The Industry Standard

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If one thing is sure, it’s that the cable industry is filled with leaders and innovators who are pushing forward their companies with new services and operational strategies. But each year, there’s one MSO that stands out just a little bit more because of their sometimes-daring exploits, tenaciousness and creative drive. Multichannel News pays annual tribute to those leaders with its Operator of the Year honor.

This year, there was little question that Time Warner Cable deserved that designation. In the following pages, the MSO’s executives explain why they’re willing to stay at the front of the pack with new technology rollouts, how they are maneuvering through potential regulatory quagmires to roll out their Digital Phone service, and how they’re finding new ways to market an increasing number of products. This has not been an easy year for any MSO, but for Time Warner Cable, serving 10.9 million customers clearly means 10.9 million reasons to stay ahead of the game — if not a few million more.

It was a warm, sunny day in late August at Time Warner Cable headquarters — nestled on the shores of the picturesque Long Island Sound in Stamford, Conn. — and chairman and CEO Glenn Britt looked almost giddy.

Maybe it was the weather — it was the first rain-free day in the Northeast in what seemed like weeks — or maybe it was the fact that annual company picnic for Time Warner’s Stamford employees was just a few hours away.

But as Britt and three of his fellow executives (vice chairman and chief operating officer John Billock, chief financial officer Landel Hobbs and executive vice president of corporate affairs Lynn Yaeger) began to speak, it was quickly evident that their enthusiasm wasn’t in anticipation of the three-legged race or the water balloon toss (two actual picnic events). They were genuinely excited about the promise of the cable business.

That is not an enthusiasm that is necessarily shared by all cable investors, who have driven down the industry’s stocks by nearly 12% in the first eight months of the year, panicking over everything from satellite and telephone competition to basic-subscriber losses.

The rest of the cable industry helped fuel that panic with second-quarter basic-subscriber losses that far exceeded expectations — the eight publicly traded MSOs lost a combined 230,000 basic customers during the quarter — while satellite companies added nearly 800,000 new subscribers.

Time Warner Cable fared better than most of its peers, losing 21,000 basic subscribers in a quarter that is traditionally slow as college students and snowbirds return to their summer homes. Only Cablevision Systems Corp. added subscribers during the period, about 7,500.

Britt did not write off the subscriber losses; Time Warner Cable says it expects subscriber growth to be flat for the year. But he also put the declines in perspective. As a 30-year veteran of the cable industry, Britt has a lot of history to draw from.

“If you look at the market for multichannel video, that’s a very mature market,” Britt says. “Depending on what survey you believe, 85% or 90% of the homes have purchased that from either cable or satellite or, in some cases, both of us. So that market doesn’t inherently have a lot of growth left in it.”

While there is still healthy growth in new homes, Britt says that basic-subscriber growth has been flat at Time Warner Cable for the past couple of years.

“While we are losing some market share, it’s not like 20 years ago when all of these homes hadn’t bought that product,” Britt says. “To compete, what we need to do is very simple: I think we need to become much better marketers — I think we’re better than we were a couple of years ago, but we need to get much better at that. We need better customer service, and we need to keep introducing new products.”

Time Warner has certainly excelled in introducing new products — it leads the industry in digital video recorder penetration (with 591,000 DVR customers in the second quarter); it is in the throes of rolling out cable telephony service, and it continues to gain traction in subscription video on demand and other services.

TECHNOLOGY PIONEERS

Time Warner has always been the technology leader in the cable industry — it developed the hybrid fiber-coax technology that all cable operators use today. And it has been at the forefront of digital and SVOD deployment. That technological leadership is not about to change, Britt adds.

“Having been the technology leader, that is also a never-ending process,” Britt says. “I think we’ve gotten very good at rolling out new products. Yes, there are logistics involved, there’s training involved, but it’s pretty amazing what you can do once you set direction and get people pointed in the right direction. Yes, it’s a challenge, but it’s a challenge of organization and execution.”

But just what is the big deal about being innovative anyway? Time Warner Cable has sunk millions of dollars into new technology over the years, while other operators have sat back and waited for those new technologies to take hold before rolling them out. And then there are the technological projects that don’t work out. Time Warner Cable had big plans for its server-based video-on-demand technology Mystro, but pulled the plug after it discovered that obtaining rights for server-based content would be an extremely onerous task.

