Seeking broadband’s bottom line

Jun 25, 2001  •  Post A Comment

Wall Street finally is starting to quantify what may be an uncomfortable or even lethal gap between the huge investments cable operators make to increase bandwidth and the revenues and cash flow-or return-generated by new digital services.
ABN AMRO analysts John Martin, Spencer Wang, Thomas Sheehan and Mark Holmes are a multimedia team that takes a hard look at how soon media companies will begin reaping the rewards of their hefty broadband investments. The results are a bit of a surprise.
In the 58-page report “Return on Bandwidth,” the analysts say advanced new cable services, beyond those being deployed today, will be the big winners, “carrying attractive marginal economics.” But it’s all a matter of timing.
With more than 80 percent of the U.S. cable plant already sufficiently upgraded for these new services, most cable operators won’t expect to see decent return on their investments for at least another three to five years.
Presently, the cable industry’s average return on invested capital is in the mid-single digits-well below the analysts’ cost of capital estimates of between 10.5 percent and 12 percent.
The report contends that $50 billion in cable system upgrades during the past six or so years and the deployment of new, higher-return businesses “should result in the improvement to the industry’s return on invested capital characteristics beginning in 2002.”
But historically, capital spending levels, industry acquisitions and early stages of new business deployment have resulted in low levels of return on invested capital, the report maintains. Although investment levels for capital-intensive cable companies are peaking, cable operators are finding themselves in an economic squeeze as they attempt to wean subscribers from existing services to higher-priced interactive ones to better cover their costs.
Interactive runaway train
The analysts estimate that the new interactive services collectively will generate after-tax returns in excess of 25 percent once they are up and running.
Put another way, an estimated 50 percent of the current per-subscriber valuations of around $5,000 is attributable to the core analog video business, leaving the other half betting on new services. Nearly 35 percent of the value is attributable to a combination of digital video and high-speed data, leaving about 15 percent to not-yet-developed services, including video on demand and interactive TV.
Because cable alone has the capacity to provide cross-product bundles on its own to customers, it has a competitive advantage over all other media, the analysts conclude.
Interactive television will be a catalyst to unlocking that exceptional value. As a result, the analysts are bullish on such stocks as OpenTV, Gemstar-TV Guide, Liberty Digital, Comcast Corp. and Cox Communications.
The report is the first attempt by a leading investment banking firm to assess the supply-side economics and technological feasibility of interactive television services over advanced cable services. It reinforces one golden assumption made by all concerned for the past five or more years: Cable’s fat two-way pipe into the home, once it’s cranked up and running at full speed with new interactive services, will be like a runaway train.
Cable operators will be the gatekeepers who determine what new services are launched on their platforms. But clearly such interactive services as video on demand, high-speed data, digital video, interactive program guides, t-commerce (television-commerce), interactive advertising and interactive program channels will be paramount.
However, satellite operators already are well into the process of introducing interactive services. EchoStar has deployed OpenTV’s interactive middleware to more than 1 million subscribers, and that figure could swell to 4 million or 5 million by year- end. Similarly, DirecTV is offering Microsoft’s Ultimate TV in combination with a satellite receiver and a TiVo set-top box and has launched a Wink service for its subscribers. These moves have put cable operators on notice.
Not surprisingly, the ABN AMRO analysts concede, “The relatively slow rollout of interactive television in the U.S. has caused some to wonder not only when but in some cases if interactive television will be rolled out.”
The “return on bandwidth” (ROB) formula the analysts use to measure the relative attractiveness of certain advanced cable services (and their relative consumption of bandwidth) will likely be the first of many such attempts to provide new financial metrics for an interactive age. In the ROB formula the amount and cost of bandwidth consumed for each new interactive service offered is as important as the amount of revenues and cash flow each new service is expected to generate compared with the overall investment made by cable operators to upgrade their plant for expanded bandwidth.
Consumer demands
Their analysis indicates that consumers will most demand and cable operators will most offer interactive program guides, high-speed data connections, interactive TV advertising and t-commerce opportunities.
They will edge out interactive programming channels, digital video offerings and video on demand, which generally has been expected to be one of the leading killer applications of the new interactive age.
Over the course of the next five years, cable operators will realize a 17.8 percent return on their invested bandwidth capital, compared with barely 2 percent in 2001.
Digital video is expected to represent only about a sixth of that, even though it is expected to generate an average of $6.78 in monthly cash flow per subscriber this year and up to $6.68 per month per subscriber in 2006, with monthly revenues of $10 per subscriber in 2001 and up to $12.76 in 2006.
High-speed data, which is expected to be used by about half of all broadband homes by 2006, will generate much higher returns on investment. It will generate an average of $5.17 per month per subscriber in cash flow in 2002 and an estimated $6.05 in 2006. Monthly revenues generated by high-speed data, which take into account the lease of cable modems, will average $21.24 per subscriber in 2002 and $15.27 by 2006, the analysts estimate.
Because of the high cost of content acquisition, VOD represents the potentially lowest return on bandwidth investment to cable operators, the report maintains, even with high penetration rates of up to 100 percent past 2004. The average monthly cash flow per subscriber from VOD is estimated to be $11.54 in 2002 and $8.58 in 2006. Cable operators, sharing half their VOD-generated revenues with content providers, will see average monthly revenues of $3.50 per subscriber generated in 2002 and $4.50 in 2006.
The highest return on bandwidth investment of any new services will be generated by interactive program guides that will be supported by advertising revenues and subscriptions. Although the guides will generate an average of only 17 cents per subscriber in monthly cash flow in 2003 on $2.21 in monthly per-subscriber revenues, they will generate $1.07 in monthly cash flow by 2006 on $5.95 in monthly revenues.
The report gives high return-on-investment scores to interactive advertising and t-commerce, which will be highly dependent on devices that make standard televisions interactive.
However, Wall Street isn’t buying any of it until it sees tangible results. The delays in interactive television services have led investors to question not only when-but also if-the interactive services will appear.
The analysts point out that today most cable stocks trade at 15 percent below their target, implying that the market places no value on unquantifiable new services.
All that puts the onus back on cable operators to ramp up new services and generate sufficient consumer response to those services to begin to close the gap between investing and reaping the rewards of their new expanded bandwidth. In a soft, troubled economy, that may not be as easy as they initially thought.