Kagan's Column: Cable and Telcos Spy Each Others' Turf—but Only One Sees Green

Cable World, Feb 7, 2005

By Paul Kagan

What's in a name? Marketing potential, of course. So cable operators are giving up on something the public won't grasp--VoIP--and calling it Digital Phone instead. Comcast, Time Warner, Rogers and Bright House are already on board, but it won't be an industry trademark; the telcos use it too.

And that's good. The public already has enough trouble with new terminology like whatever-on-demand, enhanced vs. high definition, LCD/DLP/plasma/HD and that indecipherable family of frequencies starting with 802.11 and ending in a, b, e or g. (Did they leave out "f" for obvious reasons?) Better yet, nexgen 802.11, appropriately lettered "n," will be ready by March 2007, exposing the weakness of its ancestors with 4-5x greater speed at 100 Mbps. Hopefully, it will go through walls, too.

There's no question that the civil phone war is on, even if it hasn't hit the front pages yet. Comcast CEO Brian Roberts told analysts at Citigroup Smith Barney's meeting in Phoenix Jan. 10 that Comcast will have phone service passing 15 million homes by the end of this year, and all of its footprint by the end of 2006. Marketing will be node by node, with expected penetration of 20% (8 million subs) by year five, with a 40% operating margin on revenue of $40/month/sub. "That's five years," Roberts said. "It took us seven for high- speed data." But he's hardly giving up on yesterday's modem. "Our target market is nearly 40 million high-speed customers," he said, followed by the secret words built into no analyst projections: "You don't have to have cable to sign up for the modem."

The telcos got there first, creating a triple play by selling DBS video signals to their phone subs. But Verizon, SBC and BellSouth are taking three different routes into the video overbuild business. VZ is spending billions to get fiber direct to the home; SBC, working with Microsoft, hopes to drive IP video to the set over DSL; and BellSouth is trying to make up its mind. "We like what we see in IPTV," BellSouth chairman/CEO Duane Ackerman said in Phoenix, "but the question is how do you make money at it? We're going ahead [with satellite video] while we sort out which technology is best to use, because we need to be in the market against cable. It won't boost our earnings but it gets us in the market. Satellite helps get people to drop cable, so we can sell them DSL."

It has taken the telcos more than a decade to decide they really need to do something. And Ackerman voiced the RBOC mantra: "The shift from wireline to wireless and from narrowband to broadband--targeting the consumer market--seems like the right thing to do." He noted a remarkable stat: wireless, long- distance, broadband and Yellow Pages account for 65% of BellSouth's revenues. "So will DSL lead your marketing, rather than local phone line?" one analyst asked. Ackerman's reply: "Ultimately, everything will be running on broadband connections. We live in a world where ring tones are a $2.5 billion business in the U.S. It costs more for the tone than to download the whole song!" Two other observations describe the challenge facing the telcos. Regarding satellite video's ability to generate free cash flow, he said, "We don't make a lot of money, but there's no downside. We haven't bolted out of the gate because we want to be sure we can make money in video." And, a fundamental problem that has long held the telcos back: "We intend to keep our dividend growing. We also intend to pay down debt. We also intend to invest money in our business. All three of those are on the table." That's a tougher triple play to sell than the satellite package.

P.S.: By year-end 2004, the avg. monthly revenue per sub for major MSOs was $70-80 , so new, bundled voice subs could represent a $115-$125/month household this year. It's no wonder the telcos are pressured to "be in the market."

An added thought on overbuild hurdles. CableLabs' David Reed told SCTE Emerging Tech attendees in Huntington Beach, Calif., on Jan. 12 that "telcos' advanced video technology over DSL needs loop lengths shorter than 8,000 feet. In Italy, 90% of the phone loops qualify, but in the U.S., only 35% of telco local loops are that short. That's why some RBOCs are going with fiber to the home. Telcos may choose to enter video on a breakeven basis to maintain service viability. What they really want are nexgen TV applications based on IPTV and DVR viewing. That's a leap from existing technologies."

Analyst/investor Paul Kagan is chairman/CEO of Kagan Capital Management, Inc. in Carmel, Calif. He owns shares of Comcast, Time Warner and Rogers. Information in his columns is not intended to be a recommendation to buy or sell securities.

[Copyright 2005 Access Intelligence, LLC. All rights reserved.]