PHONE COUNTS SOAR

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Wall Street got its first peek at the growing power of cable telephony when Time Warner Cable reported second-quarter digital phone customer additions last week that blew away analysts’ estimates, possibly setting the stage for other MSOs that are just beginning to roll out the product.

Time Warner Cable reported 242,000 telephone additions in the quarter, ending with 614,000 voice-over-Internet protocol customers. That far outpaced analysts’ estimates of 180,000 additions in the period.

That robust growth also is expected to bode well for Comcast Corp., which just began to aggressively market its telephone service.

In an Aug. 3 conference call with analysts to discuss second-quarter results, Time Warner media and communications group chairman Don Logan said that the voice additions show no signs of slowing down.

“We are marketing aggressively now across our entire footprint … the strong growth that we’ve had in the first half is evidence of that,” Logan said on the call. “The demand for our VoIP product has been strong and we think it will continue to be throughout the balance of the year.”

Overall, the numbers for Time Warner Cable were impressive — revenue growth of 11%, cash-flow growth of 10%, 144,000 new digital-cable customers (its biggest spike since 1993) and 201,000 new high-speed Internet customers. It was the second consecutive quarter of 200,000-plus high-speed Internet additions for Time Warner.

COMCAST IMPRESSED

Comcast also reported second-quarter results last week and was equally impressive — revenue was up 10% and cash flow rose 13%. Comcast also added 284,000 digital-cable subscribers in the period and 297,000 high-speed Internet customers.

Sanford Bernstein & Co. cable and satellite analyst Craig Moffett said Time Warner’s telephone subscriber growth should translate well to Comcast.

Comcast, which reported its earnings the day before Time Warner, added about 15,000 VoIP subscribers in the quarter. That was offset by the loss of about 13,000 circuit-switched customers Comcast inherited in its 2002 merger with AT&T Broadband.

Comcast has about 1 million circuit-switched telephone customers, but is downplaying that technology in favor of VoIP.

Earlier this year, Comcast said it would put VoIP service in front of about 15 million homes and expected to have about 250,000 digital phone subscribers by the end of the year.

In a conference call with analysts last Tuesday to discuss second quarter results, chief operating officer Steve Burke said Comcast was on track to meet those goals.

“We’re now in full deployment mode,” Burke said of the VoIP rollout.

Moffett estimated Comcast was about six to nine months behind Time Warner in the digital phone rollout with twice Time Warner’s footprint.

“By this time next year, Comcast should be — at least in theory — at least matching Time Warner’s subscriber-growth rate, and by the end of next year should be doing close to twice that,” Moffett said.

Moffett said that Comcast should be compared to Time Warner moreso than the other cable-telephony leader, Cablevision Systems Corp. (which reports its second quarter results on Aug. 9), because their phone strategies are nearly identical.

“Investors are more likely to look to Time Warner as a benchmark for Comcast, because Time Warner is using a more restrained pricing strategy that is more similar to the one that Comcast is likely to use,” Moffett said. “Cablevision has been much more aggressive in pricing. I think investors are hesitant to see Comcast go down that path.”

Moffett was also encouraged by digital and high-speed data growth at both Comcast and Time Warner. Demand for those products was thought to be in decline.

“The fact that the flagship digital offering is still adding subscribers at an accelerating rate is an indication that the consumer value proposition for digital is getting better and better,” Moffett said. “Two years ago, digital was nothing more than a bunch of extra channels. Today it’s DVR, it’s HDTV, it’s video on demand and there is a laundry list of reasons to get digital beyond just more channels and a multiplex of HBO.”

Time Warner also sowed improvements in basic-subscriber growth, losing just 5,000 basic customers in the seasonally weak quarter, compared to a loss of 10,000 customers last year. Comcast shed 77,000 basic subscribers, compared to 92,000 one year ago.

Moffett said the Time Warner basic-subscriber numbers were significant given that the MSO gained about 25,000 basic customers in the first quarter.

“For the first half they swung from a 10,000-subscriber loss [in 2004] to a 20,000-subscriber gain,” Moffett said. “While statistically that may not be all that significant, optically it makes a huge difference to the investor community.”

Adding to the enthusiasm is that subscriber growth at one of cable’s biggest competitors, DirecTV Group Inc., is beginning to slow.

DirecTV added 225,000 net new subscribers in the second quarter, far below the 300,000 many analysts expected and its lowest subscriber growth since the second quarter of 2003.

DirecTV said the slower growth was due to a more stringent credit-checking policy and the churning off of non-paying customers. Churn in the second quarter was 1.69% per month, compared to 1.43% in the same period last year.

DirecTV hinted after its first-quarter announcement that growth would slow down, but most analysts didn’t expect it to be quite as dramatic.

“People are probably too quick to connect the dots between satellite-subscriber growth and cable-subscriber losses,” Moffett said. “DirecTV’s weaker subscriber growth came from its higher churn rate in its subscriber base, which was largely a function of its involuntary disconnects. But in some ways, it suggests that the gains DirecTV had over the last year haven’t been entirely at cable’s expense. They have largely been bringing new customers into the category, a good number of whom had questionable credit.”

DIRECTV TRIMS SAC

DirecTV appeared to sacrifice subscriber growth for financial performance. In the second quarter, revenue was up 33% to $2.9 billion and cash flow nearly doubled to $505 million.

In addition, subscriber-acquisition costs were down to $646 per subscriber — compared to $656 per customers in the first quarter — and retention marketing expenses were down 17% year-over year to $5.11 per subscriber.

Moffett cheered DirecTV’s new strategy.

“This is a positive step toward a more sustainable economic model,” Moffett said. “People could look back on the DirecTV second-quarter earnings a year from now and say this was a watershed moment for the whole multichannel industry,” he said. “This marks a decisive step away from the promotional brinksmanship that has been gripping the video sector for the last year and suggests we could be moving toward a more stable and attractive economic future.”

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