Cable Operators

Cover Story: Overbuilders Version 2.0

11/01/2009 11:00 AM Eastern

For years, cable companies with the audacity to compete against their MSO brethren were given a bad name in the industry: overbuilders.

Facing increasingly larger incumbents, many were left for dead after financing dried up for alternative providers in the earlier part of the decade. But three companies — publicly traded RCN and Knology and the privately held WideOpenWest — have not merely survived but thrived, reporting growth rates that rival and in some cases surpass the incumbent operators over the past five years.

WOW's Colleen AbdoulahWOW CEO Colleen Abdoulah believes it's time to retire the overbuilder moniker. “What is sad about it is, it's an old label,” Abdoulah said of the term. “It goes back to the green-mailer days, when people would come in and build a couple miles of plant get bought out and leave. It's time to just get rid of it. We're like any other competitor, like Verizon or AT&T.”

The rivalry between incumbent MSOs and so-called overbuilders has raged since the beginning of cable and peaked at various times over the last 20 years. Under an unspoken agreement, big cable operators have historically refrained from offering service in a market already served by another cable MSO. At a July 2000 CTAM conference panel with Mediacom chairman and CEO Rocco Commisso and Digital Access CEO Joe Cece, Commisso chafed at Cece's insistence at being called a BSP (broadband-service provider). Commisso predicted that the competitive segment would dry up faster than its financing.

“Joe has no idea what it means to have trench warfare,” Commisso said of Cece, according to a Multichannel News report at the time.

Commisso was right about the financing — the bubble that had funded dozens of overbuilders in the late 1990s and 2000 burst in 2001 and 2002 and companies like Digital Access, Carolina Broadband and American Broadband all disappeared with it.

Others managed to hang on through a combination of debt restructuring (like RCN and Knology), purchasing state-of-the-art fiber network assets on the cheap (like WOW's 2001 purchase of Ameritech New Media, after SBC Communications bought Ameritech and shifted strategies), aggressive marketing and strong product offerings and customer service.

And they became masters of trench warfare.

As time passed and new telco competitors entered the broadband race, the animosity also appears to have softened a bit. That's true even for Commisso, who still believes that the companies that have survived are benefiting from low-cost plant, obtained either through restructurings or buying distressed companies on the cheap. Although he claims no overbuilder in 20 years has survived with their original capital structure intact, he is willing to (grudgingly) give credit where credit is due.

“I think WOW has got a great reputation,” Commisso said in a recent interview. The differentiator, he added, has been the triple play, which allowed companies with low penetrations — overbuilders generally top out at 20% to 30% penetration of homes passed — to eke out a business.

“The triple play has given the overbuilders the ability to generate a business model that is compelling even at lower penetration rates. My position 10 years ago was at $40 a month [for video service], there was not enough room for everyone to make money,” Commisso said. “You can't have a business at $40 a month and 20% penetration; no way. Now, 20% [penetration] at $100 a month? Maybe.”

Both Knology and RCN restructured through prepackaged bankruptcies (Knology in 2002 and RCN in 2004), and while Knology has focused on secondary and tertiary markets, RCN adopted a metropolitan strategy. Almost immediately after emerging from bankruptcy protection RCN began to rationalize its footprint, selling off about 20,000 subscribers in California (including San Francisco) and focusing on five core markets: New York; Boston; Philadelphia/Lehigh Valley, Pa.; Chicago; and Washington, D.C. (where it is the incumbent operator). Today RCN has about 430,000 customers (up 12.6% since 2004). Revenue in 2008 was $739.2 million, up 52% from 2004.

RCN CEO Peter Aquino, a former telco executive who first joined the company as a turnaround specialist during the bankruptcy, said the financial restructuring was a boon to the company. Said Aquino: “We inherited great assets with a barrier to entry.”

Miller Tabak media analyst David Joyce said that RCN took a risk in targeting larger markets, but it has paid off. “They have selected to be in markets where they have deep pocketed competitors, but if they're considered a David vs. Goliath from a consumer services standpoint, that can be to their benefit,” Joyce said.

He added that having a state-of-the-art fiber network also gave RCN a jump on the incumbents. “They were offering 20 Megabit [per second] service, which was twice the speeds of the big incumbents in their markets,” Joyce said.

With a more manageable balance sheet, RCN was able to focus more on operations, specifically honing in on broadband opportunities in major metro markets.

“If you're clustered, it's better operationally,” Aquino said. “The Northeast corridor for us was an absolute must. Because we had Boston, Philadelphia, Lehigh Valley, New York and D.C., that corridor had a bunch of things going for it. One, it was close enough so I could operationally control it and two, that telecom corridor was probably the best telecom corridor in the country.”

That corridor also proved ripe for RCN's business product, RCN Metro. Targeted at large businesses, Metro is turning out to be a strong engine for growth — in the second quarter, revenue was up 11% to $47 million and EBITDA rose 33% to $16 million.

RCN's early video growth was pegged in part toward the large number of ethnic channels the company made available. Senior vice president of strategic and external affairs Richard Ramlall estimated that RCN currently has about 480 choices for international programming — 85 linear channels and VOD. Those choices, he said, may increase as several exclusive satellite deals for several networks are beginning to expire. RCN, he said, will be in the mix.

“Those international networks recognize with cable, especially with the triple play that the satellite guys don't have, this is a huge area for distribution,” Ramlall said. “They're coming to us.”

