AT&T to Nudge Up Tech Spending

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It's not often one hears a died-in-the-wool cable executive uttering the words, "We think telephony is a better business than high-speed data."

But that's exactly what AT&T Broadband CEO William Schleyer told analysts at a Salomon Smith Barney Inc. retreat two weeks ago. Schleyer and Broadband chief operating officer Ron Cooper offered analysts with more details on the MSO's 2002 capital-expenditure and technology priorities, in advance of its merger with Comcast Corp.

News that AT&T Broadband would "moderately" increase its capex budget in 2002 had vendors breathing a sigh of relief. The Denver-based MSO had virtually shut off its spending spigot in 2001.

"The [AT&T capex] forecasts this year show a nice return," said Arris Group Inc. senior vice president of marketing and communications Mike Horton. "They will be at least back where they were at the end of 2000. Because they dropped so low in 2001, this means a nice return."

AT&T has targeted Boston, Chicago and San Francisco for complete buildouts, Cooper said. Operating chiefs in those three markets now report directly to Cooper.

"We're focusing on markets where we have the best opportunities," he said.

That will help AT&T expand its high-speed-data universe from 62 percent of homes passed to 70 percent by year-end, and would bring its telephony footprint from 34 percent of homes to 40 percent. Most of the capex money will be spent completing those rebuilds, Schleyer said

The MSO's strategy with respect to ongoing operations and focused rebuilds is designed to improve operating margins, as well as to give Comcast the platform its wants when it takes control of AT&T Broadband's systems.

AT&T plans to refine its digital-video pricing and packaging strategies, which will help improve margins, Schleyer said. Bringing certain customer-care and sales functions in-house will be another priority, said Cooper.

"Customer service has slipped a little bit," Schleyer added.

The company has already hired 50 in-house customer-service representatives in Boston, and is looking at a similar strategy in Chicago and San Francisco, Cooper said.

"We need first-call resolution and better training," he said.

The company also may expand its e-care program, which handled 500,000 queries via the Internet during the Excite@Home Corp. high-speed-data switchout.

Although the Boston, Chicago and San Francisco rebuilds will receive the most attention, Cooper said, Seattle and Denver could also get capex monies.

But AT&T's strategy to increase its margins from the mid-20 percent range to 30 percent before Comcast takes the reins seems to center on increasing telephony and data penetration in some of those major markets, as well as improving customer service to retain more subscribers.

"We think we can get to industry-level margins in fourth-quarter 2003," Schleyer said.

Telephony penetration exceeds 20 percent in 20 AT&T communities, said Cooper. In Chicago and Salt Lake City, it has reached 28 percent.

Meanwhile, data penetration stands 15 percent in San Francisco, 14 percent in Boston, 12 percent in Seattle and 11 percent in Denver, he said.

ENHANCED REVENUES

But Broadband's telephony footprint is about half the size of its data footprint. That fact — coupled with telephony's improving economy of scale — led to Schleyer's bullish assessment of telephony.

"It's got a higher revenue per subscriber," he said. "It's got similar margins and currently, we've got deeper penetrations.

"The fixed costs of the telephony business are largely behind us," he added. "We can scale to quite a few million subscribers." (The company recently passed the 1 million subscriber mark.)

"The subscribers come on at a very high incremental cash flow and the variable costs also start to come down," Schleyer concluded.

The average telephony subscriber produces about $300 in earnings before interest, depreciation, taxes and amortization (EBITDA) each year. That figure will climb to the high $300s by 2005, Schleyer said.

Today's telephony-related capital costs of slightly under $700 per home will drop to more than $500 by 2005.

"The scale economics work the same way for data," he said. Still, the heavy investment in telephony cost AT&T Broadband five margin points, Schleyer acknowledged.

Schleyer said AT&T's data business reached EBITDA breakeven in third-quarter 2001, but took a hit in the fourth quarter, thanks to the Excite@Home migration. Telephony will break even in the first quarter, he said.

AT&T saved $2 per month from switching out its Excite@Home cable-modem to its own network, which includes backbone support from AT&T Business Services under a contract that runs through 2003. Schleyer said the deal is a market-rate contract.

The $60 million the MSO spent to switch out high-speed-data subscribers would be split between AT&T Broadband and AT&T Business Services, he said. But the new network allows for delivery of multiple ISPs and tiered pricing, as well as other new revenue-producing services AT&T has been developing, Schleyer said.

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