Cable Operators

Tapped Out

4/19/2010 4:01 PM Eastern

Are consumers reaching
their breaking point on
entertainment spending?

Prices for cable, satellite
and telco video services
are reaching all-time
highs, even as viewers scramble to
cut costs in a stagnant economy.

Cable operators, who have managed
to keep rate increases low
while finding ways to cut operating
costs, may be forced to raise
prices again as the growth in programming
expenses consistently
outpaces video-revenue growth.

It couldn’t come at a worse
time. While pundits are still debating
whether the recession has
ended or is just experiencing a
temporary lull, unemployment
is still hovering around 10% and
consumer spending is expected
to trend downward, pressuring
each household’s ability to pay
for entertainment.

SPENDING PRIORITIES
Will strapped families look to
shave their cable or satellite bills
to save money? Or, as cable operators
predict, will they recognize
the inherent value in their cable
subscriptions even more during
a recession and instead cut out or
severely curtail other activities
like dining out, going to the movies
or taking vacations?

cover image April 19, 2010One cable customer — HDTV
consultant and senior HDTV
moderator of the AVS Forum Ken
Holsgrove — could speak for the
masses. Holsgrove said he pays
Comcast about $125 per month
for digital services, some sports
tiers and high-speed Internet service
in Plymouth, Mich. And
while he considers himself
a loyal Comcast customer,
that could change. His Detroit
suburb is is serviced by
WideOpenWest, AT&T U-verse,
Dish Network and DirecTV.

“If I couldn’t find the right deal
for myself which I thought was
equitable and fair for the channels
I was getting and the quality
of service, I would switch to
another provider in a heartbeat,”
Holsgrove said.

The good news is that so far,
consumer spending on entertainment
has held up, increasing
steadily each year. According to
the federal Bureau of Labor Statistics,
the average U.S. household
spent about $3,374 in 2008
(the latest figures available) on
entertainment and communications,
which includes pay TV as
well as movies, dining out, mobile-
phone charges and vacation
spending. That amount was up
about 3% from 2007.

While the 2008 numbers are
dated, they include the beginning
months of the recession, and the
2009 results, due later this year,
are expected to be down in practically
every category.

One data point from the 2008
numbers should cause some
pay TV providers some concern.
In a presentation to the UCLA
School of Law earlier this year,
media consultant Tom Wolzien
— a former television news executive
and media analyst at Sanford
Bernstein — noted that of
the households surveyed for the
2008 results, one-third had a total
income of $30,000 or less per
year, one-third was at $30,000 to
$60,000 and one-third at more
than $70,000. After diving into
the numbers, Wolzien found that
the low-income households were
spending 47% less than the average
(about $1,800 per year), the
middle-income homes spent 10%
less and the high-income homes
spent 59% more than the average
(about $5,354 per year).

for one-third of the population, in
terms of mass media, it’s going to
be very hard to get new stuff into
that group,” Wolzien said. “Onethird
of the population is going to
be looking for deals and only onethird
of the population will drive
the new cost business.”

Already, charges for basic-video
services are nearing $70 per month
and most of the publicly traded cable-
system operators are reporting
average monthly revenue per unit
well in excess of $100 every 30 days.
While that is also due to the wider acceptance
of high-speed data service
(penetrations are averaging about
30% to 40% for most cable operators)
and phone services (with penetrations
in the 15% to 20% range) there is
no doubt that video services account
for the bulk of those charges.

For example, in 2009, Comcast
reported monthly average revenue
per unit (ARPU) of $118.20, a
6.4% increase over the $111.05
generated in 2008. Video
ARPU in 2009 was
$68.54, up 3.8% from
$66.03 in 2008.

The trends were
similar at Time
Warner Cable.
Total monthly
ARPU for
the second-
largest
cable operator
in the
country was
$101.84 in
2009, up 4.4%
from $97.53
in 2008. Video
ARPU for
that same per
iod was up
4.1% to $68.92 in
2009 from $66.18
in 2008.