The capacity for those additional networks is there because RCN is winding down its all-digital initiative, dubbed Analog Crush, which is freeing up bandwidth for HD channels as well. Analog Crush began two years ago Chicago. The last market — Lehigh Valley, Pa. — should be completed by Christmas.

While RCN has focused on major metro markets, Knology has centered its business on secondary and tertiary markets, operating in 12 areas — Panama City and Pinellas County, Fla.; Knoxville, Tenn.; Charleston, S.C.; Columbus, Augusta and West Point, Ga.; Montgomery and Huntsville, Ala; and Rapid City and Sioux Falls, S.D.

Like RCN, Knology sees big growth opportunities in business services — the enterprise segment accounts for about 20% of total revenue and 15% of total connections. And according to Holt, it also is Knology's fastest-growing segment.

Knology has also built a solid reputation in the deal market. It bought PrairieWave Communications, a 57,000-subscriber operation in South Dakota, in 2007 for $255 million and Graceba Total Communications, with 25,000 customers in Alabama, for $75 million in 2008. Holt said he would like to do more deals, but they would have to fit Knology's stringent requirements.

Joyce said that Knology has succeeded by sticking to its knitting — it's in markets where there isn't a lot of telco competition — and by making good acquisitions. Joyce estimated that both the PrairieWave and Graceba deals were done at 7.5 times forward EBITDA multiples when Knology stock was trading in the 9.5 times range.

Holt added that aside from its own deal discipline, the current economic environment is proving to be a roadblock. While credit markets are beginning to open up, public cable valuations are still low and pricing expectations for potential sellers are still high.

In the meantime, Holt sees other avenues for growth — mainly in extending the Knology network in markets where it already operates. “We can fill in neighborhoods we didn't build,” Holt said. “In 2001, when the capital markets crashed and we ran out of money at that point, we just had to stop building. We've got some nice demographic neighborhoods we can build today and achieve very high ROIs.”

In the past, competitive providers and the telephone companies have been accused of targeting affluent neighborhoods, so-called cherry-picking. But most franchise agreements, in response to these complaints, require providers to offer service to all areas of a community, not just the wealthiest parts.

WideOpenWest isn't looking to fill in its markets and, in a bit of a departure, doesn't necessarily see big opportunities in business services. But the company has shown incredible growth in broadband and phone penetration and expects those opportunities to continue.

Privately held WideOpenWest hasn't focused as much on business, but instead on broadband and phone; its subscriber base has grown by about 34% since 2002 and it has boosted penetrations of high-speed-data and telephony penetrations by double digits every year in the same time frame. According to Abdoulah, WOW's high-speed data penetration is 87% of basic customers; telephony penetration is 57%.

WOW has built its reputation on customer service and has nine first-place JD Power awards in Internet service, residential phone and cable TV categories to prove it. Last Wednesday, it added its 10th J.D. Power Award, winning top honors in Internet services customer satisfaction in the North Central region — its third award this year, making WOW the only provider in 2009 to be awarded first place in all three categories — Internet, residential telephone and residential cable.

Abdoulah said WOW's success has been built on a focus on high-speed data service. “We had a very clear strategy,” Abdoulah said. “We knew early on that video-only was not going to be a long-term sustainable model. It had to be the bundle.”

WOW first offered the two product video and data bundle for $44.95 per month — competitors were offering similar service for between $49.99 and $54.99 per month. More importantly, Abdoulah said the bundle price wasn't a promotional hook that would ramp up after a short period of time. The price was guaranteed, which made a big difference with customers.

While WOW would not release subscriber figures, it is estimated the company has about 360,000 customers in Michigan, Illinois, Columbus and Cleveland Ohio and Evansville, Ind. In those markets the company competes against Comcast, Time Warner Cable, Insight Communications and AT&T.

Abdoulah said for the most part, WOW has grown organically, attracting new customers with its bundled packages and stellar customer service.

Abdoulah said WOW's customer-experience success — she refuses to call it customer service — is tied to two factors: keeping employees happy and driving home the importance of satisfying customers across the entire organization. Abdoulah said it is no accident that WOW has a 97.3% satisfaction rate with its employees and a 94.7% satisfaction rating with customers. She adds that it all boils down to stressing that every employee strives to make the customer experience live up to the company name.

“When they [customers] engage with us it's a different experience,” Abdoulah said. “We're 99% on time; we're there within one-hour time windows — if you call us today and ask for our services and ask when you have to stay home, we'll say, 'How does 7 to 8 sound?' You call our call center you'll get in within 30 seconds and you'll talk to a live person.” Management is required to either be out in a truck and/or monitoring service calls once a month.

Abdoulah said that the company is looking at opportunities to expand in its current areas over the next two to three years. “Up to now, we've been investing a lot of capital on large, double-digit growth in our advanced products and now that we have slower organic growth, we can divert and redirect those capital dollars through extensions,” she said.

If the company can build on its success, Abdoulah said, bigger cable operators will have to respond with more than just names.

Although they are considerably smaller than their MSO rivals, competitive broadband providers RCN, Knology and WideOpenWest have had comparable growth rates. Penetration rates for new services for the three competitive broadband providers and the top cable operators:
Penetration (of basic video subs)

  Data Phone
SOURCE: Company reports and MCN estimates

Second quarter performance from the two publicly traded competitive broadband providers, RCN and Knology:

  Q2 '09 Q2 '08 % Change
SOURCE: Individual company reports
Free cash flow$10.0($0.3)N/A
Free cash flow$13.1$9.439%


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