Charting the Next Frontier

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The annual ritual of pre-holiday investor conferences came to a close last week, with one common theme seeming to permeate the cable presentations: new technology rules.

Sure, there was the usual touting of year-to-date financial performance, some 2004 financial guidance and the occasional dig to pricey programmers. But for the most part, the MSOs that presented at the two conferences — held simultaneously between Dec. 8 and Dec. 11 by investment banks UBS Warburg LLC and Credit Suisse First Boston Corp. — spent most of their time trying to sell investors on the vast revenue and cash-flow potential of video-on-demand, digital video recorders, HDTV and cable telephony.

All of the cable operators that presented at both conferences last week unveiled voice-over-Internet-protocol plans for next year, with some being more aggressive than others.

Even Comcast Corp., which has put the telephone service it inherited in its acquisition of AT&T Broadband a year ago on the back burner, said it saw huge potential in VoIP.

Comcast already has about 1.25 million circuit-switched telephone customers left over from AT&T Broadband, and executive vice president and co-chief financial officer John Alchin said at the CS First Boston conference Dec. 9 that the service has finally achieved profitability.

Alchin said that in the third quarter, the telephone service has 15% operating cash flow margins, setting a goal of 25% OCF margins in 2004. But it is unlikely that Comcast, which has been focusing successfully on stemming subscriber losses at the former AT&T systems and rolling out new products, will expand its circuit switched footprint.

Alchin said Comcast already has VoIP service in suburban Philadelphia, and will expand that service to Hartford, Conn.; Springfield, Mass., and Indianapolis in 2004, with a broader rollout scheduled for 2005.

While that may be a little behind its MSO peers, Alchin added that Comcast has learned a lot from its circuit-switched business.

"This is not a greenfield project that requires us to get up and running," Alchin said.

But Alchin seemed much more enthusiastic about new video services like VOD, subscription VOD, HDTV and DVRs.

Rollout Rates

VOD is currently available in 50% of Comcast's markets, expanding to 80% in 2004. HDTV, now in front of 75% of Comcast customers will grow to 90% next year and DVRs, now available to 10% of subscribers will be 100% available in 2004.

Comcast's DVR numbers are impressive and, contrary to some thinking, actually enhance the VOD product, Alchin said.

In Alexandria, Va., for example, Alchin said that Comcast has achieved 10% DVR penetration in just five months, averaging 1.2 DVR boxes per household. In addition, he said, 46% of DVR households in Alexandria use the VOD service as well.

In Naples, Fla., Comcast said DVR penetration was 4% in the first month of deployment.

Alchin was equally bullish on HDTV, adding that in Philadelphia, 10 HD channels are currently available with more on the way.

Cablevision Systems Corp. telecommunications division president Tom Rutledge also was high on DVRs, adding that the Bethpage, N.Y.-based MSO would roll out the equipment in 2004. That's on the heels of an aggressive VoIP introduction.

Cablevision plans to make the VoIP service available to its entire high-speed data footprint by the end of the year, offering an all-in local and long distance package for $34.95 per month.

Rutledge said the returns on the VoIP service — which currently has about 5,000 customers — can be substantial.

VoIP Margin: 40%

He estimated that operating cash-flow margins on the VoIP service would be about 40%, adding that the projection is conservative. That return is substantially lower than the 60% to 80% margins some MSOs see on high-speed data, but it is expected that VoIP margins will rise over time.

Rutledge estimated that incremental costs for VoIP service would average about $150 per customer, about $50 each for cable modems, the soft switch to deliver the service and truck rolls for installation. But as cable-modem prices continue to plunge — Rutledge said that they are more like $30 each now — and more customers self-install the service, those costs could be substantially lower.

But even at $150 in incremental costs, the cash flow per subscriber of $15 per month translates into a 10-month payback period for the service.

Cablevision also reversed its stance on DVRs, saying it would likely roll out Scientific Atlanta Inc.-supplied boxes as early as April.

Rutledge told reporters at the CSFB conference that the MSO probably could have rolled out DVR-enabled boxes sooner, but opted to wait. He added that he didn't believe the products would be as popular as they are.

Cablevision also feared that the DVR product would cut into its VOD offering.

Time Warner Cable, which began an aggressive rollout of DVRs earlier this year, said the boxes have been flying off the shelf.

DVRs Draw Crowds

At the CSFB conference, Time Warner Cable chairman and CEO Glenn Britt said that lines at Time Warner's Manhattan customer service center on 23rd Street stretched around the block one Saturday morning.

"As fast as we get these boxes, they're going out the door," Britt said.

But most investors were more interested in Time Warner Cable's VoIP plans. Last week, the MSO said it had reached an agreement with Sprint and MCI to deliver a cable telephony service that will be priced around $39.95.

At the UBS conference Dec. 11, Britt said that he expects the telephone service to reach cash flow break even in its second year of operation and to generate positive free cash flow in the third year.

"There is not a large fixed cost," Britt said. "There is a lot of room to play with costs, down and up."

Britt told investors that the rollout will be carefully staged.

"Next year is about getting ready for business," Britt said. "2005 is when we can start stepping on the marketing accelerator."

While Time Warner's VoIP service will be priced less than the rival local exchange carrier offering, Britt said there is room to drop prices if need be.

"We can go very low and still make money," Britt said.

Post-Beta At Cox

For Cox Communications Inc., which has perhaps been the most successful MSO in the switched telephony arena, VoIP also is on the agenda.

Cox's VoIP service in Roanoke, Va., has just left the beta testing stage, and executive vice president and chief operating officer Patrick Esser said an active marketing campaign for the service will begin at the end of the month.

HDTV also has big potential: Esser estimated that between 300,000 and 500,000 customers were expected to buy HD sets in Cox's footprint in 2003.

"This is a wakeup call for Cox," he said. HDTV is currently available in 85% of Cox's footprint.

Cox launched DVRs this year in four markets and expects to add four additional markets by the second quarter of 2004.

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