Ahead of The Curve

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Five days before Cox Communications Inc.’s corporate parent announced plans to take the company private, CEO Jim Robbins was in his office, fielding a reporter’s questions about the cable company’s future and playing his cards close to the vest.

Asked whether or not Cox, the nation’s fourth-largest operator, was a buyer or might be a potential seller, Robbins replied, “Our game plan is: We like this business a lot,” later emphasizing how much parent company Cox Enterprises Inc. loved the cable industry.

<p>Cox at a Glance</p><p>As of June 30</p>

Homes Passed

10,441,754

Basic Subs

6,262,688

Digital Subs

2,278,523

Residential HSD

2,246,109

Phone Subs

1,133,650

Bundled Subs

2,473,373

On Aug. 2, family-run CEI, the MSO’s biggest shareholder with a 62% stake, displayed that love with an $8-billion offer to buy out the 38% of the cable company it didn’t already own.

Robbins declined further comment for this story after Cox announced its plans to go private.

HAS SET THE PACE

Public or private, with 6.3 million subscribers, Cox has been a cable-industry paragon for how to shrewdly compete and thrive in what’s become a brutal marketplace.

Ensconced in a leafy corporate park in Atlanta, Cox boasts one of the highest basic-subscriber growth rates in the industry. Although it lost a net 54,000 basic customers in the second quarter, Cox is projected to increase basic distribution by just under 1% this year, in the neighborhood of 0.8%. That’s considered real growth in cable these days.

Binding customers with its pioneering discounted bundle of three services — video, voice and data — Cox’s churn rate has stayed low.

And in an industry long branded as poison to consumers, Cox executives proudly tout two recent J.D. Power & Associates awards (for telephone service) like badges of honor.

Despite all that, Cox and CEI officials have long lamented that Wall Street hasn’t given the MSO its due.

Prior to CEI making its initial $32 per share offer, the MSO’s stock price was languishing in the $28 range, not far from its 52-week low.

As a private company, Cox can pursue its “to-do” list this year and not be hamstrung by the short-term Wall Street metrics that make it hard for the MSO to complete with direct-broadcast satellite providers and the telcos.

“Cox will have the ability to go a little faster, to spend a little more money and to have more pricing power,” says UBS Warburg analyst Aryeh Bourkoff. “They’ve done very well with the bundle where they’ve offered it, but it’s only available in half their markets with voice. So Cox is approaching a strategy where it would be more aggressive in other markets in rolling out voice — in rolling out the full bundle — in order to drive down churn and boost returns.”

Cox executives have some ambitious plans for the rest of this year — and beyond.

Earlier this month, Cox took an aggressive swipe at its rivals in the high-speed data and dial-up arenas by essentially upgrading its offerings at no extra charge.

Using the slogan “Fast is Beautiful,” Cox increased the speed on its flagship $39.95 bundled data service and is rolling out a lower-speed $24.95 “value” tier in most markets, even opening up the less expensive offering to non-cable subscribers.

“We think there’s a lot of opportunity for people to switch from dial-up to broadband, but in order to do that, it’s not one size fits all,” says Dallas Clement, Cox’s senior vice president of strategy and product development. “We have to segment.”

This strategy of offering inexpensive high-speed data service to noncable homes got a warm reception on Wall Street.

“The $24.95 Value package, I’m guessing, is going to be pretty successful getting dial-up customers,” said Citigroup Smith Barney analyst Niraj Gupta. “We always felt these cable companies were leaving a lot of food on the table by effectively pushing you into having to pay $50 to $60 for high speed.”

But that’s just one step. Cox is also doing what Robbins reportedly calls “polishing the stone or diamond”: improving the MSO’s video offering.

SVOD IS COMING

Cox is expanding the clusters where it offers video on demand and plans to launch subscription VOD starting this fall. So far, Cox has closed a deal with Home Box Office and Cinemax for SVOD.

“We’re very excited about getting subscription video on demand for the premium product to our customers coming this fall, and looking at ways to deliver other content,” said Joe “It’s-the-bundle-baby” Rooney, Cox’s senior vice president of marketing.

Cox is also enlarging its digital video recorder footprint, to 95% of its markets by year’s-end.

On the programming front, Cox is in the process of recasting its Spanish-language tier, in an effort to increase penetration among Hispanics, a key demographic in many of the operator’s key clusters.

The MSO also is examining creating premium broadband content, tailored to individual subscribers.

Finally, as part of the update of its beloved bundle — “Bundle 2.0,” as Clement puts it — Cox wants to make the bundle “more sticky” by integrating features like caller ID or e-mail to the television.

The perennial question about Cox is whether it is big enough to survive long term. By going private, the MSO won’t be in the market to buy any systems, none of Adelphia Communications Corp.’s clusters, for example, for several years.

It seems Cox’s mantra remains “big isn’t always beautiful.” As Robbins cautions: “Witness AOL Time Warner.”

Being big sure helps in negotiations with programmers, though, because size secures volume discounts on license fees. But Gupta noted that Cox’s recent long-term contract renewals with ESPN and Fox Sports Net, which he says average out in the 5%-6% range in terms of increases, give the MSO more of a comfort level in terms of future program costs.

And if the MSO had ended up paying a hefty sum for any Adelphia systems, that would have outweighed any upside from scale that Cox would have gained, according to Gupta.

