Cable Needs A Wireless Play

One of the longstanding raps against cable MSOs is that just when they finally start to generate positive earnings, they’ll make new capex-intensive investments. This purportedly upsets investors because it tends to divert cash that might otherwise end up in their pockets. According to Wall Street analysts, MSO share prices have been depressed lately in part because investors fear that the cable operators may spend heavily to build and/or buy their way into mobile wireless.

Thus, when Comcast and Time Warner Cable said on 3 December 2007 they would not bid in the FCC’s upcoming auction of 700MHz spectrum, there was a bump in their shares that analysts attributed to relief that the MSOs were not about to jump into the wireless market.

"I think a lot of people had discounted it, but this is the final indication that they're not going to go out and start a wireless company," said Todd Mitchell, analyst at Kaufman Bros. "I think it's going to be an expensive auction and it's rigged towards the incumbent phone companies, so it's nice to see Comcast remove itself."

"(It) should remove some overhang on the stock as investors were previously concerned about the potential for significant spending, not only in the auction but also on a network build-out," said Thomas Eagan, analyst at Oppenheimer Co, in a research note.

In fact, it made good sense for the MSOs to forego the 700MHz auction because of the FCC’s convoluted rules on how this spectrum will be used. But this does not mean the MSOs will necessarily give up on competing in wireless, nor should they. Here’s why:

Strategic defense. Cable needs an effective competitive response to progress by the big telcos in integrating their market-dominating mobile wireless businesses with their fixed phone, TV, and Internet access services that compete directly with cable.

Growth. Mobile wireless represents an outstanding growth opportunity for cable. There is a lot of money there, at ~$135B in annual US cellular revenues or ~$46/subscriber/month. To translate this into households, since these are cable's subscriber units, given an average of 2+ cellphones per household, each household is generating (again, on average) ~$100 per month in wireless revenues. This exceeds cable's current average of ~$95/subscribing household/month. Clearly, adding mobile wireless would significantly increase cable’s per-household revenues.

Aligned evolution. The evolution of mobile voice into mobile multimedia is well aligned with cable’s own mix of Internet access, TV, and phone products. Mobile operators’ revenues from “data” applications are increasing rapidly, now at ~$19B per year, up 126% from 2005.

Financial returns. Although it does require substantial investment, mobile wireless can produce attractive financial returns. Note, for example, that during the first 9 months of 2007, Verizon Wireless (VZW) produced disproportionately more net cash relative to VZW revenues than the net cash produced by the parent company’s wireline business. In other words, Verizon Wireless is not only profitable, it is subsidizing other segments of the company.

Verizon Financials for 9 months ending 30Sept07 ($Million)
Wireless: Revenues $32,439-> Operating Cash Flow $12,640 - Capex $4,903= Net Cash $7,737
Wireline: Revenues $37,776-> Operating Cash Flow $10,287 - Capex $7,873= Net Cash $2,414
Source: Verizon SEC 10Q. Operating Cash Flow is defined as operating income before depreciation & amortization.

But, you ask, how can cable MSOs compete with the incumbent wireless operators? The answer is, it depends on what they do, but cable does have significant assets that can help:

• an existing subscriber base of 65M+ households
• proven capability to bundle new services with existing services, most recently fixed VoIP phone service with TV and Internet access
• opportunity to create & promote wireless multimedia extensions of their existing TV, phone, and Internet access services
• existing network facilities that can be used to support mobile networks, e.g., for backhaul from base stations
• potential use of aerial cable plant to mount microcells which could substantially increase usable mobile network capacity
• unique capability to provide quality-of-service (QoS) management for in-home traffic that is carried via home WiFi links and cable modems for users with dual-mode cellular/WiFi handsets.
  

Like most publicly-traded companies, the MSOs would prefer that their share values go up, rather than down. But, bottom line, the MSOs need to have a credible wireless play despite initial investor unhappiness. If the MSOs' story is properly told to investors and other stakeholders, and if they proceed intelligently into mobile wireless so that incremental successes can be demonstrated, the short-term hit they may take on share prices will be compensated by higher share values later.

