Pretty good...
How Hot Is Cable, Really? Time Warner, Comcast, and other cable powers have Wall Street on their side, finally. Their chiefs don't necessarily see John Malone as the Messiah, but his hype serves them well. After all, he helped enlist Silicon Valley in the fight against their greatest adversaries: the Baby Bells.
Andrew Kupfer Reporter Associate Rajiv M. Rao
02/16/98
Fortune Magazine
Time Inc.
Page 70+
(Copyright 1998)
You would think that with the cable industry's dark recent past--the way its stocks tanked after most of the cable-telco deals flopped, the way the information superhighway evanesced like a mirage--cable guys would be gun-shy about hype. And they are; the cable chieftains of Comcast, MediaOne, and Time Warner all agreed to be interviewed for this story, but they mainly seemed eager to dole out reality checks. Privately they mostly agree that when TCI Chairman John Malone conjures up his grand design for the future, he is just blowing smoke--and, as one CEO dryly put it, "stirring his equity."
It's ironic that Malone has become the poster boy and leading spokesman for his industry, the cable champion and technological visionary pitted against Bill Gates. His peers don't hesitate to point out that TCI is technologically the most backward of the major cable companies. While other players have inested billions of dollars to add digital smarts and extra capacity to their systems, Malone has starved TCI, ruthlessly cutting capital investment to shore up the company's shaky finances.
That's a big reason Malone's confreres disapprove of his bombast. But perhaps they protest too much. Press them, and they acknowledge that a certain amount of hype serves their $30-billion-a-year industry well. So what if Malone is making the future sound a whole lot closer than it really is? If he piques Silicon Valley's interest, it may well scare up the technology and capital that the cable companies need for their short-term goal, which is simply to sell more and more video services. And in cable's perfect world, Silicon Valley's support could strike a crucial blow for cable against the slow but mighty Goliath they most dislike--namely, the $110-billion-a-year local telephone industry.
The mating dance between cable and the Valley brings together two of America's most growth-hungry businesses, and it has intensified over the past year. High-tech companies are banking on a fast digital connection into the home to help sell more microprocessors and software--in PCs hooked to online networks and in digital set - top boxes. With new standards in place for ultrasharp high-definition TV, the television seems destined to become an important digital device.
All the attention from Silicon Valley has caused a remarkable turnabout in cable's fortunes on Wall Street: Most stocks have doubled in the past year (see chart). It has also heightened the paranoia in this close-knit, dynastic, nepotistic industry that the Valley, and Bill Gates in particular, will figure out a way to soak up all the juice, just as Microsoft and Intel did in the PC business. Only this time the nerds from Silicon Valley may have met their match. Malone and his peers know all too well the dangers posed by ceding control of their technology to Microsoft, and they are a notoriously tough bunch with whom to negotiate.
The big issue for the cable industry is that whoever controls the technology of the set - top box will be the gatekeeper on tomorrow's TV systems, including televised entertainment and whatever services accompany it. Cable understands this concept very well; it wrested away the same function from the three broadcast networks, which controlled everything that appeared on TV until cable gradually found its way into two-thirds of American households and developed its own programming. As analyst Tom Wolzien of Sanford C. Bernstein notes, "Cable isn't interested in giving up its gatekeeper function to become merely a conduit."
The game so far has been very cat-and-mouse. When Microsoft offered to supply the industry with cheap set - top boxes last year, in exchange for a cut of future service revenues, cable guys Gerald Levin of Time Warner, Jim Robbins of Cox Communications, and Brian Roberts of Comcast joined Malone to say, in effect, "Gee, Bill, thanks. But no thanks." Instead they opted for Malone's plan for the industry to keep a tight rein on set - top -box technology by bidding out each hardware and software component to different high-tech suppliers. There's no guarantee that, say, Microsoft won't eventually win most of the business for the operating systems. But so far the industry has blocked Gates from getting the guaranteed cut of future action he covets. Says one top cable executive about the barons of Silicon Valley: "Everything we can think of requires their brains. But as long as you control the distribution--the pipeline that is the proliferating network--you can hold them back."
Comcast has shown that it's possible to sleep with the beast and not wake up legless. Roberts, the president, sensed that Gates was enthusiastic about cable and that he wanted to signal Microsoft's interest without risking a power grab that could polarize the industry. Little Comcast--a company with four million subscribers, vs. 14 million for TCI and 12 million for Time Warner--was the perfect choice. For Gates, investing in Comcast was like investing in Switzerland, a way of not taking sides. Roberts was able to negotiate a deal that didn't obligate Comcast to buy any Microsoft products. Now it appears that the worst thing Gates could do to Comcast is sell his stock. He can't make the company do things like boycott other software suppliers. He can't complain either: The value of Microsoft's $1 billion investment is up $500 million in only seven months.
