(excerpted from PDS Consulting 2009 New Year's Day paper to Friends & Colleagues)
- Stock market still doesn’t “get” cable.
- Mobile wireless in cable’s future.
- From Internet TV: Growth or dumb piping.
- The coming of convergence.
The Market
By December 2008, shares of Comcast, our proxy for the US cable industry, were 56% of their 1999 value, their lowest end-of-year level of this decade. Meanwhile, cable’s average revenues per basic subscriber were up, with Comcast’s 2.58X higher than in 1999[1], as more subscribers bought cable’s triple play of digital video, broadband access, and cable telephony.
In earlier New Year’s notes[2], I argued that the market was undervaluing the MSOs’ strong market position and growth potential. This disconnect persisted during 2008, a year that in economic terms qualifies as a full-fledged Queen Elizabeth II annus horribilis. Despite the recession, 2008’s parting gift, the facts about cable that the market doesn’t “get” are still valid and therefore are not repeated here. However, things can change.
When Internet access and cable telephony were added to cable’s original hybrid blend of TV broadcasting and common carrier, “cable” took on a new meaning. The National Cable Television Association (NCTA) was re-named National Cable and Telecommunications Association (still NCTA!). Now the cable industry’s boundaries may shift again due to mobile wireless, Internet TV, and convergent services.
Mobile Wireless in Cable’s Future
Why mobile wireless matters to cable:
- Quadruple play, adding mobile wireless to fixed TV, broadband, and phone, has proven highly successful for operators outside the US .
- According to a recent national survey, 17.5% of US households are now wireless-only; Over 30% of adults aged 18-29 live in wireless-only households; Among households with fixed and wireless phones, over 20% receive all or almost all calls on cell phones[3].
- Wireless is a magnet for innovation, VC investment, and market buzz. It’s the next new thing for multiplatform advertising and distribution of multimedia content.
- Competitive vulnerability: The big telcos have mobile wireless and the MSOs don’t. Before too much longer, cable’s triple play will be trumped by attractive quadruple play offers from AT&T U-verse/AT&T Mobility and Verizon FiOS/Verizon Wireless. Verizon is now negotiating programming content deals that encompass both FiOS TV and mobile distribution. Growth of cable telephony will be eroded by wireless substitution.
Among US MSOs, only Cox has announced that it will build mobile wireless network facilities in its service areas. Cox’s mobile wireless initiative will set precedents for cable operators in testing features, pricing, and bundling options. Cox will also determine availability and cost of roaming agreements with incumbent wireless operators for calling that occurs outside of Cox’s initially-limited service areas.
For now, the other major MSOs are following a different path. Comcast, TWC, and Bright House (along with Intel and Google) recently purchased minority shareholdings in Clearwire, which is now building a 4G WiMax network. Using the Clearwire network, these MSOs plan to offer data-centric nomadic and mobile extensions of their fixed Internet access services. If they decide to add mobile voice, which is vital to compete with the incumbent wireless operators, the MSOs may do so as re-sellers of Sprint’s 3G network capacity.
The MSOs’ Clearwire-based strategy is not a slam-dunk. A WiMax network operator will have higher cost and sparser choice of equipment than operators employing the much more widely adopted LTE (Long Term Evolution) 4G wireless technology. In the US , three of the four largest wireless operators have stated they will deploy LTE, leaving only Sprint/Clearwire with WiMax. Both Alcatel-Lucent and Nortel have decided to allocate their technology development resources to LTE while reducing their spending on WiMax. Fewer handsets will be available for WiMax (or WiMax plus 3G voice) than for the competitive 3G and 3G/LTE systems.
To compete effectively, the MSOs must have flexibility to implement their own features and pricing priorities for wireless voice, data, and multimedia without having to rely on third-party network operators that have separate agendas such as Clearwire and Sprint. On this, we’ve heard discouraging words from Clearwire’s CEO who said that its [ MSO ] shareholders “do not have the ability to direct the activities of the company nor is their approval required to undertake major business initiatives such as where or when we build our network[4].” The Clearwire deal may provide a useful learning experience but is unlikely to get the MSOs where they need to be.
Alternatively, the MSOs could buy Sprint. It would immediately establish the MSOs as credible mobile wireless competitors to own the third-largest US wireless operator with 41M mobile wireless subscribers, nationwide spectrum, a nationwide 3G mobile wireless network, plus its 51% ownership of Clearwire, a worldwide Tier 1 Internet backbone network, and a large Long Distance telecoms business. Because of well-publicized problems and the overall stock market debacle of 2008, Sprint is cheap. Its market cap has shrunk to $4.6B[5], down 88% since its peak on the first trading day of 2008. Given Sprint’s $23B enterprise value (market cap plus debt less cash), each Sprint subscriber is currently valued at $579 (10 months of postpaid per-subscriber revenue), as compared to Comcast’s $3,094 (28 months). For Comcast and other MSOs that might take this leap, integrating and managing Sprint would be a major challenge; however, given the cable operators’ unique assets, it is not beyond their abilities. It would be a game changer for the industry.
Getting serious about mobile wireless will require substantial MSO capital investment, a prospect from which Wall Street invariably recoils. To appease the analysts, MSOs ritually take the pledge not to violate the No-New-Major-Capex taboo. But kowtowing to this taboo is getting in the way of cable operators’ making decisions that are optimal for their shareholders. Given a well conceived, communicated, and executed strategy for the MSOs’ market entry in mobile wireless, eventually Wall Street will accept that the required investments are necessary and will pay off.
