the tremendous demand for broadband connectivity in the residential market," Bilotti wrote. That's a good sign for cable operators. As more people get online and use the Internet for play as much as for work, the value of high-speed connections will grow accordingly.
Digital cable will be the key for MSOs that want to offer advanced interactive services. Again, estimates for eventual digital penetration vary widely, with some in the industry speculating that digital [TV] could hit 100% penetration.
Right now about two-thirds of cable subscribers have set-top boxes in the homes, most of which are analog. But it's very likely that the last analog set-top box has been installed, so those boxes will eventually be swapped out for digital set-tops.
"Theoretically, that alone could drive digital to 70% of subscriptions," says Shapiro at Banc of America. Cablevision will be closely watched as it implements its digital strategy. Beginning next month, Cablevision will begin a 1,000-person test of Sony's souped-up digital set-top box. The initial test will ramp up to 5,000 by early next year, and Cablevision expects an aggressive rollout in the second quarter of 2001.
Cablevision signed a $1 billion contract with Sony to supply 3 million advanced set tops to the Bethpage, New York company, enough to supply all of Cablevision's customers in the New York area..
Because of the huge investment, Cablevision is taking its time to make sure the technology is right. It also will wait to see what the customer wants. The box will include a modem, access to video-on-demand, email and interactive features, but the company is waiting for feedback from customers as to design and layout.
So who is winning what can arguably be called the most important race for MSOs in decades.
Generally Cox and Comcast are lauded for execution of their rollout strategies. Companies that have a comprehensive marketing plan, including retail distribution, will stay ahead of competition, nearly everyone following the industry agrees.
On Comcast's earnings conference call, Steve Burke, president of Comcast's cable division, said retail distribution "is absolutely critical" to growing that business.
Comcast, which finished the quarter with about 303,000 Comcast@Home customers, expects its weekly install rate for modems to jump to 8,000 per week by December, up from 5,000 a week in the third quarter. Although Comcast's overall data penetration is a little more than 6%, in the earliest markets in which it launched the service, penetration rates are more than 20%.
By year-end, Comcast, which signed a distribution deal with Radio Shack, will have retail distribution at about 600 outlets. Comcast has also seen a rise in self-installations of cable modems – a benefit to the company as it reduces truck rolls. About 15% of the modems Comcast sold in the first week of November were self-install kits.
Cablevision has a natural distribution outlet in the consumer electronics chain it owns, The Wiz, and will also attempt to grow its online fulfillment operations.
Analysts have suggested that the lack of consolidation prospects in an industry where the eight or nine largest players control about 85% of the market has played into the downturn of cable stocks. But if the MSOs execute on their promises, and deliver new and profitable streams of revenue through the deployment of new services, investors will follow.
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