As we often hear, “There’s the good news, and then there’s the bad news…” In cable, the good news is that cable MSOs are taking two-thirds of all broadband data (ISP) customers and own two-thirds of the broadband consumer market. In fact, three out of five of the largest broadband providers are cable companies.
Furthermore, they are going after voice customers with VoIP, offering the service at an incremental fee plus video, a strategy that erodes the ILECs’ base. In fact, because they are also content providers with plenty of mindshare, cable MSOs are a more serious competitive threat to ILEC local service dominance than the CLECs are. The CLECs, after all, do not, for the most part, go after residence customers; they are too difficult to provision en masse. Instead they go after the aggregated enterprise customers that reside in MTUs because provisioning them is a simpler and less costly process. In fact, many analysts predict that if cable MSOs can crack the code on delivery of voice and can centralize their management and repair functions, they could become the first choice for the delivery of integrated services. And today they seem to be doing this—and are just beginning to announce wireless as a secondary service option. In late December 2004, Sprint and Time Warner announced their intent to work together to give Sprint the ability to sell the “quadruple play” of voice, video, data, and wireless. This places them squarely in the game, offering a converged set of bundled services to customers for as single, low price.
The U.S. cable industry is taking its voice penetration strategy seriously. The industry as a whole has invested over $70 billion in network upgrades to accommodate the demand for high-speed data, and although cable companies have attracted significant numbers of voice customers away from ILECs, the ILECs have done very little in the way of competitive pricing or service expansion to combat cable—though SaskTel’s MAX service is intriguing. The newly released DOCSIS 2.0 for high-speed data promises transmission at very high bandwidth—as high as 30 Mbps. Furthermore, the operating margins on cable modems are quite high—35 to 40 percent.
So what’s the bad news? The bad news is that there is more to running a successful company than having impressive technology. The cable industry’s debt load is enormous because they have all invested heavily to ensure market penetration and their ability to deliver the services demanded by customers. Adelphia, for example, the sixth largest cable company in the United States, has nearly $14 billion in current debt and approximately 5 million subscribers—which works out to a debt load of $2,800 per subscriber. And while this number seems large, it also seems (perhaps) manageable—until we begin to factor in other numbers. Subscribers spend approximately $800 per year on services. However, cable companies spend an average of $480 per year to provide routine service to each subscriber, which leaves $320 per subscriber. Furthermore, capital spent on routine maintenance averages roughly $100 per subscriber, leaving far less in the way of income against incurred debt. And to add insult to injury, this figure does not take into account in any way the capital required to perform ongoing (and required) network upgrades.
Cable analysts use a number of measures for assessing the financial health of cable companies, including operating income (EBITDA) as opposed to free cash flow; they also use return on capital as a good indicator. Today the number averages about 5 percent on a pretax basis, which is not a particularly impressive number.
The top five cable MSOs serve 81 percent of the overall U.S. market, while the top ten serve 95 percent. There is still significant competition for cable from satellite providers: Consider DirecTV and the many services it offers. Their primary market is distributed, commercial video service with 80 percent market penetration and very slow growth (roughly 1 to 2 percent per year). They primarily serve residential markets and are motivated to (1) enter the enterprise space and (2) diversify their line of product offerings. (Readers may have seen the frontal assault on cable posed by the satellite providers in the voracious pig commercials that were recently aired.)
Cable MSOs are not taking the attack idly, however. As the satellite industry pushes hard for customers, cable providers are striking back, keeping rates steady in markets that are most prone to attack by satellite providers and raising prices in markets where it is warranted. They are also relying on broadband Internet access and its high profit margins to bolster revenues and to provide a loudly proclaimed competitive advantage, since satellite providers cannot yet offer Internet access that provides equally satisfactory service. Others are aggressively advertising bundled service packages that offer distributive cable services, broadband Internet access, and telephony for a small additional fee.
Even though satellite prices are typically cheaper than cable for entertainment packages, the magnitude of the price difference is shrinking in many markets. As pay-per-view sporting events and other premium lineup components become more and more expensive, satellite providers are being forced to make the same price hikes that the cable providers have been forced to make to cover costs. And while there is a place for satellite in the provider lineup, its advantage as a big-footprint provider is rapidly being winnowed away as cable and telephony service provider penetration increase and provide fixed access to the same set of services.
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