From Internet TV: Growth or Dumb-Pipe
US viewers watched 9.5 billion videos online during November 2008[6] during which time they were not watching cable’s TV channels, VOD , or advertising. While the majority of these Internet TV videos were probably transmitted over cable’s high-margin broadband connections, most also involved no direct technical or business participation by cable operators, indicating the risk that cable systems could become dumb pipes for Internet TV content. No-one wants to end up as a dumb pipe.
There’s still time to get this right, from cable’s perspective. Professionally produced TV content that is available online does not yet match the programming on cable; the good stuff that you want to watch online is still hard to find; the picture quality of impulse-selected streamed video is still subject to impairments; Internet TV business models are still evolving and some video aggregators will fail; and there is not yet a convenient-enough way for consumers to be able to watch Internet TV on their new flat screen HD TVs.
On the other hand, progress is being made on each of these gating factors. For example, since consumers are generally reluctant to accept another set-top box, Netflix has now arranged to deliver its online content to TVs via existing in-home devices including Microsoft’s Xbox 360 game console, an LG Electronics DVD player, and/or a TiVO DVR, as well as through its dedicated set-top box from Roku. On choice of online TV programming, while Netflix’s selection of 12,000 titles is much smaller than its DVD library due to licensing restrictions, I suspect (without side-by-side checking) that it is at least comparable to the selection available via cable VOD . If you like NBC series such as 30 Rock, you can see complete episodes on Hulu.com shortly after their original NBC broadcast, and with less intrusive commercial interruptions.
In defensive mode, MSOs have complained about paying cable carriage fees to programming networks whose video content can also be consumed online for free. Some cable programming networks are responsive to such hints and are pledging to limit the content that they make available online. Cable operators are also effectively (if not necessarily intentionally) slowing growth of Internet TV by what they are not doing, i.e., by not supporting reception of online content on cable set-top boxes, and by not marketing a home networking product that would facilitate TV display of PC and online video content.
MSOs can participate proactively in growth of Internet TV by negotiating with online content partners to provide higher-tier, more reliable delivery of their premium content. Cable operators have technical means to accomplish this since they manage the QoS (quality of service) of their broadband access connections. This is sensitive politically because net neutrality proponents would likely accuse the MSOs of discriminating against non-affiliated sites or against sites unable or unwilling to pay for higher-level connections. To reduce political risk, until now the MSOs have shied away from offering such deals.
However, on balance the cable (and telco) ISPs will likely prevail if they seek to exploit this opportunity. After all, the ISPs’ network facilities were built with their own risk capital. Good-better-best options are common in the marketplace and generally are not perceived as discriminatory. To stay on the right side of net neutrality, the ISPs would allow any online content provider to select (and pay for) the higher-tier broadband connections on equivalent terms. The ISPs would also perpetuate the status quo by placing no restrictions on user access to any online destinations.
Another proactive step is for major MSOs themselves to become providers of online infrastructure and content. For example, Comcast has moved deliberately to establish a significant online presence by acquiring online assets including thePlatform (video content management, transcoding & syndication), Plaxo (online address book and social networking), Fancast.com (online TV), Fandango (movie trailers and tickets), and FearNet.com (online & multiplatform horror TV). Comcast has also upgraded its portal, Comcast.net, at which users can find “over 137,876 videos” among other attractive features.
The Coming of Convergence
Convergent services variously combine TV, Internet, phone, and mobile wireless components in a new product category.
Such services have been discussed for a long time but, for various reasons, they have not yet made a significant appearance on US cable systems. Now conditions are becoming more favorable for wider deployment, potentially generating additional revenue streams from advanced advertising, subscriptions, and transactions.
Examples: A PCCW ( Hong Kong ) subscriber can purchase a movie theatre ticket on a TV channel that shows movie trailers, download the “ticket” to his or her wireless device, and show the ticket information as a barcode when entering the theatre. TV Caller ID provides information about an incoming phone call on a subscriber’s TV set so that the subscriber can decide whether to heave himself off the sofa to pick up the phone or allow the call to go to voicemail. With Integra5’s MediaFriendsTM TV Chat, a new application that will combine elements of TV, social networking, and mobile wireless, like-minded viewers can coordinate their watching of the same TV shows and communicate with their buddies by texting SMS messages that appear on all of their TV screens.
One of the obstacles to rapid deployment of interactive services has been non-standard video operating environments across cable’s disparate local systems. To create a national footprint for interactive services, CableLabs’ “tru2way” middleware platform is being installed on new consumer electronics devices, including new set-tops. Meanwhile, pending availability of the new devices, CableLabs’ less fetchingly named EBIF (Enhanced Binary Interchange Format) specification will enable interactive TV and advanced advertising apps to run on millions of legacy set-top boxes that have limited memory and processing capacity.
Convergent applications will come sooner, better, and in greater quantity, once MSOs have practices in place that welcome innovations from third-party developers. Among their New Year’s resolutions for 2009, the MSOs might include a task to implement such practices, along with taking another look at strategies for mobile wireless and for Internet TV.
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[1] Comcast operating cash flow margin also has increased, to 40% (same as in 2007), from 34% in 1999.
[2] See Telling Cable’s Story _ 1 January 2008 , Re-valuing Cable_ 1 January 2007 , and Why Cable Shares are Undervalued_ 1 January 2006 , at www.pdsconsulting.net.
[3] Blumberg SJ, Luke JV. Wireless substitution: Early release of estimates from the National Health Interview Survey, January-June 2008. National Center for Health Statistics. Available from: http://www.cdc.gov/nchs/nhis.htm. 17 December 2008
[4] CEO statement was made during conference call with analysts on 1 December 2008
[5] As of market closing on 24 December 2008
[6] Nielsen data, in Advertising Age, “Hulu November Viewers Down, but Total Viewing Up,” by Michael Learmonth, 22Dec08.
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