News

Life in the MSO Middle: Cable Ones Tom Might

6/06/1999 8:00 PM Eastern

Cable One Inc., the Phoenix-based MSO owned by The Washington Post Co., has been in the
news recently as one of the next midsized MSOs to potentially be swallowed up in the
latest round of cable-industry consolidation frenzy. On May 13 -- one day after Cox
Communications Inc. stunned the cable world with its announcement that it would purchase
TCA Cable TV Inc. (the deal that spurred speculation of a Cable One takeover) --
Multichannel
News finance editor Mike Farrell spoke at length with Cable One president Tom Might
about consolidation, the cable industry and Cable One's changing place in both. An edited
transcript follows:

MCN: Could you describe Cable One for those who may not be familiar with the company?

TM: We're not one of the more known MSOs. We operate in 14 states, but we're
concentrated -- 75 percent of our subscribers are in just five states: Mississippi, Texas,
California, Oklahoma and Arizona, in that order.

And through selling off smaller systems last year and interconnecting remaining
systems, we're moving toward having 43 systems for 740,000 customers -- roughly 17,000 to
18,000 subscribers per system.

MCN: What's it like to be a 740,000-subscriber MSO in today's climate?

TM: The Post Co. is very happy to be in the business. We've doubled in size in the
past several years, and our cash flow is terrific. Our customer satisfaction is good and
growing even higher. We're preparing the company to deploy all of the new revenue streams
over the next several years. So there's a lot of contentment with the operation and
performance of Cable One at The Washington Post Co.

As far as scale: Are we big enough to stay in the business, which, I think, is what
you're getting at? The Washington Post Co. has access to all of the capital that we could
ever need at very low rates, so we don't have a capital constraint because of our size.

Programming costs: As you may know, we entered into a process a year-and-a-half ago to
negotiate in a very different way with programmers. We've had a lot of success. We may not
be getting AT&T [Broadband & Internet Services-type] rates, but we're getting a
lot better rates then we were.

As far as [being] big enough to handle the new-revenue-stream technology, I think
digital video is really an extension of analog. The skill sets are easily within the
company.

For data, we've been dabbling in it for three years, and we've now launched a dial-up
[service] by ISP Channel across 70 percent of our subscriber base -- 700,000 homes. So
we've learned an awful lot about the Internet-access business, and we feel that we could,
if necessary, go to high-speed on our own.

If not, we're being pursued by @Home Solutions, and we like the conversations we're
having with them. So either doing it on our own or with their support, I feel comfortable
there.

Telephony is a different story. I don't think we could do that on our own. And AT&T
[Corp.] will hopefully be extending the partnership opportunity to smaller operators at
some point. Hopefully, so will others, and not just AT&T. But that's a couple of years
down the road for us.

MCN: You mentioned AT&T and TCA, which just sold out to Cox at least partly because
it wasn't big enough to do a telephony deal. Is that a dilemma you're facing?

TM: I would agree with that. But I don't think you necessarily have to sell the
company to find the partner. I think perhaps there were other reasons for them to sell the
company, but that could be one of them.

But as I mentioned, hopefully, AT&T will be extending partnerships. And I hope
others will, too. Cox is very capable of doing it on its own, and it may be extending a
helping hand for a cut of the revenues to others, as well, I would imagine.

MCN: Do you think it would make sense to band together with other operators that are
your size to present a united front in negotiating a telephony deal with AT&T or
anybody else?

TM: I don't know. It's early to have focused on that, since we're not thinking of
telephony for the next couple of years, anyway.

MCN: What's the plan for new services?

TM: Beginning next year, we're going to launch digital video throughout the
company, and we're going to do it within 12 months once we start. We're going to launch
data beginning next year and do that over four years or less. Telephony is third on our
list, because it's the lesser-developed technology, and we will need some outside help
there.

So we've got our heads plenty full with new revenue streams for the next year or two.
Maybe that's three years from now: I don't know the precise timing. Some of it will depend
on how well AT&T manages to roll out its own systems. We've set our digital and data
time line, but not our telephony time line so far.

.

MCN: What are your plans for high-speed data right now?

TM: Well, we're talking with @Home Solutions right now and ISP Channel. I'm trying
to think if we're talking with HSA [High Speed Access Corp.] or not. Yeah, we've talked
with all of them at one time or another.

I know we're actively meeting with @Home Solutions and ISP Channel this month several
times. In fact, I spent, with my whole team, a whole day in Tyler, Texas [TCA's
headquarters], last week, looking at [TCA's] Internet operations, which it does on its
own. [TCA chairman] Fred Nichols and I have been comparing notes on that. I don't know if
Fred changed his mind, or the prices got too high, but he was rather content doing it on
his own.