Wireless Weapon in Big Telco v. Cable

The big telcos are taking their first baby steps to exploit their mobile wireless assets in the all-fronts competition with cable operators.

As of the end of 2Q07, Verizon Wireless served 62.1M customers while ATT Mobility served 63.7M. To the extent that the big telcos can bind wireless with their other products, it's likely that they can stanch churn in otherwise vulnerable categories... especially residential and small business fixed phone lines... and boost growth in other areas such as Internet access and multi-channel TV.

In this regard, there have been highly significant institutional changes at both of the telcos. Obviously, as ATT pointed out, its merger with BellSouth enabled ATT to acquire complete control over their formerly jointly-owned wireless operator, thus allowing more flexibility to exploit opportunities for marketing and technical convergence between wireless and fixed products.

Changes at Verizon are more subtle but are also significant, despite VZ's inability to date to buy out Vodafone's share in VZW. During the last year, c-level executive transfers from Verizon Wireless have infused the leadership ranks at the Verizon Communications mother ship. These include Dennis Strigle, president and COO, formerly president and CEO at VZW; John Stratton, EVP and CMO, formerly VP and CMO at VZW; and Richard Lynch, EVP and CTO, formerly EVP and CTO at VZW. Such transfers import a hyper-competitive attitude from the wireless side. They also encourage greater appreciation for potential synergies between wireless and other VZ products. Ironically, while these c-levels were at VZW, they most likely vociferously resisted efforts to associate their own fast-growing wireless with mature and boring fixed products. Given their new responsibilities, they probably now see the cost/benefit ratios of convergence somewhat differently.

Examples to date of converged wireless + fixed products from Verizon:

• Calling plans that include unlimited home-to-mobile phone calling. Single wireless + wireline services bill.
• Bundling for price discounts of various wireless plans with one or more of home phone, Internet access, and TV

Examples from ATT:

• Bundle of fixed local and LD phone, AT&T Yahoo! DSL, and AT&T Mobility wireless. Sold online only.
• "Unity" calling plans with unlimited calls to/from ATT's "calling community" of 100M wireless and wireline phone numbers, available to both residential and small business customers in AT&T's 22-state service footprint.
• ATT Mobility handsets with capability to access ATT Yahoo! portal can select and schedule TV content downloads to an ATT Homezone DVR receiver.

Such examples are not especially novel conceptually. Similar features have been discussed in connection with the Pivot mobile wireless service being introduced by cable MSOs and Sprint. However, they are significant because they are finally beginning to appear in the market and because of the big telcos' massive presence in wireless, still totally unmatched by anything on the cable side. For their part, the MSOs' Pivot venture has had a run of bad news. Time Warner announced recently that subscriptions to Pivot have been underwhelming and Sprint stated that it would not offer Pivot in any additional Sprint stores. The MSOs also possess spectrum that they purchased in last year's AWS auction but they have not yet announced how they plan to use this resource.

Every time cable stocks lose value in the market, pundits point out that one of the reasons is that investors fear operators will make big investments in wireless. Strategically, however, such investments may be unavoidable as well as highly beneficial to the MSOs, both defensively and offensively. Mobile wireless is one of the most vibrant and lucrative segments in the complex of info-telecoms-entertainment businesses; cable MSOs have assets they can bring to the party and they should be going after their share.

AT&T plus Echostar: Dumb Money

There are rumors afoot that AT&T might buy Echostar, or maybe DirecTV, as a shortcut to obtain a meaningful subscriber base in multichannel video services. Why would AT&T do this? One reason might be that AT&T's ongoing buildout of its hybrid-fiber-wirepair network for U-verse is seen as progressing too slowly to make a difference in its strategic competition with cable. U-verse's 126,000 subscribers as of September 2007 are a long way down from the millions served by the larger cable MSOs and by the DBS operators, which translates into much higher per-sub programming costs. Perhaps more significantly, AT&T is accustomed to carrying the biggest guns in each of its markets. Being the little, tiny guy in video is uncomfortable culturally for the biggest kahuna in fixed and wireless telecoms.

