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.