While Britt agrees that wait-and-see strategy has worked well in the past for some operators, he says the game is much different now.

“In the old cable business, [innovation] didn’t matter so much,” Britt says. “But today, when we’re in such a competitive environment, having new products and being there fast and early is really important. I think we’re going to see more innovation from satellite companies, particularly with News Corp. buying DirecTV [Inc.]. I think the [regional Bell operating companies] are gradually getting focused on innovation. We’re going to see competition for new products that consumers respond to. It isn’t going to work anymore to just wait and watch and say 'I’ll do it later.’”

Yaeger says that innovation is an integral part of Time Warner’s corporate culture.

“It goes back to the heritage of the company,” Yaeger says. “Qube, the Full Service Network, Mystro, we’ve always been years ahead.”

Yaeger was referring to three past Time Warner technology initiatives — Qube was the first interactive television service, introduced in Columbus, Ohio, in the 1970s; the Full Service Network was another interactive venture, this time in Orlando, Fla., in the 1990s; and Mystro, a server based on-demand video project was trialed earlier this year in Green Bay, Wis. All three projects were scrapped by the parent company, but provided invaluable information into interactive technologies.

“Sometimes [innovation] doesn’t always work out, because it’s inherently more risky than laying back and drafting as quickly as possible,” Billock says. “That kind of thinking today is changing a bit for everybody because the pace of change is geometrically faster. You can’t afford to be too risk averse. You have to be highly creative, you’ve got to know when to pick your spots, and hopefully more times than not we’ll make the right investment and development decision.”

As an example, Billock used Time Warner Cable’s aggressive rollout of IP telephony service — currently in 21 markets and expected to be available across the entire 10.9 million-subscriber footprint by the end of the year.

“When we got into the phone business, we were driving IP-telephony technology, we worked this very hard to get it ready for primetime,” Billock says. “It was not an easy task for our technologists and our technology partners. But guess what, we did it because we thought that speed to market was an essential element for our company.”

Citigroup Smith Barney cable analyst Niraj Gupta agrees, adding that it could be more dangerous for an operator not to invest in innovation, given the current competitive environment.

“No one has an unlimited amount of capital to spend, but in areas that are clearly important to customers, a company needs to pick its battles that they want to focus on and they’ve got to try to be first to market, or certainly close to that, with products that matter,” Gupta says.

Gupta points to Time Warner Cable’s aggressive rollout of DVRs as an example.

“Time Warner was pretty early with DVRs, relative to the rest of the industry,” Gupta says. “On the Comcast side, Comcast wasn’t particularly bullish on the DVR concept and neither was Motorola [Inc., Comcast Corp.’s largest set-top box supplier]. The combination of the two put Motorola way behind the curve in terms of deploying that product. And it’s hurt cable clearly.”

Gupta acknowledged that sometimes investments in new technology won’t work out. And while he says there are consequences, they are much higher for not being an innovator.

“Wall Street is going to punish you if you waste money on something no one wants, but it’s going to really penalize you if you’re falling behind in the competitive battle.”

Sanford Bernstein & Co. cable analyst Craig Moffett adds that innovation, especially in today’s competitive environment, can translate quickly in to more customers.

“The winners are going to be the ones who are the most nimble and the best at adapting their marketing strategy on the fly,” Moffett says. “Time Warner right now has more lines in the water than anybody else in the cable industry and that’s likely to help them catch more fish.”

THE NEXT HOT THING?

The latest technological marvel is video telephony, which several companies like Ojo and Viseon Inc. are rolling out equipment for its deployment. Time Warner is getting into the fray by offering a video Instant Messaging feature for its high-speed Internet customers.

The videophone has been around for about 40 years — AT&T introduced an experimental videophone at the 1964 World’s Fair. But it hasn’t caught on because of the cost and problems with transmission technology.

Britt says that Time Warner Cable is not going to rush blindly into the videophone market, but that it does see a future in video applications for its high-speed data product.