It is true that by offering Echostar's DISH (in the former SBC territories) and DirecTV (in former BellSouth territories), AT&T can claim to have a video play that serves a respectable ~1.9M video subs. But these are, after all, DBS subscribers. AT&T is only one of several DBS distribution channels.

By acquiring Echostar and its 13M subs, AT&T would gain immediate entry in its own right into the club of big multichannel video service providers, with all that that entails. Buying DirecTV and its 16M subs would make it the second largest video provider, after Comcast.

Either way, Echostar or DirecTV, this would be a big blunder for AT&T. While each of the DBS operators is a highly credible competitor in linear multichannel video, the game is changing to include interactive, on-demand and bundled products. In these areas, DBS is crippled. The DBS operators have no effective response to VOD; downloading video content to DVRs for replay later does not compare in terms of connvenience or choice. They have no broadband Internet access solution that can compete in the data rate arms race with cable and Verizon FiOS. While the DBS national footprints are an advantage for Echostar and DirecTV as national providers, AT&T could only exploit the DBS coverage within its own regional area for purposes of bundling with its telecoms and Internet access products. Elsewhere, AT&T would simply offer DBS service, probably less effectively than current DirecTV or Echostar managements.

Echostar's market cap is currently north of $20B. Charlie Ergen can be expected to demand a healthy premium such that AT&T's total acquisition cost for 100% of the company would likely approach or exceed $30B. What else could AT&T do with this money? Well, with this kind of investment, AT&T could upgrade its network build-out to provide truly competitive broadband connections to subscribers, like Verizon FiOS does with its fiber-to-the-premises. AT&T has put forward its hybrid-fiber-wirepair network architecture as a much lower cost (and therefore smarter) approach than Verizon's FiOS, so adopting Verizon's approach after all might be embarrassing for some AT&T execs, at least for awhile. And it would take 3-5 years before AT&T could show results from this investment. By comparison, it might seem easier to buy Echostar (or DirecTV), avoid the embarrassment, and obtain a quick hit of millions of video subs now; but, to paraphrase Richard Nixon, for AT&T's long-term strategic interests, this would be the wrong choice.

Who's going to buy Yahoo?

There was speculation a few weeks ago that Microsoft had Yahoo in its sights. There were denials all around and maybe it wasn't so. But, this terrific online asset (full disclosure: I own Yahoo shares) is likely to attract other media players that current lack a large scale web presence.

My bet for Yahoo's most likely and most logical buyer is on GE. You heard it here first! Consider that GE's NBC Universal is beginning to exploit its broadcast network/studio assets on the web, most recently through the announced venture with News Corp, but otherwise GE has yet to establish a significant online presence. A media company that has ambitions to become and remain a major force in the information/entertainment/communications field has to be on the web, where much of the action is and where Yahoo is still the world's largest destination. GE’s strategy is to be the biggest in each of its markets and I expect GE will decide that being a heavy hitter on the web is key to its future role as a major media company. Buying Yahoo would instantly establish GE as a big web player and, moreso than most potential acquirers, GE can afford it.

Unless it changes course and unloads NBC Universal, I think a huge online acquisition like Yahoo is in the cards for GE, and it’s hard to think of a web business more like Yahoo than Yahoo itself.

Internet TV

The current stage in the evolution of the new medium of Internet TV reminds me of cable circa 1980, with a range of elements coalescing to produce something new, something very big. The signs are clear: (1) major content suppliers are piling on, (2) devices and systems are being introduced to enable viewing of Internet content on TVs in addition to PCs, (3) Internet TV aggregators are building audiences and devining ways to monetize their ever-increasing content, and (4) advertisers are spending an increasing share of their ad dollars on Internet TV sites.

Internet TV is a long way from matching, let alone replacing, the cornucopia of TV content delivered by multi-channel providers, whether through linear TV or VOD. But it is taking shape as another distribution channel for video content. It is a potentially significant competitive challenge for cable on multiple dimensions, but it also represents a terrific opportunity for major cable operators to extend their footprint as TV distributors. Given that there is no way to "beat" Internet TV, the best approach for cable may be to join in on the fun.

Ways to do this: Create niche websites. Acquire Internet TV aggregators that already have a foothold. Enhance MSO portals.