At this point, we're reasonably content that we can do most of it on our own, given as
much as we know about being a dial-up on ISP. We won't have the same price breaks, but on
the other hand, we won't be giving away up to 45 percent or 50 percent of the revenue off
the top, so we won't need the price breaks to come out in pretty good shape. But that
decision is in front of us in the next couple of months.

MCN: By partnering with ISP Channel, HSA or whomever, the costs won't be that high?

TM: Well, if you partner with them, the costs are very high, because they want 45
percent to 50 percent of the revenue off the top. That's pretty high. That may be the only
good solution for somebody that has 100,000 subs. At 740,000 subs, we can certainly afford
to hire a staff, and we already have for dial-up purposes. We can extend that skill set on
a per-subscriber basis that I think is affordable.

MCN: How is your dial-up Internet service doing?

TM: Well, we just started. We rolled it out to the whole MSO in the past few
months. We're adding a couple of hundred [subscribers] per week. And I think within a few
months, we'll be adding about 500 per week. We tinkered with it for a couple of years in a
few systems and got it right, and we just started rolling it out in scale.

MCN: Do you think a lot of those customers will eventually migrate to a high-speed
service?

TM: A long time from now. Part of the reason why we did this -- well, there are a
couple of reasons. One, we wanted the skill set -- we wanted to know the Internet
business. We didn't want to launch high-speed before having time to learn it.

The other is that research after research shows that 70 percent of the people are not
willing to pay more money for higher speed -- not today. Therefore, if you're only going
to offer a high-speed solution, you're confining yourself today to 30 percent of the
market, at most.

This way, we'll offer both services indefinitely. We'll avail ourselves of 100 percent
of potential market share -- not that we'll get all of it. I'd rather be going after 100
percent than 30 percent. It's not very profitable, but it's great experience and it's
market share.

And our intention would be to offer both services under the same brand name. It's much
easier to upsell someone who is a telephone or dial-up customer to high speed than to tell
somebody that if you're the high-speed provider, slow speed is good, too.

We can market people up without confusing the brand, I think. I don't think that @Home
[Network] can come up with a slow-speed solution that is consistent with the brand.

MCN: How important is being able to offer telephony to an MSO of your size?

TM: When you look at the price per sub that people are paying in all of these
deals, telephony has to be a very, very big piece to justify them. You just can't get
there with video and data. So it's very important that in these deals that are being made,
there's no question about it. It will take flawless execution to deliver that kind of
value and, hopefully, someone like AT&T can do that and teach others how to do it --
hopefully, us.

For our customers, there's a fair amount of discontent with the RBOCs [regional Bell
operating companies]. We measure customer satisfaction. We have 1,000 customer surveys per
month in our MSO, and we measure customer satisfaction not only with us, but with the
telephone company and the power company.

And we've caught the telephone companies in customer satisfaction. In many markets, we
significantly exceed them. So there's probably some pent-up demand in some systems --
particularly in U S West territory, [where] we have a lot of systems -- for an
alternative. But it's not something people are calling us about and asking for -- that's
for sure. We'll have to work hard to market that brand and that service when we do launch
it.

MCN: You hear about cable deals going for $4,000, $5,000 and even $6,000 per
subscriber. Does that put a lot of pressure on you to seek out a deal?

TM: It certainly puts pressure on The Post Co. and on me to make sure that we're
doing the best thing for our shareholders. We can't ignore that responsibility. I think
there is a significant premium on the price of a cable sub right now, so we do have to sit
and think, what's the best thing for our stockholders -- to go it alone, to merge with
somebody else, to do an [initial public offering], possibly even to sell.

It's not something The Post is enthusiastic at all about doing. But we certainly have
to examine the numbers. There's a huge tax consequence to selling that wipes out almost
all of the premium value versus staying in the business and enjoying all of the new
revenue streams.

MCN: Does that take you out of the acquisition market?

TM: Mostly, it does, because as an example, we added almost 300,000 subscribers in
the past few years at an average of $1,800 per subscriber, and we're very disciplined
buyers. I can't rationalize the $4,000 level at The Washington Post. AT&T can very
well rationalize it because of the access fees [paid to RBOCs that] it has at stake [as a
long-distance carrier].

We did a lot of big acquisitions last year -- big for us -- but I doubt that any will
come along in a range that we would like this year. But we are doing two. One closed just
last week. And another one -- the letter of intent has been signed for 2,000-plus
[subscribers] last week.

