MorganStanley Dean Witter report from NCTA Conference:
Cable Television: Richard Bilotti
NCTA Conference Stresses ‘Execution' Gary Lieberman – 6/18/99
We draw three broad conclusions from the recent 1999 Na-tional Cable Television Convention:
· Cable operators suggest digital deployment is moving ahead of schedule and surpassing expectations. In 2000 we believe that cable digital set-top deployments will exceed new DBS (direct broadcast satellite) subscriber additions.
· The FCC has taken a supportive role in the proliferation of broadband. It commented that the Portland court ruling requiring AT&T to provide open access to its cable network will not hamper the evolution of broadband and that federal regulation is unlikely. Instead, the agency believes that market forces should decide the fate of broadband. Implicit in this statement is an assumption that the cable television industry will move to negotiate “arm's length” open-access agreements on its own accord.
· As the dust clears in the cable industry, seven major companies have survived, but the industry remains “bal-kanized.” As the number of major players has shrunk, the participants have become increasingly differentiated in terms of future growth strategy. Some emphasize teleph-ony, others look to digital video content-creation and distri-bution, and a third group is pursuing broadband data and multimedia.
Cablevision Presentation (CVC, $70, Strong Buy). CEO Jim Dolan is confident that the Portland ruling will be over-ruled and that it will have no impact on the current rollout of the cable modem business. This battle cry was repeated by every cable television company. We agree, but the industry appears to be going with the theory that if a statement is repeated enough times it will become true. At the end of 2001, Cablevision will have completed its current rebuild plans, and capital spending will drop by approximately 30%. In order to increase capacity in the future, Cablevi-sion will add electronics to its network but will not need to rebuild the fundamental architecture. From a strategic per-spective, Cablevision is following the “island nation” ap-proach. Clearly, the company believes that enormous verti-cal integration in a single market, New York (its Boston and Cleveland operations are much smaller), can offset its rela-tively small size. This seems somewhat akin to Switzerland remaining neutral in World War II.
Comcast Presentation (CMCSK, $37, Strong Buy). Presi-dent Brian Roberts discussed Comcast's debt structure, noting that, while Comcast doubled its size over the last year, it has kept its net debt close to $6.0 billion. As a re-sult, debt as a percentage of capital has fallen. He also stated that 75% is fixed-rate debt as a hedge against interest rate volatility. He was the sole participant to acknowledge that Federal Reserve policy was as meaningful as FCC pol-icy. On the digital front, Comcast announced that it would far surpass its digital subscriber projections this year, ex-pecting to end the year north of 400,000, or 30% above its original plan. It intends to market digital services to 75% of its customer base by the end of the year. Comcast has em-phasized the deployment of digital set-tops rather than data and telephony products more than any other operator.
Mr. Roberts stated that QVC is not simply a shopping serv-ice but also an entertainment provider that generates enor-mous customer loyalty. He believes that the Web-based model of retailing is not the right approach, as it sacrifices margin to attract customers rather than creating an enter-taining retail experience. The Internet could be used as a tool to reduce operating costs in the next several years. He views iQVC as an entertainment site that draws a wide vari-ety of people rather than just a general merchandiser.
AT&T Presentation (T, $56, Neutral). AT&T anticipates that, by late 2000, Bell Atlantic will be allowed to offer long distance bundled with local services. AT&T also assumes that Bell Atlantic will be subject to independent third-party testing and at least one large-scale market test of its ability to comply with the FCC's 14-point checklist for being al-lowed into the long distance market. However, CEO Mike Armstrong declined to comment on how the development of long distance offerings by Bell Atlantic might cause AT&T to change its own anticipated pricing structure.
The year 1999 marks the pilot for AT&T's telephony rollout over cable, in which 10 markets will be targeted. AT&T expects a negligible number of customers from this initial However, in 2000, Mr. Armstrong believes telephony will grow to include several hundred thousand customers (we interpret this as a range of 500,000 to 1 mil-lion lines). By 2001, AT&T expects that full rollout will be achieved, with more than 1 million lines installed per year. In addition, AT&T has clearly stated that Internet protocol (IP) would be phased-in gradually, and that initially it will deploy a circuit-switched product. AT&T forecasts 30% penetration in 3–5 years. We feel this is realistic unless the UMG acquisition is postponed.
Time Warner Presentation (TWX, $66, Strong Buy, target $82). The most important news occurred after the company presentation. CFO Richard Bressler will step down to be-come the head of the new Digital Technologies unit. Mr. Bressler was one of the chief architects of TWX's financial re-engineering in 1996–99, which produced about half of TWX's incremental EBITDA. Now he will be the czar or COO of digital across the company. Digital products should create more than 50% of the expected incremental EBITDA at TWX in 1999–2004. Clearly, chairman Jerry Levin be-lieves that the various digital initiatives at each division need a centralized source of strategic vision.
CEO Joe Collins focused on the deployment of digital set-tops and video-on-demand (VOD). Time Warner currently has 25,000 digital set-tops deployed and aims for 400,000 by year-end. We estimate that, by the end of 2000, Time Warner should have close to 1,000,000 digital customers. Mr. Collins hopes that this accelerated pace of set-top box deployment will aid basic subscriber growth and help it compete with DBS. Time Warner is optimistic about VOD and believes the product will be economically viable in 2000. Mr. Collins indicated that no additional staffing would be needed at the local operator level to deploy VOD. And the digital set-tops currently being deployed are capa-ble of converting VOD with a remote software upgrade.
Cox Communications Presentation (COX, $36, Outper-form). More than any other cable company, Cox has com-pleted the transition to becoming a telecommunications pro-vider, and its growth comes from a wider array of products. Cox made three important points regarding its telephony rollout: It plans to offer both residential and commercial telephony, which we believe could provide equal cash flows. In our most optimistic scenario, we would expect telephony to generate $100 million dollars of EBITDA in 2000 from combined residential and commercial telephony. Within 5–8 years, residential and commercial telephony could generate an estimated $700 million of EBITDA.
Cox believes that an IP telephony product is 2–3 years away. The prerequisites for launching either IP or circuit-switched telephony include getting the public permits to put distributed power supplies in each of its markets; installing OSS/BSS capabilities (operating software and business software); and increasing staffing levels in each system to accommodate the actual volume. There does not appear to be a capital cost advantage for IP over circuit-switched technology even after IP becomes available in several years.
FCC Presentation. The FCC provided a favorable re-sponse to cable operators on the status of open access, espe-cially in regard to the Portland decision. FCC Chairman William Kenard met with cable companies at a private meeting and basically asserted that the agency is not in fa-vor of municipalities regulating open access. He described municipal policy as being chaotic. On a broader note, he reassured the industry that, due to the relative infancy of the Internet, he favors a competitive model rather than FCC regulation. He intends to take a wait-and-see attitude in order to observe the number of evolving technologies and companies and their impact on industry dynamics. As a result, he is not interested in forcing open access on cable operators. However, it is also clear that he expects market forces to create arm's length open-access agreements. This type of “voluntary” compliance is similar to the policy used with respect to the RBOC mergers. The FCC ultimately approved the transactions, but it worked to soften the politi-cal landscape by encouraging voluntary initiatives by the involved RBOCs to open their networks to competitors.
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