“[Videophone] never really worked before, it was always pretty clumsy,” Britt says. “There were behavioral factors that were issues. Whether or not it’s the next hot thing, we’ll have to see. The great thing about our business is there are hundreds of things we can do. Our challenge is to pick which ones we want to do first [and] see what the consumer reaction is. Before anyone stands on the mountain and pronounces this is the next great thing, they better make sure the consumer actually wants it.”

While Time Warner Cable gets points for innovation, its consistent financial operating metrics have kept it in good standing with analysts. Part of the Time Warner Inc. media and online juggernaut, the cable operations have reported consistent revenue and cash-flow growth and have at times propped up the parent company’s underperforming assets.

Not that Wall Street appears to be taking much notice. Priced at $16.45 per share on Sept. 13, Time Warner stock is down about 10% this year and is 15% off its 52-week high of $19.30.

CALL FOR NEW METRICS

Having an underperforming stock despite showing strong financial metrics is nothing new in the industry — most of the publicly traded MSOs are in the same boat. But it has caused some operators to call for analysts to use metrics beside basic-subscriber growth to measure health.

Hobbs says that analysts shouldn’t ignore traditional benchmarks — revenue, cash-flow and free-cash-flow growth. They should just add a few more to the mix.

“They will tend to pick a particular metric and only focus on that in any one given quarter,” Hobbs says of Wall Street. “There probably is no one 'killer’ metric, you’ve got to look at a host of different things.”

Hobbs says that analysts should drill deeper into the numbers to determine financial health, looking at metrics like advanced digital average revenue per unit (ARPU), total ARPU out of the home and further down the road, total cash per passing. He adds that non-financial metrics, like customer satisfaction indexes should also be given more weight.

Given cable’s past history, tying your stock price to customer-satisfaction ratings appears to be a sure path to the cellar, but Hobbs says that shouldn’t be the case.

“There is a correlation. If you’ve got higher customer satisfaction, you’re going to see a reduction in churn, which is going to improve your operating results and margins,” Hobbs says.

Gupta says that customer satisfaction is playing an increasingly important role, and pointed to one of the better performers in customer satisfaction surveys, Cox Communications Inc. That MSO is in the process of being taken private by its parent company, Cox Enterprises Inc.

Moffett is a little skeptical of using customer satisfaction as a performance metric.

“Customer service rankings for cable have never been as bad as people think,” says Moffett, who does not cover Time Warner stock. “A lot of the complaints you get from cable customers are about price more than customer service. Cable gets saddled with people who don’t like the pricing of multichannel in general and they are voting on the fact they don’t like paying for TV. I take it with a little grain of salt.”

But Moffett agrees that Wall Street should look beyond the traditional metrics when evaluating cable companies, including customer relationships.

“Other than Cox, nobody in the cable industry has done a good job talking about total customer relationships,” he says. “A customer paying you $40 per month for high-speed data at an 80% margin is even more valuable than the customer paying you $35 per month for expanded basic at a 60% margin.”

Billock, who is in charge of operations, says the customer satisfaction doesn’t necessarily mean ranking higher on the J.D. Power customer satisfaction survey. There are other ways to track customer satisfaction, he says.

“We have our own surveys, we actually do mathematical customer surveys monthly — outage numbers, phone stats and we watch that on a monthly basis,” Billock says. “We also do surveys which reflect the J.D. Power approach — what is our overall satisfaction, what are the components of satisfaction. It’s not coincidental that our happiest customers are the customers that buy more from us. It’s not coincidental that a triple-play customer churns the least. It’s a simple dynamic, but one where we have to constantly focus our marketing and development efforts.”

DIVISIONAL TEAMS

While corporate is doing its part to better customer relationships, the real work is done at the system level. And Time Warner Cable has a strong divisional management team that is doing just that.

Improving customer service doesn’t just mean answering complaints quicker and making sure installations are done right and on time. Providing the services and programming that customers want is a big part of it too.

For example, executive vice president Bill Goetz, in charge of Time Warner markets in Texas, Los Angeles and Memphis, Tenn., says in the San Antonio market, Time Warner Cable introduced a Spanish-language tier — called Más Canales — to compete with ethnic offerings from direct broadcast satellite competitors DirecTV and EchoStar Communications Corp.