We've got a deal signed for another 8,000 [subscribers] at very attractive prices. But
they're adjacencies -- we tie into our headend with a piece of fiber -- and the seller
didn't have other huge alternatives. So we are doing those scale of acquisitions.

And there have been some trades that we have been working on for several years. It's
our strategy not to be in urban markets. We still have those systems, and we'll spend our
time trying to get those trades done now.

MCN: In the past six years. seven newspaper companies have exited the cable business.
Given the fact that valuations are so high now, how do you justify staying in the cable
business to The Post?

TM: Well, most of those exited a number of years ago. And some of them didn't take
their money out -- they just took somebody else's stock. [Advance/Newhouse], for example,
went to Time Warner [Inc.], and its money stayed in the business. But it got out as an
operator. It got out at a much lower price, but an attractive price then.

Since then, the attainable value of a cable subscriber has gone up substantially
because the new revenue streams have all been developed since [the newspaper companies]
exited operating the business. So while the prices are a lot higher than what they were
tempted to leave at, so are the rewards for staying in.

So right now, The Post is excited about all of the new, Internetlike revenue streams
that are going to be available to Cable One.

MCN: Is an IPO in your future, then?

TM: If we were to try to lock in some of these high market values -- it may not be
this high forever -- there are a number of ways of doing it other than just selling the
company and maintaining control.

One would be to do an IPO and to spin off the cable division, but to still be a
majority shareholder and the controlling party. That would be a way to keep the assets in
the family, to keep control, but to bring in some of that market valuation.

There are going to be, over the summer, up to three MSO IPOs, and we could be a fourth,
perhaps.

MCN: You mentioned your ongoing effort to create a universal programming lineup,
cutting down to 37 networks in an effort to keep programming costs down. How is that
going?

TM: It was on the heels of 10 years of programming costs going up 14 percent per
year, per subscriber -- maybe even longer than that, but at least 10 years. At the same
time, the FCC [Federal Communications Commission], or Congress and the FCC, imposed a 17
percent reduction in our rates. So we were virtually passing along all new revenues for a
number of years to the programmers. Everybody's margins were going down quite a bit.

So a year-and-a-half ago, we started a new programming strategy to increase the
leverage of our 740,000-customer base. We decided to limit our future analog carriage to
just 40 satellite channels, and to require anything else that we would carry to be
digital.

So we drew a line in the sand -- only 40. Then we promised those networks that we could
make acceptable deals where they would get the entire MSO or they wouldn't get any of the
MSO.

We had full or partial carriage of up to 80 networks at that time somewhere in the
company. We're going to decide, or have almost decided, on 35 of those channels centrally
that will get MSO-wide or, as you called it, universal carriage. The other five will be
picked locally, mostly for religious and ethnic channels that will vary from system to
system.

So far, we have signed 28 networks for long-term full-MSO or almost-full-MSO carriage.
The deals have been terrific and very creative. I think it's been a win-win for both
sides. Net, it's allowed us to have lower rate increases for our customers. We're real
happy with the result.

MCN: How long are the agreements for?

TM: They've varied. Some are until 2002 to 2003. We've avoided these 10-year deals
that some networks tried to get. They've had balances of leverages changing as time goes
forth, and I don't want to be stuck with long-term commitments as new networks are
developed.

MCN: Can you name some of the networks you have signed up?

TM: We've signed up a whole fleet of Turner [Broadcasting System Inc.] networks --
we've agreed to carry seven of its eight channels across the company. We've got both of
A&E [Television] Networks' channels. We've got all of Viacom [Inc.'s] product.

I don't have the list in front of me, but we have a lot of great channels signed up at
this point. And we're down to seven slots and at least 14 realistic contenders for those
seven slots -- the remaining seven MSO-wide slots.

MCN: What about ESPN?

TM: We're out of contract with ESPN. We've been out of contract, I think, since
Dec. 31. We've worked hard together. They've really come to the table. We've tried to make
a deal -- we just haven't been able to get there yet.

This last rate increase is going to make it that much harder. The [Walt] Disney Co., I
think, has displayed some extreme arrogance in managing its cable- and
broadcast-network-affiliate relationships, proclaiming last year that content was king and
treating distribution as if it was powerless. That's how we've been treated with their
rate increases.

So it's interesting to see, at least for the time, their earnings down 41 percent last
quarter. DBS [direct-broadcast satellite] and cable values are soaring. But Disney has six
networks. We've cut back to just three, and we have contracts for only two right now.
We'll cut back to fewer than three if we have to [in order] to keep the overall payments
to The Disney Co. in line with what we think the market value for their product is versus
others.

