Cable Operators

Fuel-Cost Hikes May Bite Cable Industry

10/14/2005 8:00 PM Eastern

Rising energy prices could force consumers to cut back on expenditures for communications services, and cable video and high-speed data products could take the biggest hits, analysts warned.

Citigroup Smith Barney cable and satellite analyst Jason Bazinet, telecom analyst Mike Rollins and economist Steve Wieting put together a report which said that with energy costs expected to rise more than 30% from $4,000 per year in 2005 to $5,300 per year per household by 2006, consumers will look to cut back on discretionary spending.

Changing Channels: Why Consumers Switch
With fuel costs rising, penny-pinching consumers move to the lowest-cost alternatives in choices they make. While cable’s basic service packages are the least expensive, Verizon’s expanded services are the most affordable.
Comcast Time Warner Dish DirecTV Verizon
Basic Package 29 cents 35 cents N/A* N/A* 56 cents
Standard/Expanded 61 cents 44 cents 33 cents 53 cents 30 cents
Basic Digital 30 cents 23 cents 31 cents 32 cents 28 cents**
* Does not offer basic service ** Includes expanded basic channels plus sports/movie package channels
Source: Company reports and Citigroup investment research

Wieting, Citigroup’s chief economist, said that while consumers have so far swallowed higher costs for gasoline, that will likely change as winter approaches and prices for heating fuel and electricity rise.

During an Oct. 6 conference call to discuss the report, Wieting said he first believed expenditures for things like travel would be hit hardest. But after a conversation with Bazinet and Rollins, he warmed to their premise that communications spending could be affected as well.

“These [communications] expenses are much more flexible,” Wieting said on the call. “It does seem to be an area where consumers can ratchet down.”

According to the report, about 70% of the $41,000 per year each U.S. household spends — based on U.S. Bureau of Labor Statistics information — are fixed costs for housing, food, health care, insurance and transportation (excluding gas expenses).

That leaves about $4,000 per year for energy and $8,300 per year for entertainment, apparel and miscellaneous expenses.

Said Bazinet and Rollins:

  • By switching from wireline telephone service to wireless service, consumers could save at least $420 per year.

  • Another $300 per year can be saved by switching from cable-modem service to lower-priced digital subscriber line service.

  • Shifting from telco wireline service to cable voice-over-Internet protocol telephony could save another $240 per year. Dropping cable video service for direct-broadcast satellite saves another $145 per year.

  • And if a consumer were to upgrade from dial-up Internet with wireline phone service to a cable modem with service from an independent VoIP provider, like Vonage Holdings Corp., that could save another $70 per year.

Low-cost DSL service has already affected cable-modem customer additions: DSL captured 54% of high-speed Internet net additions in the first half of 2005, compared to 52% in the first half of 2004. Bazinet and Rollins expect the gap to widen as consumer budgets tighten.

Bazinet and Rollins estimate that DSL will capture 54% of high-speed Internet additions in 2005 — 4.7 million new DSL customers, versus 4.1 million new cable-modem users.

By 2007, DSL should capture 60% of new high-speed additions, the analysts wrote, with cable attracting 100,000 fewer high-speed subscribers than were originally forecast.

On the video side, Bazinet estimates DBS providers EchoStar Communications Corp. and DirecTV Group Inc. will continue their subscriber-addition leadership.

New video competition from telephone companies like Verizon Communications Inc. and SBC Communications Corp. will have the biggest impact on cable, Bazinet wrote.

Verizon has only just started to roll out video services as part of its FiOS offering in one market — Keller, Texas — but Bazinet believes aggressive pricing will cause at least a small share shift as the service becomes more available.

“Typically, overbuilders capture 30% of the market with brands that are lesser known than Verizon’s,” Bazinet said on the conference call, using a term for wireline cable video competitors. “It is possible they will see an adoption rate that exceeds what overbuilders see.”

The key, Bazinet said, is the price per channel for the FiOS service. While cable beats out Verizon in the basic cable package — at 29 cents to 35 cents per channel per month, compared to 56 cents for the Verizon service — that disparity disappears as expanded packages are taken.

According to the report, Comcast Corp. and Time Warner Cable average 61 cents and 44 cents per channel, per month for the standard and expanded-basic package. EchoStar’s Dish Network and DirecTV average 33 cents and 53 cents, respectively, for a similar package, while Verizon’s price drops to 30 cents per channel per month.

“If cable and DBS do not respond, we believe the incumbents could see significant defections,” the analysts wrote.

September