Programming
costs have accelerated
at a much
faster pace. For Time Warner Cable,
programming costs rose 6.5%
in 2009 to $4 billion while video
revenue grew just 2.2% in that
year. Comcast’s video revenue
rose 1.1% in 2009, while its programming
costs grew 8.8%.

While cable operators have consistently
said that they were not losing
customers to the recession, they
have said the economic downturn
appears to have cut into premium
subscription services. For example,
Time Warner Cable’s premium-
channel subscription revenue
fell 4.2% from $913 million in 2008
to $875 million in 2009. Transactional
video-on-demand revenue
(mainly pay-per-view movies
and events) dipped 8%
from $399 million in
2008 to $367 million
in 2009,
according to the company. Comcast has also
said it has felt the effects of the recession
most in its premium-channel
subscriptions, but does not
break out the figures.

And it’s not just the larger operators
that are feeling the pinch. At
Massillon Cable, which has about
50,000 subscribers in Ohio, president
Bob Gessner said his customers
have been cutting back
on some services like premium
channels for about the past 18
months.

“I’ve described it as cutting
back, not cutting off,” Gessner
said. “Obviously, there is always
a push back when you raise rates.
They want to keep all the services
they have they just don’t want to
pay as much for them. I take that
as a mixed blessing — they want
their service, but they are mindful
of their wallets.”

Meanwhile, overall cable margins
(including high-speed data
and phone) have held steady at
around 40% for the past three
years for Comcast and at about
36% for Time Warner Cable in the
same time frame. To many analysts,
that is an indication that cable
has been pretty successful in
taking costs out of the business.

Wolzien said that margin behavior
is a key to determining
where the pressure really lies in
a media business.

“If [margins and earnings]
have held, then you could
argue that cable companies
are taking costs out of
the business,” Wolzien said.
“If revenues are down and
the margins have held,
that means that earnings
are down and you could
argue that it is a variable
cost business.”

While no cable operator
has said it will
dramatically increase
video, high-speed
data or phone prices,
practically
every publ icly
traded MSO has
said that video
margins will be compressed in
2010 and beyond, mainly due to
retransmission consent and higher
programming costs.

 CABLE SUBSCRIBERS
 2009  62.1 million
 2008  63.7 million
 2007  64.9 million
 SOURCE: NCTA

VIDEO MARGINS WANING
According to Sanford Bernstein
cable and satellite analyst Craig
Moffett, direct video gross margins
for some operators are already
on the decline. In a recent
research report, Moffett noted
that Comcast’s gross video margins
have declined from 68.1% in
2004 to 63.6% in 2009. For Time
Warner Cable, the decline was
even more pronounced (68.2%
in 2004 to 60.6% in 2009). Satellite
giant DirecTV saw a less dramatic
falloff (58.9% in 2004
to 57% in 2009), but the margins
were decidedly lower.

For Massillon, said Gessner, video
margins have probably dipped
about 10% to 12% over the past 10
years. And Massillon’s margins are
much lower — Gessner estimated
they are under 50% — than the
larger MSOs.

“The margins on video have
been decreasing every year,”
Gessner said.

Gessner said he has been able to
pass along his costs — for the past
8 years Massillon has increased its
Lifeline service rates only by the
amount its programming costs
have increased. But he said it’s
getting tougher to do with retransmission
consent costs adding to an
already rising expense line.

“It’s the same pressure, there’s
just more of it,” Gessner said of retransmission
cost increases.

While retransmission consent
has been around since the passage
of the 1992 Cable Act, only
in the past few years have stations
been fighting for and getting cash
in exchange for carriage of their
television signals. And in the past
year, broadcast networks have
gotten into the act, extracting fees
up to $1 per subscriber per month
from pay TV providers.

One of the early proponents
of cash for retransmission consent,
CBS, estimated that it will
haul in $100 million in such revenue
in 2010, rising to $250 million
by 2012.

