Keeping It Low

11/30/2003 7:00 PM Eastern

After dodging a bullet by receiving a largely favorable report from the U.S. General Accounting Office in October, MSOs are beginning to set increases for 2004 that are below the recent norm.

The GAO report, issued Oct. 24, stated that cable rates have risen 40% in the past five years — while inflation has risen only 12% — but recommended that no federal regulation of the industry was needed.

The GAO also blamed cable rate increases largely on increased programming costs, a mantra that the industry has been spouting for years.

With rate-hike season starting so soon after the GAO study — many cable operators implement their rate increases in January, meaning they must notify customers and municipalities at least one month earlier — operators seem to want to keep the waters calm.

No MSO has openly cited the GAO report or the threat of government scrutiny as a reason for lower rate hikes, but Time Warner Cable spokesman Mark Harrad said the report has helped cable get its message out to customers.

"It certainly didn't hurt," Harrad said of the report. "I think it helped explain some of the issues that haven't been well-explained in the past.

"I think it's a little early to judge what everyone's reaction is going to be. Cable rates go up annually for a variety of factors and I think the public is starting to understand some of those factors and more importantly, appreciates the added value they're getting for what they're paying for."

Cablevision Systems Corp. was the first MSO to reveal its 2004 rate plans, announcing Nov. 21 that its average rate increase for its three video services — basic cable, Family cable (expanded basic) and iO: Interactive Optimum digital cable — would be about $1.59 per month, or 3.2%, beginning in January and February.

That is one of the lowest rate increases Cablevision has imposed in years. Last year, the average increase was about 5.3% and rates rose 5.5% and 7% in 2001 and 2000, respectively, despite rising programming costs.

Cablevision said in a statement that the 2004 price adjustment reflects higher programming costs, increased investments in customer service and network improvements to enhance service reliability. It said programming costs have risen about 13% this year.

Time Warner Cable expects prices for expanded basic to rise about 4.9% beginning in early 2004 and Cox Communications Inc. said that it expects to be below last year's average rate increase of 4% to 5%. Most other MSOs are expected to keep their rates in line.

Charter Communications Inc. spokesman Dave Andersen said in an e-mail that the St. Louis-based MSO is still working on its 2004 capital budgets. While he added that price adjustments are determined on a market-by-market basis, he added, "the philosophy is to not adjust prices upward in the foreseeable future."

Adelphia Communications Corp. and Comcast Corp. also said they are still determining what their rate increases will be for the coming year. Insight Communications Co., which doesn't implement rate increases until March, also said that it had no available data.

Mediacom Communications Corp. did not return calls for comment by press time last Wednesday.

These rate increases are based on an average of rate hikes for expanded-basic service, and individual increases can be higher or lower. Rate increases for individual markets can vary according to the amount of investment in that market. A system that has recently gone through a major rebuild — adding channels — will likely see a larger increase than one that hasn't.

According to published reports, in San Jose, Calif., Comcast has proposed a 3.5% rate increase for expanded-basic service, while in Dallas — a former AT&T Broadband system that Comcast has spent $70 million to upgrade — expanded-basic rates will go up as much as 9.5%.

Despite differences between markets, Harrad said Time Warner's overall increases are considerably lower than the 5.2% rise in 2002 and the 7% hike in 2001. Harrad said lower capital expenditures for rebuilds are part of the reason for the smaller increases, as well as some programming cost savings, because many of its contracts are multiyear arrangements.

"We're still facing some huge [programming] increases, but there's been some leveling off of deals we've been able to renegotiate," Harrad said.

Harrad added that while Time Warner has always strived to keep price increases down, the increased competition from direct broadcast satellite also plays a role.

"Video is a mature business and there is certainly plenty of competition in the video market," Harrad said. "We want to make it as attractive an offer as possible to as many customers as possible."

Most analysts expect rate increases to come in between 3% and 5%, mainly because of increased competition with DBS and declining capital budgets as rebuilds wind down.

Only Comcast is expected to increase rates at the top of the range, mainly because it still has several rebuilds to complete as part of its acquisition of AT&T Broadband last year.

Still, that's a far cry from the 5% to 10% rate increases that cable operators were criticized for imposing in the not-too-distant past.

UBS Warburg cable debt and equity analyst Aryeh Bourkoff said three dynamics are driving lower rate increases: competition with satellite, cable operators asking customers to pay more for incremental services and reaction to regulatory scrutiny.

"You have to assume, given the competitive environment and the higher programming cost increases that the core video margin for the cable industry will track over time," Bourkoff said. "New services like data and telephony will contribute to offsetting that margin erosion."

Bourkoff doesn't believe rate increases have bottomed out. "Cable operators have, on a system-by-system basis, experimented with rate freezes," he said. "But from a consolidated level, I believe this does represent a continued diminishing increase."

(Cable One Inc., which froze rates for all of 2003, is still deciding whether to implement an increase in 2004, CEO Tom Might said. If rates do rise, it won't be any more than 5% on expanded basic, 4% on digital and 4% on the video and data bundle. Cable One generally implements rate increase in March and April.)

Bourkoff said his models show rate increases ultimately track the rate of inflation, currently at about 2%.

"Cable economics have changed, the revenue stream has become more diversified and the satellite companies have taken a lot of share in the video business," Bourkoff said. "Cable economics today are a lot more diversified than they were even 10 years ago, when it was simply basic-rate increases and video-margin driven."

But with lower rate increases — and the fact that most cable operators are not raising prices for high-speed data service — could cable be setting itself up for diminished growth in the coming years?

According to Fulcrum Global Partners cable analyst Richard Greenfield, the answer is yes. But that's not such a bad thing.

Greenfield said that with rate increases approaching the inflation rate and subscriber growth stagnant, the mid-to-high teens earnings before interest taxes, depreciation and amortization (EBITDA) growth that many MSOs have reported over the last two years is essentially a thing of the past.

"EBITDA growth is set to slow notably over the next two calendar years. Free cash flow [cash flow after interest payments and capital expenditures are made] develops, but EBITDA growth slows notably," Greenfield said. "I think the growth that you've seen — mid-teens plus — long-term, I think the cable industry is a 10% to 11% growth business.

"I don't think you're going to see anybody put out guidance in the mid-teens next year, except for Comcast, because they have AT&T."

Greenfield said that lower EBITDA growth shouldn't affect cable stocks, as investors focus more on free cash flow generation.

The GAO report appeared to squelch what had been a burgeoning call for re-regulation of the industry, particularly by Sen. John McCain (R-Ariz.), the Senate Commerce Committee chairman.

McCain had called for the GAO report — some say hoping to find some evidence of cable rate-gouging — but many believe that the reregulation movement has run out of gas, at least for now.

McCain has also postponed planned hearings on the report, initially, at least, because of filibuster efforts in the Senate.

Rate Increases*
2004 2003
* Expanded Basic service
Source: Individual companies.
Time Warner Cable4.9%5.2%

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