MCN: Those three are?

TM: We're carrying ESPN and Disney Channel MSO-wide and ESPN2 partially.

MCN: If you're not able to reach an agreement with ESPN, won't that hurt your systems?

TM: Oh, I've told them there's no way we won't. We have to carry ESPN, and they
know that, and that's the leverage they're using. At least today we have to carry it.
That's not forever.

Again, our approach will be to cut back our expenditures on Disney Co. programming and
other places to make up for it. We've worked really hard, both of us, and we have come
close and been very creative. And I'm appreciative of their effort. It's just that they've
stuck themselves with some huge programming costs, and the rate increases that they're
passing on to us are just too much to add on top of all of the other Disney Co.
programming we're buying.

MCN: Have any other operators come to you and asked about joining you in negotiating
for programming?

TM: Two have inquired about how we're doing it. But most of those our size that
would have enough subs to have some leverage at the table if they bargained the way we
did, with all or nothing, don't negotiate their programming. They either get the rate from
AT&T or some other large affiliate parent, or from Telesynergy Inc., where they
negotiate in bulk that way and get rates that they're satisfied with that way. There are
very, very few independent MSOs negotiating their own programming at this point.

MCN: Do most of them also go through the National Cable Television Cooperative for a
lot of their programming?

TM: I think a lot of the smaller ones do. We are a member of the NCTC, and we use
it for five networks out of the dozens that we carry right now. The rest we do better on
our own, or as well.

MCN: Is it becoming more and more difficult for smaller operators to deal with
programming costs?

TM: Well, it's certainly gotten a lot better for us in the past 18 months. What
happens next? We're locked in now in most cases through, say, 2002 or 2003, so I really
haven't thought about the next wave of negotiations that will start in a couple of years.
We have to start working on our digital negotiations now, since we have a launch that's
ahead of us. But we wanted to finish analog first

.

MCN: Operators today have higher programming costs, huge expenses for upgrading their
networks and expenditures to roll out advanced services and telephony. You have to do all
of this while keeping rate increases low. Does something have to give soon? Or are a lot
of cable companies avoiding the issue that in order to pay for all of this, you're
probably going to have to raise your rates?

TM: No, I think not. We modeled it out very carefully, in great detail, for 10
years. And given the fact that we have now established much better relationships with a
number of programmers, we can live with reasonable rate increases to our customers once
the rebuilds and launches are done.

I think all of the Wall Street models -- and I would concur with them -- show the
analog-video business sort of stabilizing at 5 percent or 6 percent cash-flow growth, and
then the kicker being the new revenue streams. You can do that with reasonable rate
increases. Our programming costs are double-digit, and our fixed costs are
low-single-digits in growth. They balance each other out nicely.

MCN: Is it easier for a company your size to keep your rates down than, say, a company
the size of Cablevision Systems Corp. or someone else? You see operators with 5 percent
rate increases in some areas and 17 percent increases in adjacent areas.

TM: We do that, too. Every rate increase is looked at individually. We have targets
on what a rate should be for a given channel count, but we never used to. So systems are
starting with all kinds of illogical relationships between channels and rates, from back
before regulation.

Now, we're methodically working our way to a very rational rate for the amount of
programming we're offering. Those that were way underpriced are getting rebuilt and moving
up. Some that were priced way too high are very sensitive to DBS erosion, so they're not
taking any rate increases, even though they're going through rebuilds. Or maybe they're
only taking a $1 [per month] rate increase, even with the rebuild, because they had priced
themselves way too high many years ago.

So here we have very different rate increases from one system to another because of the
starting point. But we're moving toward a very consistent rate across the entire company
and, as you know, a very consistent channel count across the entire company. So it'll be
almost a universal rate and a universal channel lineup a couple of years down the road.

MCN: Are you seeing a subscriber loss to DBS?

TM: No. Our subscriber growth is plugging along at 1.5 percent per year internally,
even though we're -- interesting fact -- the most highly penetrated midsized or large MSO.
We have 77 percent penetration.

And interesting as well, we just had our biggest quarter of subscriber growth in
history. We grew by more than 8,000 subscribers in just one quarter -- the first quarter
of this year -- through terrific marketing.

I've got a great sales-and-marketing team throughout the company. They have found ways
-- even at 77 percent-penetration -- to put on 1 percent in one month. So we're doing fine
against DBS at this point.

MCN: Was that mainly through special promotions?

TM: It's an annual effort on an MSO-wide basis to get out there and ask for the
business, and it worked. It's the second year we've done it, and it's even bigger. It's
not lots of discounting or free service: It's just selling better and marketing better.
We're quite pleased with the result. Customer satisfaction is actually climbing in the
company right in the face of DBS growth.