“We were able to assemble different Spanish-language programming and keep the margin such that if some people decided they wanted just that tier, we were OK with that,” Goetz says. “The whole idea was to make sure that our Hispanic community knew that we were the place to go for the programming they were interested in, not just the Dish guys.”

In Hawaii, executive vice president Jim Fellhauer (who is also responsible for the Green Bay, Wis.; Hawaii; Jackson/Monroe, Miss.; Kansas City; Minneapolis; National; Nebraska; and San Diego systems) says Time Warner Cable is offering a local cooking show that is wildly popular with customers.

Fellhauer says that a division president in Jackson, Miss., devised a way for lower-income customers to better pay their bills — allowing them to pay on a weekly instead of monthly basis or allowing them to pick the day on which their bills arrive, to coincide with the day they receive their paychecks.

“All of our divisions really think about how they can better serve the customer,” Fellhauer says.

Better serving the customer also means using the platform in creative ways, says executive vice president Carol Hevey, whose territory includes Cincinnati, Columbus, Northeast and Western Ohio and Milwaukee.

“In our southeast Wisconsin division, we took the VOD platform and created a local on-demand service, Wisconsin On Demand, which has just done phenomenally well in viewership and acceptance by the community,” Hevey says. “It really leverages our digital platform and our video on demand product, and it was something that wasn’t necessarily thought of when we first launched video on demand. The division locally and the folks in Wisconsin found a way to take that and make it better than we thought it could be.”

In the Southern California division, Goetz says that the systems there created a free-on-demand platform with lifestyle programming, including yoga, meditation and spiritual programming.

Time Warner Cable president Tom Baxter says that having the executive vice presidents together in Stamford allows for quick decision making. (Although executive vice president Barry Rosenblum is mainly in New York, he has an office at headquarters.)

“There is so much going on now and there are so many changes and so many adjustments you have to make during the year, it’s great to be able to get everybody together on short notice and say, 'Hey we just learned something, we want to try this new marketing campaign or this new offer,’ and be able to quickly communicate face to face,” Baxter says.

Rosenblum, in charge of most of New York State, including Manhattan, adds that the divisions tend to talk to each other as well. “Good ideas tend to spread rather quickly,” Rosenblum says.

Baxter says the executive vice presidents are asked to travel out to the field as well — he says an informal agreement exists that each will visit every one of their markets at least once per quarter.

RAINBOW DEBATE

While Time Warner Cable has made strides in bringing diverse programming to its subscribers, it has been in the news lately for one channel it pulled off the air — for about 10 days — in the Manhattan system, the Madison Square Garden Network. While that dispute is still pending — Time Warner agreed to put the channel back on its systems after reaching a tentative agreement with MSGN parent Rainbow Media Holdings, no deal has been worked out yet.

Rosenblum says that dispute also has some tie-in to customer service.

Rainbow had proposed raising rates for the channel to $4 per subscriber per month for MSGN and its sister network Fox Sports New York, according to some reports. Time Warner had been paying $2.90 per month per subscriber for the two networks. Time Warner balked mainly because of the diminishing value of both networks — they lost the National Basketball Association’s New Jersey Nets and Major League Baseball’s New York Yankees to the Yankees Entertainment & Sports network. And they could lose the MLB’s New York Mets after the 2005 season.

“Cablevision didn’t have the Yankees for well over a year, and their business is doing well,” Rosenblum says of a similar regional sports dispute between Rainbow’s parent and the YES network. “If we didn’t have MSG, business would be fine. They have a relatively small yet vocal audience. For the greater good, it is important that we take a position that doesn’t allow programmers, whether they’re regional or local or national, to cause us to have to raise rates an excessive amount.”

As part of the Time Warner media conglomerate, which includes cable networks, a broadcast network [The WB] and several local television stations, a movie studio and vast magazine and book publishing operations, Time Warner Cable is unique in that it is one of the only truly vertically integrated companies in the sector. But that doesn’t mean that the cable business is cutting sweet deals with the content division or vice versa.

“Time Warner isn’t about synergies in the sense that you crunch businesses together and pretend they are the same business,” Britt says. “Clearly there is a stronger relationship between cable and the Turner networks and Warner Bros. and AOL, but that doesn’t mean we’re in the same business and do the same things everyday. There is an economic relationship. The reason to have these things in one company is that dealing with the production part of the movie business is inherently very risky. By having control of distribution, you reduce the risk.”