“If it costs you too much to make an acquisition, then at the end of the day the benefit that you get from lower programming costs you’ve given away by overpaying in a transaction,” he says.

REVENUE GAINS

Although Cox’s basic-subscriber numbers have dipped, the MSO last month reported strong revenue and cash-flow gains in the second quarter. Revenue rose 12%, to $1.6 billion, and operating cash flow gained 16%, to $616 million.

During the quarter, Cox added 60,300 digital customers, to hit 2.3 million total; 97,500 high-speed Internet customers, bringing that total to more than 2.2 million; and 66,260 phone customers, to 1.1 million.

Among cable operators, Cox hasn’t been shy about meeting its adversaries head on, programmers included. The cable company last year was engaged in a bitter public dispute with ESPN over the sports giant’s annual 20% rate hikes. Then in February, Cox and ESPN resolved their differences when they struck a pact that called for lower rate increases, reportedly in the neighborhood of 7%. Several other operators have announced similar deals since then.

With the recent Fox Sports Net deal, Cox has sewn up most of its programming contracts for the near term, with some exceptions. A few weeks ago, Oxygen Media chairman Geraldine Laybourne paid Robbins a visit at the MSO’s headquarters.

“She was in this office yesterday, with [Oxygen president] Lisa Hall, telling me about all the great things they’re doing about Oxygen,” Robbins says. “They’ve got contract negotiations going on with us, so they’re covering all their bases, which is very nice. But the way we operate is, that’s [Cox senior vice president of programming] Bob Wilson’s province.”

The dress code at Cox’s headquarters may be casual and laid back, but the corporate culture instills cutthroat competitiveness against the enemy: namely, DBS and the telcos. Around the building are signs for the “CIA,” which stands for Cox Intelligence Agents.

Cox chief operating officer Patrick Esser jokes that those signs are supposed to come down when there’s media in the building.

Under the CIA program, Cox’s employees are fed information about rivals and services, be they DBS or DSL, and are encouraged to proselytize about cable’s superiority outside work.

“We kid about it,” Esser said. “The goal is, many times you’re at a dinner party and someone says, 'I’m thinking about getting DSL.’ You can explain the benefits of a cable modem versus DSL. You’re very valuable to our company at that time.”

In fact, Clement claims that Cox’s espousal of the pro-cable gospel in Atlanta is probably benefiting the city’s resident cable provider, a certain Philadelphia-based MSO.

“We have over 1,000 employees in Atlanta: I think we can meaningfully move the penetration for Comcast [Corp.],” Clement says.

“I seriously think we have,” Esser shot back, in jest.

Earlier this year, Robbins even told Wall Street analysts he wears a CIA belt clip.

On the marketing and sales side, Cox has also proven aggressive and innovative. The MSO has tried several approaches to marketing HDTV, including using retail consumer-electronics outlets. Cox started out selling HDTV set-tops at retail, but now offers just the service at retail stores, leasing the boxes to consumers for $6 a month on top of digital.

“We have HDTV out to 90% of our footprint today, and we’re adding 9,000 to 10,000 HD customers a month,” Esser said. “It’s a very robust service.”

In Phoenix, Cox hired college students to hawk the cable system’s HD service at electronics stores on weekends.

In San Diego, Cox has partnered with Sony Corp. and Major League Baseball’s San Diego Padres to promote HDTV. Cox bought an HD production truck produce the more than 100 Padre’s games that run on its local network, Channel 4, in high-def. The Padres have also set up Sony HDTV sets throughout the team’s home field, Petco Park, and Cox is giving a year’s worth of HDTV service to consumers who buy Sony HDTV sets in that market.

“What we’re learning in San Diego and Phoenix is this is a show-me product,” Rooney said.

DEDICATED TO SALES

In terms of overall sales, a number of Cox’s clusters now have created dedicated sales forces — manned by employees trained in sales and who work on commission — to field consumer calls relating to Cox’s services.

“When you put real sales people in a market, and a fair amount of their compensation is at risk, that really drives bundled sales,” Rooney said.

There is internal competition between these dedicated sales teams, who all have nicknames. It’s the “sharks” in San Deigo, the “scorpions” in Phoenix, the “vipers” in Tucson, Ariz., and the “hurricanes” in Virginia.

While Cox was a forerunner with circuit-switch telephony, modems and the bundle, it has been slower than other MSOs deploying VOD and voice-over-Internet protocol service. Cox officials said they’d rather take their time rolling out products that may still be a little “buggy” than tarnish the MSO’s reputation for good service.

“We’ve tried not to differentiate ourselves based on getting the early adopters,” Clement said.

By the end of the year, 48% of Cox’s digital homes will have access to VOD, or “entertainment on demand,” as the MSO calls it, according to Esser. VOD is now in seven Cox markets.

Cox has been slower to roll out VOD because it was focused on phone service and high-speed Internet service, he added. “We had so many business opportunities in front of us that our priorities may have been different than other MSOs.”

It’s a similar story with VoIP. Cox has already deployed the service in Roanoke, Va., and plans three or four more VoIP launches this year.

Cox officials said that they were in the voice market early, successfully, and hence have no imperative to rush into VoIP.

“Eight years ago, we had the balance sheet to go after circuit switch,” Clement said. “No cable company had the gall to go after the ILEC’s [incumbent local exchange carrier] business, but we did. We rolled out circuit switch broadly in the markets where the business models made sense.”

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