Comcast Corp. and Charter Communications are raising the bar on digital video and data deployment to a height that not all cable operators can hurdle in a financially challenging year.
Comcast last week raised its year-end targets for digital subscribers (to 2.2 million from 2 million) and data cable modem subscribers (to 950,000 from 750,000).
It also openly committed itself to cable telephony, perhaps not surprisingly, as it continues its pursuit of AT&T Broadband. Until now, Comcast has taken a cautious approach while waiting for Internet-protocol telephony.
Comcast also reiterated its full-year forecast for 12 percent to 13 percent cash flow growth on 10 percent to 12 percent revenue growth, even as it is integrating 2 million new subscribers from swapped or acquired systems.
“The 13 percent increase in cable cash flow we had in the second quarter is an acceleration that demonstrates that new products do deliver increased operating cash flow,” Comcast President Brian Roberts said. “We’re comfortable that we can grow new services and still meet high cash flow targets.”
Days earlier, Charter Communications also beat its own and analysts’ estimates with second-quarter revenue growth of 16 percent and operating cash flow growth of 14 percent, as well as better-than-expected basic and digital customer growth.
Despite an aggressive rollout of new services, it is maintaining its previous year 2001 forecast of 12 percent to 14 percent growth in earnings before interest, taxes, depreciation and amortization on 15 percent to 18 percent revenue growth.
Charter rocked industry peers and analysts, disclosing that in the second quarter it added 20,000 more digital subscribers than originally expected, resulting in 25 percent overall digital penetration-the highest in the industry-on the way to a total of 2 million digital subscribers by year-end.
Charter said it has achieved 50 percent digital penetration in some markets without overlaying much more than additional video product. Charter also bucked the persistent downturn in basic service plaguing all multiple system operators by growing its basic subscriber base 2 percent last quarter.
Although its high-speed data growth lagged in the period, analysts said Charter remains on track to exceed its own 2001 targets with an estimated 630,000 high-speed data users by year-end. Even with 11 percent penetration, high-speed data “is a huge cash flow driver whose 38 percent margins will grow,” said Charter CEO Jerry Kent. Each incremental data subscriber is more than twice as profitable as a digital customer, analysts say.
Although Charter executives insist there is “no magic bullet” to their advanced service success, video on demand clearly is a catalyst for early digital video conversion and growth for all of cable.
Charter’s industry-leading deployment of video on demand in eight markets-set to expand to 12 markets, representing 2.2 million homes, by year-end-already is generating 55 percent margins. The company last week said it should be able to reach a record-high 60 percent digital video penetration within three to four years.
The aggressive rollout of advanced services by Charter and Comcast stands in sharp contrast to the sequential decline in second-quarter new revenue units reported by many other cable operators, who pinned the problem on seasonality tied to college students’ summer disconnects and limited price discounts and marketing campaigns.
While upping the industry ante, Comcast and Charter’s results also underscore how quickly new services can be a lucrative source of new revenue that can even foster cooperation among MSOs.
“Working with other cable companies, there is a big opportunity to galvanize the swaps that will round out clusters and to find ways to create these new services across multiple systems so that this is a win-win for the industry as we face more competition in the years ahead,” Mr. Roberts said last week.
But whether the flames of advanced services continue burning brightly depends heavily on the cable operator and the economy.
Second-quarter earnings reports from major cable providers generally have underscored a stronger-than-expected rollout of broadband services that are gradually turning profitable. But companies also acknowledge there are plenty of speed bumps ahead that could slow the ability of new revenue streams to adequately offset costly system upgrades.
For instance, Cox Communications last month conceded its basic customer growth in 2000 will be flat and not up 2 percent as originally expected, while the 1 million new service revenue-generating units it expects in all of 2001 will just barely exceed 2000 levels. Cox said its full-year 2001 revenues are still expected to increase between 14 percent and 16 percent, and operating cash flow should grow between 12 percent and 13 percent, both as originally forecast.
“We are encouraged by the important contributions that our digital, data, phone and business services make to our company’s long-term growth plans,” said Cox’s Jim Kennedy.
AOL Time Warner last month also reported lower-than-expected digital, high-speed data and basic subscriber growth in the second quarter. It ended the eriod with 2.3 million digital subscribers, or 20 percent penetration, and 1.4 million high-speed data subscribers, or 12 percent penetration, which AOL Time Warner CEO Gerald Levin said underscores “the growing strength of the broadband platform.”
Although Mr. Levin predicted fourth-quarter improvement, Time Warner is falling short of analysts’ digital subscriber projections by as much as 9 percent for new service additions and by 7 percent on a sequential basis from the first quarter of this year. High-speed data subscriber growth in the second quarter also declined 5 percent from the first quarter and missed some analyst forecasts by as much as 6 percent.
AOL Time Warner officials predict they could double the installed base of cable modems and digital set-top boxes in 2002 from 2001, with 94 percent of the company’s cable plant now upgraded.