NEW CORPORATE ERA

Synergy was a much more loaded word after the 2001 merger with America Online, which notoriously tried to force divisions to work together and failed miserably. But now that many of the executives from the AOL regime are gone, synergy is encouraged but not mandated.

Since Richard Parsons was named Time Warner Inc. CEO, “We have a much more collaborative environment than what we had before — Time Warner was famous for feuding fiefdoms,” Britt says. “Dick has brought a new sense of calmness and maturity to the company, where we are all talking together and doing things together.”

Still, Britt says that his company and AOL are working together.

“The relationship between AOL and cable is really the same,” Britt says. “AOL is grappling with the transition from dialup to broadband, at the same time trying to maximize the dialup business. We are working together.”

Parsons’ successful effort to bring down Time Warner Inc. debt also took some pressure off of the cable operation. The parent company had once contemplated spinning off the cable unit into a separate publicly traded company, in part to help it raise some cash to pay off debt and to allow Comcast Corp. to monetize its 21% stake in the cable operations without Time Warner having to pony up any cash. That plan was put on hold after the Securities and Exchange Commission began an investigation into questionable accounting practices at the AOL unit (allegedly done well before the Time Warner merger). But the Time Warner Cable IPO isn’t as pressing an issue as it once was, because Time Warner has successfully paid down a large portion of its total debt. (It’s now at $16 billion compared to $20 billion a year ago.)

THE ADELPHIA FACTOR

But one way Time Warner could create a public currency for its cable company is through a reverse merger with Adelphia Communications Corp.

In early September, Time Warner chief financial officer Wayne Pace noted that type of scenario is a possibility.

“With regard to Adelphia, you’ve read and even heard [Parsons] talk a little bit about that one way might be to give up equity in our cable company to the public shareholders of another company through this approach that is like a reverse merger,” Pace said at the Morgan Stanley Media & Communications conference in New York. “But any of that has to be balanced against our commitment to a strong balance sheet and balanced against our commitment that any investment has to pass our own rigorous internal return on investment analysis or we’ll walk away from it.”

The auction for Adelphia’s 5.4 million cable subscribers — expected to raise between $17 billion and $20 billion — began earlier this month. Other possible bidders include Comcast, Cox and Charter Communications Inc. Several smaller cable operators and private equity firms are also expected to participate.

Time Warner has made it clear that it wants to grow — both Parsons and Britt have said publicly several times that they want to expand the cable footprint. But Britt says they won’t charge into the Adelphia auction haphazardly.

“We will take a look at Adelphia,” Britt says. “Whether Adelphia or any other property is available at a price that makes sense, remains to be seen. Yes, we would like to get bigger in this business, but we’re going to be very disciplined in our dealmaking. There is no point in getting bigger to get bigger. That is the way we will approach Adelphia, or anything else on the market.”

If Time Warner does become a successful bidder for all or part of Adelphia, it will be its first big cable acquisition since 1995, when it purchased CableVision Industries for about $2.6 billion in stock and assumed debt.

Time Warner was not a big participant in the consolidation craze of the late 1990s largely because Wall Street was pressuring the company to divest of its cable operations. It is pressure that Britt is glad Time Warner did not succumb to.

“If you think about the classic idea that you should buy low, that was a period when cable was very much out of favor,” Britt says. “If you go back and read the press at that time, Time Warner and [former CEO] Gerry Levin really were attacked pretty heavily for doing that transaction. It turns out the prices at which we bought those out were very good. When you’re engaged in a transaction, you need to have a good sense of what you think the business is going to do and what you think the right value is and stick to that. If the prices get too high, then you don’t do a transaction.”

Time Warner purchased CVI’s 1.3 million subscribers for about $2,000 per customer, less than half the valuations cable companies were getting in the late 1990s.

That type of disciplined approach has passed on to the new regime at Time Warner Cable and its parent. Regardless of what ultimately happens with Adelphia, the philosophy remains the same: Instead of paying inflated prices for instant growth, the company will continue to focus its resources on what it knows best, new product development, advanced services and customer satisfaction to produce steady long-term gains. And that should keep Britt and his team smiling for years to come.

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