MCN: Can you talk in a little more detail about your upgrade plans?

TM: By the end of this year, our plan calls for 62 percent at 550 [megahertz] or
better and another 17 percent at 450 [MHz] or better. We've been spending $100 per sub for
the past three years, at least on average. And most of the ones that aren't done are
recent acquisitions from last year's acquisition binge.

From a two-way point of view, we're probably at 36 percent, or we will be at 36 percent
at the end of this year. It could be as high as 66 percent next year. We made a push at
that pace. We have a lot of rebuilt plant that was rebuilt a number of years ago in the
two-way modules that we're going to put in, so we can move very quickly. But we're not
planning on rolling out data more than 25 percent per year, so we may not make the plant
two-way at quite that pace, because it would outpace our high-speed-access launch plans.

I think the other thing I mentioned is a little different than other MSOs. We deployed
fiber nodes and 100 percent standby power in all of our systems two years ago. It was to
improve reliability in picture quality, so we have a well-operating plant from the
customer's point of view. That puts us in a good position to launch new services at
whatever pace we want.

MCN: It looks like Cable One is poised to provide the whole gamut of advanced services
-- it's just a matter of when you want to do it.

TM: Well, our strategy has definitely been to be out of urban markets and to be in
markets where we are the only cable operator, so we don't have to do things because the
neighbor did it last year.

The second element is to not be first in doing things -- to wait and let others improve
the technology and improve the concept, then follow the leader when it's ready.

So we've been studying digital and data at great depth, and we are poised and ready to
launch those to a lot of subs now. In fact, one person coined that strategy as, 'Be
second, but better.' Beginning next year, we'll be rolling out a lot of new services, data
and digital

.

MCN: Your systems are averaging about 17,000 to 18,000 subscribers each?

TM: They will be after we finish a couple of more interconnects. We're close to
that right now.

MCN: Is that around the same size as TCA?

TM: TCA and Cable One are almost carbon copies of each other. We know each other
well. We exchange information a lot. And other than the fact that we're in different
states -- close states, but different states -- we're very, very similar. Both of us place
an inordinate amount of emphasis on customer satisfaction and local management quality.
We're very similar.

MCN: At a recent Paul Kagan Associates Inc. conference, Mediacom LLC chairman Rocco
Commisso spoke about tying together systems and headends in 5,000- to 15,000-susbcriber
clusters. Is that basically your strategy?

TM: Yes, but Rocco's got a very different situation. He's starting -- for example,
with the Triax [Telecommunications Co. L.L.C.] acquisition -- with systems averaging maybe
1,000 subs per headend, and he has to interconnect those to get to the size where we
already are.

Yes, we believe you need an adequate number of subscribers on a headend in order to
justify the cost of all of the services. That's why we sold or traded off 14 small systems
one year ago. We didn't think they had the scale to be first-class, full-service systems.
What we have left are customers on systems that we can offer advanced services to on an
affordable basis.

MCN: Is there a minimum number of subs per headend?

TM: Well, if there are acquisition opportunities, we prefer to acquire 10,000 or
more per headend.

MCN: You mentioned customer satisfaction as being an important part of your success.
What are you doing in that area that is unique?

TM: We put something in two years ago that's pretty unique -- an incentive program
for all of the associates in the company when we converted to Cable One from Post-Newsweek
Cable. It's really the pinnacle of what has become a dominant focus in the company on
customer satisfaction.

As I mentioned, we do 1,000 interviews per month. We know every quarter every system's
customer satisfaction, their outages -- everything the customers think about their system,
we read quarterly. We have interviews daily, but we still have a quarterly.

Based on that, we have started what we call 'Cable One Rewards.' We paid out more than
$500,000 last year to associates at the system level. This summer, I expect to pay out a
very similar amount, and I think it will grow to $700,000 next year. It's based on
customer-satisfaction-level growth in each system.

In these interviews, we ask the customer to rate the system's performance and their
satisfaction on a scale of zero to 10. Every time the system satisfaction goes up the
scale, we pay them several hundred dollars.

There are a lot of people who got $1,000 out of that program last year, and there will
be similar results this year. It's a multiyear program: If the system meets it, everybody
in the system gets the extra paycheck. A person can earn $5,000, $6,000, $7,000 in total
as the system works its customer satisfaction up over a couple of years.

So, it's pretty intense, and people are pretty focused on those quarterly
customer-satisfaction numbers. Customer satisfaction started this survey three years ago,
and it's moved up very nicely.

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