“What’s being built, from a longer-term perspective, is an infrastructure that will have the capability to give the consumer, on an on-demand basis, anything they want in interactive services.” Mr. Levin said.
More than half of AT&T Broadband’s second-quarter revenue gains were attributed to a year-over-year rise in “advanced services.” However, analysts said they remain skeptical about AT&T’s ability to meet its promised targets based on its spotty track record and said the company’s 2003 forecast for positive free cash flow relies too heavily on cost cuts rather than new digital service revenues.
AT&T Broadband recently told investors it is aiming for 55 percent penetration of digital video service, 27 percent high-speed data penetration and 35 percent telephony penetration by 2005.
However, AT&T officials concede they are several years away from being able to offer that “triple play” of services to all of its 13.5 million subscribers despite $3.6 billion in capital improvements this year. When it finally happens, it should reduce video churn by 10 percent to 22 percent for multiproduct customers, the company said.
AT&T currently has 20 percent digital penetration, 10 percent high-speed data penetration (which turns profitable this year) and 14 percent telephony penetration (which should turn profitable within nine months). But its 56 percent basic video penetration lags a 63 percent industry average. Basic subscriber growth, which declined 0.6 percent the first half of the year should achieve net growth for all of 2001, according to AT&T Broadband President Dan Somers.
Any gain helps since every 1.3 percent increase in video penetration translates into a 1 percent increase in earnings, he said.
For now, AT&T Broadband is holding to its 2001 forecast for mid-teen growth of overall cable revenues, which rose 14 percent to $2.6 billion in the second quarter.
Where VOD is barely an issue for AT&T, it is the hotly pursued digital “face lift” for Comcast, according to Mr. Robert
s, “that will power digital beyond pay television penetration levels.”
Without VOD, now offered to a trial base of 200,000 subscribers, Comcast expects the growth of its digital cable offerings would plateau. With an eye toward offering VOD to 2 million digital cable subscribers by year-end, Comcast Cable President Steve Burke said VOD “is a way to drive digital penetration deeper and faster than would otherwise be the case,” he said. “It’s something cable can do that satellite can’t, and eventually it will be a great moneymaker.”
In addition to accelerating digital penetration and minimizing overall cable subscriber churn, Comcast and Charter executives last week said consumers’ enthusiastic acceptance of advanced services is helping to pave the way for more groundbreaking, hard-won licensing agreements with Hollywood studios and other content providers, such as iN Demand’s recent deal with Hollywood studios and Time Warner’s HBO subscription VOD trials.
Charter said it has had first-hand success using VOD and its access to more than 450 VOD titles to combat direct-broadcast-satellite competition and churn in its Los Angeles systems, where it has a remarkable 60 percent digital penetration.
Charter is reporting a 35 percent profit and a 21 percent after-tax return on invested capital for its fully functional VOD. It gets an incremental $4.50 per customer per month above the $3.50 per month it receives for near video on demand.
Charter said its return on investment is running between 21/2 and three years, and it is in the final phase of its $3.3 billion network upgrade, which will be completed by early 2003.
“One of the things that helps us as much as anything else is that digital is our core product,” said Charter Chief Financial Officer Ken Cocksworth.
Richard Bilotti of Morgan Stanley Dean Witter points out that Charter is the first MSO to generate better than 16 percent pro forma revenue growth on its broadband businesses, at least 1 percent ahead of most analysts’ estimates. The company also exceeded Wall Street expectations in two important areas: reporting revenue per unit of $15.52 per digital subscriber and $28.72 per data subscriber.
Seeing the same opportunities using its own Marketlink, QVC, Comcast Sports Net and other specialized sources, Comcast last week said it will accelerate its 2001 capital spending to $1.75 billion from $1.45 billion to complete rebuilds that will facilitate advanced services. Thomas Eagan, analyst at UBS Warburg, said he believes a slowing economy “will not significantly impact new service installation rates in the near term,” since they are more “supply driven” than “demand driven.”
He said Charter’s bullish results confirmed that Cox Communications’ disappointing second-quarter subscriber growth “is not indicative of a problem with the cable sector as a whole.”
Mr. Bilotti estimates Charter’s advanced cable and telephony services will grow an average 13.5 percent annually to $3.7 billion in earnings on $8 billion in revenues by 2006.
A significant difference among the major cable operators is their willingness to provide telephony services before IP telephony technology is widely available and more affordable.
Not surprisingly, AT&T Broadband is the most aggressive with its telephony offerings, since it entered the cable business several years ago as a way to revive its dying long-distance phone business.
Cox already has been successful in launching its own cable telephony, which could see 30 percent operating cash flow margins by year-end in initial markets such as California’s Orange Country and San Diego.
Charter essentially is “experimenting” with the telephony service to 15,000 circuit-switched customers on systems it acquired from AT&T but expects to launch IP telephony service by 2003 that could grow to a $76 million cash flow with 17 percent margins by 2006.