Analysts Prize Cable's Phone Play

8/17/2003 8:00 PM Eastern

Cable operators are shifting their competitive focus away from a national video strategy to a more regional approach, aimed at capturing data and telephony customers to combat pricing discounts and the specter of a three-product offering from regional Bell operating companies.

That's what two UBS Warburg LLC analysts conclude in a recent report.

MSOs have long battled direct-broadcast satellite service providers EchoStar Communications Corp. and DirecTV Inc. for video customers.

With recent alliances between EchoStar and SBC Communications Corp. — which plans to offer a co-branded "SBC Dish Network" video service in its 13-state territory along with its voice and high-speed data offerings — and aggressive DSL discounting from Verizon Communications, cable is under pressure to fight off new threats.

The phone choice

According to the in-depth report by UBS Warburg cable debt and equity analyst Aryeh Bourkoff and telecom analyst John Hodulik, cable MSOs can either: adopt a strategy to discount and tier high-speed data service more aggressively (Bourkoff forecasts a 3% decline in cable-modem average revenue per subscriber in 2004), or roll out telephony more aggressively.

Bourkoff believes the nine major MSOs — Comcast Corp., Cox Communications Inc., Charter Communications Inc., Cablevision Systems Corp., Adelphia Communications Corp., Time Warner Cable, Mediacom Communications Corp., Insight Communications Co. and CableOne Inc. — will eventually do both.

Bourkoff estimated the RBOCs' digital-subscriber-line product is roughly $5 to $10 per month cheaper than cable-modem service.

Lowering prices would cut into MSOs' profit margins on cable-modem service — which range anywhere between 50% and 70% — but offering a telephony product could more than make up the difference.

Telephony also dramatically reduces overall churn for MSOs. On the conference call, Bourkoff estimated that cable's telephony-only customers churn at a rate of 9% per month.

Add video and data to that mix and churn rates drop to 1.5% per month.

Telephony also significantly boosts average revenue per subscriber. According to Bourkoff, monthly ARPU at Cox for bundled subscribers is $130, more than twice the average monthly ARPU of $62.

Offering telephony also increases the upside for cable stocks. Bourkoff estimated that with 30% telephony penetration by 2008, his price target for Comcast would rise by $2.80 (7%) per share.

Assuming 50% telephony penetration, push the price target by $6.22 (15.6%) in 2008.

The increase is a little less dramatic for Cox. Assuming 40% telephony penetration by 2008, Bourkoff's price target for Cox goes up by $1.36 (3.3%). At 50% penetration, the price target rises by $2.69 (6.5%).

While Cox and Comcast (via AT&T Broadband) have been offering a circuit-switched telephony product for years, Bourkoff sees other MSOs entering the telephony picture as voice-over-Internet Protocol technology becomes more available.

Verizon overhang

Most major MSOs have conducted trials on VOIP technology and next year is expected to see the start of meaningful deployment.

Cablevision Systems Corp. looks most aggressive out of the box, with plans to launch VOIP across its entire footprint in 2003. Bourkoff sees motivation in high exposure to a single RBOC: Verizon offers service in 80% of Cablevision's territory.

Cablevision has said it will offer a VOIP product beginning this month and Bourkoff expects telephony to be available across its entire footprint by December 2003. Cablevision plans to initially market the telephony service to current high-speed data customers at a $34.95 price point, about half the $72 per month (including universal service fees and access surcharges) Verizon charges.

Cablevision is expected to offer a bundle of voice and data for $75 to $85 per month, a $5 to $10 monthly discount relative to similar offerings from Verizon.

Hodulik said differences between the two products — network powering, voice quality and the use of inside wiring — don't justify a 100% premium, so Bells likely will cut their prices to about 30% to 40% above Cablevision's price.

Bell hit at core

The success of cable-modem services and the extensive footprint of many of the MSOs — Comcast passes 39.5 million homes and has 21.5 million subscribers — threatens the RBOCs core telephony base.

About 34% of Comcast subscribers are in Verizon territory, but Comcast has subscribers in 25% of all the RBOCs markets.

Comcast currently has the largest cable telephony footprint — 1.4 million subscribers it inherited from its November acquisition of AT&T Broadband. While Comcast has been reluctant to aggressively grow its telephony service — opting instead to focus on video and high-speed data subscribers — that might change next year, Bourkoff wrote in his report.

Comcast now is more exposed to one of the most aggressive RBOCs: SBC Communications. According to Bourkoff, 29.7% of Comcast's subscribers reside in SBC's footprint.

Bourkoff expects Comcast to hold off until 2004 or 2005 to seriously deploy telephony.

At Cox, which has about 839,000 telephony customers, the expectation is continued aggressive rollouts of circuit-switched service, with VOIP deployments in late 2003 and 2004.

Cox already has the highest telephony penetration among top MSOs: 18% of telephony-ready homes and 13% of total subscribers.

Cox has high exposure to the more aggressive RBOCs: 41% of its customers are in SBC territory and 16% are in Verizon markets.

Time Warner Cable also is expected to make an aggressive push for VOIP. The No.2 MSO has been conducting a market trial in Portland, Maine, since May with initial success and is expected to start additional trials in Rochester, N.Y., and the Carolinas in late 2003 or early 2004.

Other MSOs have substantial exposure to RBOCs, but are likely to focus more on internal issues rather than telephony deployment.

Adelphia — which has 49% of its subscribers in Verizon territory — is emerging from Chapter 11 bankruptcy, expected by mid-2004.

Charter, trying to pare $19 billion in debt, is expected to focus on internal matters, despite its successful VOIP trial in Wisconsin. Charter began a VOIP rollout in 2002 and expects to continue to deploy the service in 2004, but Bourkoff wrote "generating financial flexibility is a near-term focus."

Mediacom, which lost 24,000 subscribers in the second quarter to aggressive DBS competition, is likely to focus on winning back video customers than telephony. Mediacom expects to launch a telephony product by June 2004.

Insight has offered telephony since 2001 through a joint venture with AT&T Broadband in four markets — Evansville, Ind., Louisville, Ky., Lexington, Ky. and Columbus, Ohio. Insight said its telephony rollout slowed in the first half of the year, as partner Comcast got "its hands around the telephony business" after taking over AT&T Broadband last November, Insight CEO Michael Willner said.

CableOne, with about 700,000 subscribers, has no immediate plans to offer telephone service. But Bourkoff believes if Qwest Communications Inc.'s video resale partnerships with DirecTV and EchoStar prove successful, CableOne could consider a move into the telephone business. About 30% of CableOne's total subscribers are in Qwest territory.

Cable Phone Subs
In thousands, as of June 30, 2003.
Source: Company reports and UBS estimates

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