Cable’s growth engine misfiring

Feb 26, 2001  •  Post A Comment

There’s a good chance the near-term caution cable company executives are sounding could become a year-long cry as the rollout and growth of new services become longer-term propositions than first expected.
Blame it on the economy.
The decline in consumer spending and confidence isn’t going to prompt the mass cancellation of cable subscriptions, but it may not bode well this year and possibly next year for discretionary new services, such as premium-priced digital program packages, high-speed Internet access and even cable telephony.
The mounting uncertainty is not over whether such services will come to pass, but how quickly they will be supported financially by sufficient numbers of consumers and advertisers. Put another way, will the gap between the revenue returns from new digital services and the costly required investments in acquisitions, system upgrades, technology and development become so formidable that it swallows optimistic projections faster than companies and industry analysts can issue revisions?
Even the boldest and biggest cable system operators appear to be holding their breath.
The underlying message from cable companies’ recent quarterly earnings conferences with analysts has been an unofficially declared delay in the broad industrywide rollout of digital services until 2002-and with it, the trickling of new digital revenues to help offset hefty start-up costs.
“The industry is repositioning itself around the notion that subscriber and advertising revenues generated by new services might not be as robust as soon as we all thought,” said a high-profile cable analyst. “For some, the gap will be wider and last longer than they expected. Eventually, the new services will come and be very profitable. The big issue is what some of these companies do in the meantime.”
Writing on the wall
Even where cable company executives were unwilling to openly concede as much, their recently revised or absent new service forecasts for the remainder of this year are telling enough.
For instance, having been burned last year on the introduction of some new services, Cox Communications has more conservative expectations for cable telephony this year, as does Cablevision Systems and Comcast Corp. Cablevision, which has 12,000 telephony customers, has stopped marketing circuit-switched telephone service and is waiting until more economic Internet protocol telephone service becomes available next year when its Sony-produced advanced set-top boxes are fully deployed.
Comcast, the last of the major cable operators to report quarterly earnings this week, is the reigning champ with a record 1.3 million digital subscribers, or 18 percent penetration-which is an industry high. But analysts say Comcast also is expected to sound a note of caution given that the AT&T systems it recently acquired through swaps have an average 2 percent cash-flow growth that will slow its more robust 12 percent cash flow growth to 10 percent.
Perils of a bad economy
Some cable operators also are offering conservative estimates for high-speed access growth this year. Still, the top seven cable operators are expected to add 4 million new data customers to end the year with more than 7 million high-speed Internet subscribers.
But, individual company projections vary. Cablevision says it expects to have 475,000 cable modem customers by year-end, up from 238,000 at the end of last year. Cablevision’s delay of a full-fledged digital rollout to the end of the year was explained by CEO Jim Dolan as necessary to “adequately prepare from the customer service side” and “develop the proper infrastructure to support the digital box and related services.”
Cablevision said it now expects to install 100,000 of the Sony-produced advanced digital set top boxes by year-end-a far cry from the 500,000-box estimate the company offered as recently as December.
Merrill Lynch analyst Jessica Reif Cohen sees the setback as a potential plus. “Cablevision’s digital rollout is likely to set new standards for the industry, just as its data strategy led with retail availability and self-installation,” Ms. Cohen said. “Cablevision could leapfrog the cable industry with a multitude of new interactive services.”
Charter in charge
When they do finally kick in, Ms. Cohen predicts a monthly lift in earnings before interest, taxes, depreciation and amortization (EBITDA) of $12.25 per subscriber, or 14 percent above Cablevision management’s own estimate of $10.75 per subscriber, or a total of $17.95 per digital subscriber per month. Currently, other cable operators generate an estimated $8 to $10 of incremental EBITDA per digital subscriber due to initial interactive service offerings, she said.
But clearly Wall Street and cable operators are concerned that in the near-term, too many of their newfangled service offerings will be viewed by consumers and advertisers as discretionary options that can be passed over in an economic downturn.
Cablevision’s delay is indicative of the more conservative estimates and outright pullback that analysts say could become more prevalent among cable operators as the economy continues to stumble. The boxes are key to cable operators offering subscribers more digital interactive products and services.
