Cable Operators

Penetration Pique for MSO As DBS Hits More Markets

2/24/2006 7:00 PM Eastern

Mediacom Communications Corp. has been firmly ensconced in the competitive trenches since DirecTV Inc. and EchoStar Communications Corp.’s Dish Network set their sights on its cable markets three years ago.

While the Middletown, N.Y.-based MSO was busy trying to upgrade the neglected plant it acquired via 23 deals over a five-year period, the direct-broadcast satellite companies were bearing down fast on Mediacom’s markets with the introduction of local signals.

In 2003, DBS firms offered local TV signals to 15% of Media- com’s base of 1.4 million customers. Today, that percentage is well over 90%.

As a result, Mediacom has lost about 10% of its subscriber base. Chairman, CEO and founder Rocco Commisso admitted he didn’t anticipate how ferocious the competition from satellite would be. Still, he said he wouldn’t have changed his strategy of buying underperforming systems in secondary markets, upgrading them and then offering state-of-the-art products and services.

“We said from the beginning that we would bring big-market products and services to small markets and we have fulfilled that promise,” Commisso said. “We offered broadband service to our customers in Iowa before people living in the Silicon Valley had it.”

Nonetheless, the company’s success with consumers is a touch behind many of its cable peers. At 51%, Mediacom’s basic penetration rate is two points below the national average, according to Leitchman Research Group Inc. president Bruce Leitchman.

The MSO’s digital penetration rate of 33%, posted in the third quarter of 2005, is also below the industry average of 45%, he said. Part of that has to do with the economics of Mediacom’s markets, as well as the company’s late entrance into the advanced services arena, Leitchman reasoned.

“Mediacom’s challenge on the basic level is the fact that the DBS providers have a better value package,” Leitchman said. “But they can win back that leverage on the high end.” The crux, he said, is that many of Mediacom’s markets have lower-than-average per capita incomes. For instance, the average per capita income in Iowa is $30,500, which is below the U.S. average of $33,000.

What that means, Leitchman said, is that Mediacom is going to have to push the value of the higher-end products to consumers who don’t have as much discretionary income as other markets around the country.

“Cable is no longer an everyman’s service or business,” Leitchman said. “And it can be OK if you give up the low end to the competitor. Mediacom’s bright spot lies beyond video.”

It had better. The number of DBS subscribers outpaced cable subscribers in rural America for the first time last year, Leitchman told operators attending the National Cable Television Cooperative’s winter conference last month. Of those who subscribed to a video service in rural areas, he told attendees, 42% took satellite versus 37% who bought cable.

But Mediacom executives said they are up to the challenge. The company’s penetration rates for digital cable, high-speed Internet access and now telephone service are growing. In the third quarter, the digital penetration rose 9% from the previous quarter and was up more than 20% from 2004 adding 22,000 digital customers for a total 477,000 digital customers. Mediacom also added 27,000 data customers for a total 453,000 customers and added 2,000 phone customers for a total 8,000 at the end of the third quarter.

At the same time, penetration rates for DBS are beginning to slow around the country. Analysts had expected DirecTV to add at least 300,000 customers in the fourth quarter. Instead, the company added 200,000.

Dish Network, which has hammered local phone companies for raising rates, hasn’t been able to use that argument quite so much recently, because it’s had to take some heat for raising rates, too, said senior vice president of marketing and consumer services Mike Rahimi.

“When DBS first came out, they claimed they had a superior product,” he said. “And it was when it was first introduced. But that’s no longer the case. We are not as vulnerable as we were three or five years ago. We have better products and a far more compelling offer than they do.”

To be sure, Mediacom continues to roll out bundled services, including telephone in several of its markets around the country. Churn is slowing and sales of its advanced services are escalating. Indeed, company executives and some analysts think Mediacom is well-positioned to compete against the expected onslaught of competition by telephone companies.

“I think we’ll be under the radar screens for many big telcos while they concentrate on their larger markets,” said Jim Carey, senior vice president of the Gulf Breeze, Fla., division. “I think it will be a long buildout for them before they start looking at our markets. I think we have a good two-year head start.”

Wall Street analysts agree. Despite the fact that Mediacom fell below his expectations for the third quarter, Citigroup Smith Barney analyst Jason Bazinet has a “buy/speculative” rating on the stock, in part because of its rural footprint.

“Since the [regional Bell operating companies’] fiber investments are capital intensive, we believe the telcos will only make the incremental investment in areas where penetration rates for data and video services are likely to be material,” Bazinet wrote in a report last April. “Since Mediacom tends to service more rural markets, we think the company may be largely — if not totally — insulated from RBOC [regional Bell operating company] fiber investments.”

That might be the case when it comes to Qwest Communications International Inc., which operates in about one-third of Mediacom’s service territory. The RBOC hasn’t announced its video plans in Iowa yet, and executives declined to discuss the issue. However, competition from the local telephone companies and municipal cable systems remains stiff.

Over 50% of Iowa’s 150 independent phone companies offer digital subscriber line Internet access to every customer in their exchange, and over 90% of the independent phone operators have DSL service of some sort, according to Iowa Telecommunications Association executive director Dave Duncan.

Moreover, about 70% of the independent phone companies offer some type of video service to their customers, he added. Mediacom operates in 143 of those independent phone markets.

Helping those phone companies with their video plans is the Iowa Network Service, a statewide fiber network that is jointly owned by its independent phone operators.

“INS has been delivering advance services to the independent phone companies for quite a while now,” Duncan said. “They have now rolled out a video product, which I am sure many phone companies will use.”

If that wasn’t enough, Mediacom probably faces more competition from municipally owned-and-operated cable systems than any other MSO in the U.S. Mediacom competes with 13 such outfits in Iowa, noted senior vice president Charles King. And there could be more in the future. A statewide ballot initiative that allowed cities to explore creating municipal telecommunications systems was passed last fall by 12 communities. Mediacom fiercely fought the measure, ponying up more than $1 million in advertising to sway voters.

“I give Mediacom a lot of credit,” said Tom Graves, executive director of the Iowa Cable & Telecommunications Association. “They have never complained about competition from private corporations. But they get burrs under their saddle when it comes to government intervention. They were smart and very helpful in fighting that initiative.”

John Pascarelli, Mediacom’s executive vice president of operations, said it really doesn’t matter where the competition comes from. Mediacom will be ready.

“We have invested a tremendous amount of money upgrading and face-lifting all our systems,” he said. “Everything is first-class. And consumers see that and like it. The bad legacy stuff [that resulted from previous owners’ operating style and strategy] is long gone.”

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