The stakes for the cable industry are especially high now because the battle lines are being drawn against the Baby Bells and GTE--companies thought to be cable's natural allies a nanosecond ago. The recent notion that the two industries would evolve to a common sort of network--telecom executives predicted that soon you wouldn't be able to tell whether a carrier had started life as a cable company or a phone company--today seems as much a relic of the past as the switchboard operator. The telcos became convinced that upgrading their networks along the cable model was too expensive. And Time Warner's Full Service Network project in Orlando, along with other cable ventures, showed that back then interactivity was too costly to roll out on a large scale.
Now, with wires that snake past more than 90% of U.S. homes, cable operators are hungrily eyeing the residential market for local phone service. Says CEO Chuck Lillis of MediaOne (the cable operator formerly known as US West Media Group), cable companies have no choice but to pursue the telephone business: "The local telecom market is four times the size of the cable TV business. You can't not pursue that market and claim to be rational."
Equally surprising, the cable industry now appears to have a big new ally on the horizon: AT&T. Michael Armstrong, Ma Bell's fast-moving new CEO, is determined to seize a big chunk of the local phone business, where so far AT&T has flamed out, losing billions (see following story). Now Armstrong is seeking a deal with cable companies to carry local phone calls to homes. Cable industry executives predict that some alliance will emerge in the first quarter of 1998. The only question, they say, is what form the venture will take--an equity investment by AT&T in one or more cable companies, a joint venture, or a co-branding arrangement. Armstrong will say only that talks are under way, adding, "Cable is a natural for us because many of the applications we are looking at are broadband rather than narrowband"--involving high-speed data and video, say, rather than just voice. But he says that cable would not be AT&T's only play in the local market. For one thing, only two-thirds of U.S. households subscribe. For another, the technology to deliver lots of phone calls via cable is not quite ready. In many cities, too, several different cable companies split the territory, creating a headache for any company wishing to offer phone service to everyone.
AT&T's maneuvering points up the strengths and weaknesses of the cable and phone camps. While much has changed since the convergence craze of the mid-1990s, phone systems still have a long way to go before they can deliver video adequately, and cable systems are still far from ideal for handling phone calls and other two-way traffic.
Phone networks start with at least one major plus: The contest for the business market is over, and they've won it. Concedes Lillis of MediaOne: "Cable companies will not have any network superiority for any kind of large business or large aggregation of traffic. The telcos already have very sophisticated plants there"--high-capacity fiber that runs directly from their switches to office buildings. That leaves only the residential market up for grabs, which plays to the cable industry's strength: entertainment.
The cable companies have another advantage: They can raise prices at will, while the Baby Bells are still heavily regulated. Bell Atlantic President Ivan Seidenberg says enviously, "The extraordinary interest that Silicon Valley and Microsoft show in the cable companies has more to do with the fact that regulators have allowed them to build their values. When you can raise rates by 15% to 20%, everybody loves you."
The cable guys are betting they can upgrade their networks faster than the Baby Bells can upgrade theirs. Cable systems were built as one-way streets, and revamping them to carry signals in both directions--as for a telephone call--is expensive and poses daunting technical problems. Four years ago cable companies began laying fiber-optic cable between their transmission centers and the neighborhoods they serve, and larded the routes with two-way amplifiers. Costs are coming down, and new Internet technology that turns a phone call into a data signal may give cable companies a cheaper pathway for telephone calls. The jazzy new set - top boxes will be able to decipher voice, video, and data sent in digital form, and will let cable operators provide not just phone service but information of all sorts--high-definition video, online shopping, data.
But set - top boxes and fiber optics aren't enough to get the job done for cable. Devices for routing Internet phone calls over cable systems aren't commercially available yet, and the companies that are designing them--telecom equipment giants like Lucent and Nortel--are allies of cable's biggest rivals. Mainly they are concerned with helping the Baby Bells in their race to build new data networks using Internet technology. Telecom specialist Mark Bruneau of Renaissance Global, a Boston consulting company, says the gearmakers may pursue both businesses, "but if they manage it right, they will repel the cable incursion into the home telephone market and keep it a minority play." Cable companies also have to install the back-office systems that make two-way networks possible, like call centers for managing traffic flow and metered billing systems--technologies the phone industry invented.