While service providers continue
to stress that television is one
of the last consumer-spending
items to reach the chopping block
as customers look for ways to cut
costs, they can’t deny they’ve
changed direction in their marketing
efforts. One of the most
glaring examples is DirecTV,
which in the past has touted its
high-defi nition and digital video
recorder services to its high-end
customer base. In the past several
months, DirecTV has shifted
gears, emphasizing promotional
pricing — like 150 channels for
$29.99 per month for one year.
And they are not alone.

WARY ON DISCOUNTS
All of the major MSOs, as well as
such telcos as Verizon Communications
and AT&T, have emphasized
promotional pricing for
months. And though several cable
operators have said they will
ease up on heavy discounting,
they will have to tread carefully.

Toronto-based Convergence
Consulting Group president Brahm
Eiley said he believes MSOs will try
to keep pricing stable — they have
averaged about 4% increases over
the past few years — if for no other
reason than survival.

Verizon Communications had
the biggest rise in video prices in
2009 — its FiOS TV package averaged
a 30% increase, noted Eiley
— but still undercuts most cable
companies.

And even with additional pressure
from increased programming
costs, cable won’t go for a
dramatic price hike.

“I don’t think they are going to
raise prices dramatically,” Eiley said.
“That would be slightly dangerous.”
By dangerous he means that it could
further erode an already declining
base of subscribers.

Convergence estimated that
in 2009, telcos added 2 million
TV customers, satellite added
1.3 million and cable lost 1.4
million. Total TV subscriber additions
rose from 1.5 million to
almost 2 million in 2009, largely
because of the federally mandated
digital transition. But that
growth too is expected to slow
to 1.8 million in 2010 and 1.65
million in 2011, according to the
consultant.

“These aren’t the glory days of
the decade,” Eiley said.

Cable operators have been losing
subscribers by the bucketful
over the past several years — according
to the National Cable &
Telecommunications Association,
cable subscriptions sunk
from a high of 66.9 million customers
in 2001 to 62.1 million in
2009. But more than half of those
4.8 million customer losses have
occurred since 2007 (2.8 million
subscribers). While that also coincides
with the advent of telco
video, it could be argued that customers
that have switched to Verizon
or AT&T for television have
done so because of lower prices.

Cable has managed to weather
other recessions with its business
intact, Wunderlich Securities cable
and satellite analyst Matt Harrigan
said, and it should do the
same for this most recent economic
malaise.

RECESSION RESISTANT
“People seem very inclined to
retain the TV, almost no matter
what,” Harrigan said.

Harrigan pointed to data that
shows television viewing is at alltime
highs (to around five to six
hours per day), which shows that
they’d have to be very hard-pressed
to give up their cable subscriptions.
“It feels to me that the resilience is
surprisingly strong,” he said.

Still, spending has its limits
in every TV household, and distributors
face vexing questions in
costs, pricing and whether they
should just focus their attention
on the wealthiest of their consumer
base.

THE STRETCHED CONSUMER
Consumers spent an average of $3,374 in
2008 on entertainment, communications
and reading. How that spending shook out
by household income:

HOUSEHOLD INCOME  2008 ENTERTAINMENT SPENDING 
 Under $30,000/yr  $1,785
 $30,000 to $60,000/yr  $3,046
 $70,000-plus/yr  $5,354
 SOURCE: Wolzien LLC

GROSS VIDEO MARGINS
According to Sanford Bernstein cable and satellite analyst Craig Moffett,
rising programming costs have put a hurting on gross video margins
(gross profit as a percentage of video revenue) over the past five years:

   2004 2005
2006
2007
 2008 2009
 Comcast  68.1%  68.2%  67.8%  67.6%  66.2%  63.6%
 Time Warner Cable  68.2%  66.8%  64.8%  63.1%  62.2%  60.6%
 DirecTV  58.9%  58.7%  57.6%  57%  57.1%  57%
 SOURCE: Company reports and Sanford Bernstein estimates
November

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