However, even the cable companies most enthusiastic about new services have said they won’t roll them out until there is enough of a solid consumer demand-and that may not materialize at adequate levels during a recession. The rising price of advanced digital set-top boxes won’t help any.
Cablevision’s digital delay already has taken a short-term toll. Since the company’s announcement, analysts have revised their forecasts. For instance, Ms. Cohen reduced her first-quarter basic subscriber growth estimates for Cablevision from 2.2 percent to 1.8 percent. She now expects the company to sign only 65,000 digital cable subscribers by year-end, compared with her previous projection of 330,000. She has reduced 2002 projected digital cable subscribers to 550,000 or half of her previous 1.3 million estimate.
Another quarter like this one will see widespread downward revision of 2001 and 2002 forecasts for other companies and for the cable industry in general. Ironically, analysts point out that a weakening economy actually bodes well for cable stocks, which generally are viewed as a defensive, fairly predictable investment. While analysts argue that their ratings on cable company stocks typically are based on revenues and not projections for new or developing businesses, 2001 was the year that many cable companies and analysts initially planned to begin taking into account the first revenues generated by digital offerings.
One company whose numbers analysts are so far leaving pat is Charter Communications, which is widely considered by Wall Street to be “cable’s technological leader,” according to Salomon Smith Barney analyst Niraj Gupta.
During its recent earnings call, Charter management said it still expects to sign 1 million digital video and 250,000 data subscribers this year. It expects to have video on demand in more than 2 million cable homes by the end of 2001.
Interactive boost
Thomas Eagan, cable analyst at UBS Warburg, said digital will be the primary driver of growth at Charter this year, estimating that digital and high-speed Internet services will add a 9 percent incremental top-line growth and 5.3 percent cash-flow growth. The risks, he points out, remain $3.5 billion in system upgrades through 2002 and the disappearance of overhead cost reductions as the company fully absorbs system acquisitions it made the past several years.
Although Charter’s robust new service projections this year and next year remain unchanged, company executives concede they do not know how or if a continuing economic lag will hurt their plans.
“We’ll find a way to continue to slug through it,” said Steve Schumm, Charter executive vice president. “The economy hasn’t impacted us yet, but if it remains unchanged it could create a ripple effect in our business.”
The cost of capital and advertiser
spending are two potentially volatile factors for even the most optimistic cable operator. But the most potent unknown is even more difficult to predict: the timing and degree of consumer response to new services. Cable operators argue that their entertainment-based services especially represent the kind of discretionary spending that normally thrives in a recession.
They point to the fact that cable stocks generally have bounced back this year, up an average 18 percent between mid-December and mid-February.
Despite the current turmoil and uncertainty, leading industry analysts, such as Ms. Cohen, have issued optimistic long-term reports on cable’s gradually unfolding interactive fortunes reaching to 2005. In a Feb. 16 report, Ms. Cohen estimates “interactive television represents a massive high-value, high-margin, low-fixed cost opportunity for cable companies, new service revenues from which could leap from an estimated $209 million this year to $8.5 billion in 2005.”
First out of the box will be digital video, already at 8.7 million or 13 percent penetration of basic subscribers-on its way to a projected 50.5 million subscribers, or 69.5 percent penetration, by 2010. But how much of that projected growth will be retarded this year and next year in a lingering weak economy?
The money will come
The key, Ms. Cohen said, is looking out over the next several years for the new layer of cash flow that will come from digital services. She estimates the cable industry’s overall digital subscribers will grow to 15.8 million or 24 percent penetration by year-end to 23.3 million or 35 percent penetration in 2002, when incremental interactive TV EBITDA could be $388 million on an estimated $972 million in related revenues.
Cable company executives say a more reserved economic downturn could play havoc with those estimates.
Ms. Cohen insists that regardless of the timeline, interactive television presents “a revenue opportunity to cable operators that is too compelling to ignore.”
Sure enough. But they’d all be breathing a lot easier if they could begin to see some steadily increasing results that would stick.