On the other hand, local phone companies haven't had much luck cracking the cable stronghold. Cable's brawny coaxial wires can carry far more information than the relatively puny copper wires of the phone companies. Simply replacing all those twisted pairs with either fiber or coaxial cable would be prohibitively expensive. Yet the phone companies must do something in order to handle video or high-speed data.
One funky experiment by Bell Atlantic illustrates the dilemma. It had hoped to get its feet wet in cable with a stopgap technology called wireless cable, which uses radio waves to carry a slate of video programs. The phone company technologists figured out how to send their signal around buildings and over hills. But, says analyst Wolzien, "they weren't able to come up with an algorithm that would get the signal through tree leaves. That basically shot them down."
Cable can't afford to be complacent. The phone companies are investing in technology to let them cram more information over their copper. And guess what: Silicon Valley is supplying materiel on this side of the line too. Microsoft, Compaq, and Intel recently announced that they will team up with the Baby Bells to develop fast modems for Internet access using a digital technology called DSL, or Digital Subscriber Line. While the modems aren't designed to carry video, later versions of DSL hold out that promise. According to consultant Bruneau, the modems and some fancy software tricks will let phone companies build capacity without connecting a fatter pipe to the home. That, he says, could give phone companies a cost advantage over their cable rivals.
Cable guys pooh-pooh DSL technology. "People will say it works," shrugs one cable executive. "You'll have it in your story. But you can't put video over twisted pair that runs clean and delivers hundreds of channels." Still, the cash-rich phone companies are highly motivated to make DSL work, and dozens of small high-tech firms are competing vigorously to perfect the design.
As the cable guys race to retool, it makes sense that they've rallied around a single plan for the digital set - top box. Not only is it a key piece of technology, but it's also an advertisement for cable's bright future. Still, the industry harmonizing goes only so far. Malone's grandest boast--his idea that every household will get a new wonder box--makes the other cable chiefs recoil. Joe Collins, CEO of Time Warner Cable, says, "To push {these boxes} out there as a field of dreams doesn't make sense." He and other cable executives point out that many customers never order even pay-per-view movies; to give them expensive new digital equipment that can handle more sophisticated services would be a waste of money. Comcast President Roberts says, "When we surveyed our customers, 40% of them said they don't want any box at all sitting on their TV set." Time Warner's position is that only customers who order new services--a slate of extra channels, for instance--will get one of the new boxes.
Indeed, as the differences in strategy between the other major players and TCI emerge in sharper relief, so do frictions between their leaders. Malone remarks: "Time Warner is just now understanding what I've been saying about the digital boxes. I hate to say it, but the Full Service Network became a kind of a joke." On hearing this, Time Warner's Collins laughs derisively. "Malone isn't the adjudicator of all this," he says. He points to award-winning digital technology that Time Warner has already widely installed and that is currently the state of the art: "The last time I looked, the Emmy for the invention of the technology had our name on it."
Few in this industry of operators and dealmakers believe that Malone's interactive universe is within light-years of this quadrant of the Milky Way. But mostly they are willing to let him be the visionary. For now they are enjoying their renaissance, after everyone had given them up for dead.
REPORTER ASSOCIATE Rajiv M. Rao Quote: Malone's boast that every home will get a wonder box makes cable chiefs recoil. Says Comcast's Roberts: "Forty percent of our customers don't want any box at all." Cable guys like Joe Collins of Time Warner are betting they can upgrade their systems for digital interactivity faster than the Baby Bells can upgrade theirs. "The local telecom market is four times the size of the cable television business. You can't not pursue that market and claim to be rational."
COLOR CHART: FORTUNE CHART/SOURCE: WILKOFSKY GRUEN Cable Stocks Catch Fire {Chart not available--line graph of stock price indices of Cablevision, Comcast, TCI, Cox, Time Warner, MediaOne, and S&P 500 from 1996 to 1998} COLOR PHOTO: PHOTOGRAPHS BY JOHN ABBOTT Roberts' $1 billion deal with Bill Gates lifted the stock of every cable company. {Brian Roberts} COLOR PHOTO: PHOTOGRAPHS BY JOHN ABBOTT Joe Collins, head of Time Warner's cable division, says, "Malone isn't the adjudicator." {Joe Collins} COLOR CHART: FORTUNE CHART/SOURCE: WILKOFSKY GRUEN Cable Costs More and More Cable customers are paying twice what they paid a decade ago. Will new services cost even more? Price increase % change in average price, nationwide 1987-1997 CPI 40% Monthly cable service 107% Movie ticket 15% {Chart not available--comparison illustrated in bar graph} |
