Cashing in on digital services: faster rollouts by MSOs may change Wall Street's tune from `wait and see' to `count it now'

Cable World, Nov 20, 2000 by Mavis Scanlon

The new services offered by cable operators -- digital TV, high-speed Internet access and cable telephony -- may finally be catching on. Getting those services to register on MSOs bottom lines, and in their stock prices, is the next hurdle.

In the third quarter, Charter Communications averaged 21,500 digital cable installations per week, an eye-popping 80% increase in the average weekly install rate over the second quarter.

"Demand has exceeded, and continues to exceed, expectations," says Kent Kalkwarf, CFO of Charter. "We think it will continue to drive growth in the future."

Despite Charter's 20% growth in operating cash flow during the quarter, the stock fell 68 cents on the news.

Although the other major MSOs could not boast similar weekly install gains, the rollout of new services is accelerating and is beginning to show signs of getting respect from analysts on Wall Street. Impressive rollout rates were repeatedly mentioned by stock watchers as the overriding trend that stood out during the quarter.

"We're seeing signs that these products and services are finally starting to make headway to becoming a more broad-based consumer phenomenon," says Russ Solomon, VP/senior media analyst at Moody's Investors Service. "We expect this trend will continue." The hopes for revenue growth in the $28 billion cable industry are pinned on the rollout of the new services.

The relatively mature basic cable market is fighting increasing programming costs as well as competition from DBS on the video side and digital subscriber line (DSL) providers on the Internet side. Basic subscribers are growing at the lackluster rate of 1.5% to 2% annually, while rate increases for MSOs have been held in check at 4% to 6%. In addition, the lack of high-profile boxing matches has MSOs turning in weak year-over-year pay-per-view comparisons. It's no wonder revenue from new services will grow increasingly important in the next several years.

How much new revenue can actually be wrung out of these new services, and how soon? Even though unit growth in new services is becoming more visible, investors will want to see proof that revenue generating unit (RGU) growth is actually hitting the bottom line, says David Lee Smith, who follows the cable group at Dain Rauscher Wessels.

That means execution -- from system upgrades to business plan implementation to stellar customer service -- is of utmost importance. Investors have shown time and again they will not continue to pay lofty valuations if they see signs that promises made by cable operators are not being executed.

As a group, the stocks of cable MSOs are down 30% year-to-date. That's far less than the stocks of Internet advertisers or long-distance companies, which are down 80% and 54%, respectively, as of Oct. 10. The decline in cable MSO stocks far exceeds the decline in the Standard & Poor's 500-stock average, which is down 7% year-to-date.

"This is certainly very much of a `what have you done for me lately' market," Smith says. "That market wants to see a translation of the RGUs to actual revenue growth."

Adds Doug Shapiro at Banc of America Securities, "The reason why the very strong unit growth in the quarter didn't drive the stocks more is because you haven't seen enough of an impact" on the profit and loss statement.

That may change as early as next year. Both analysts agree that during the next few quarters, the year-over-year comparisons in revenue generated from new services will begin to make an impact, and that impact will accelerate towards the end of 2001.

By the end of next year, for example, the incremental revenue per subscriber generated by these new services is expected to contribute two-thirds of an MSO's total projected revenue increase, some analysts estimate.

Revenues charge ahead

A closer look at a long-term revenue and operating cash flow model provides a better understanding of the market potential for new services.

Richard Bilotti, an analyst at Morgan Stanley Dean Witter, projects that pro forma revenue for AT&T Broadband's digital services could grow to $1.1 billion in 2005, up from a projected $322.4 million in 2000. He projects revenue from high-speed data and telephony could grow even faster, jumping to more than $1.6 billion in 2005 from $326.2 million this year.

At Charter, one of Bilotti's top picks, it's a similar story. He projects digital cable revenue to grow to $734.8 million, up from an estimated $66.4 million this year. High-speed data revenue, he estimates, should grow to $562.3 million, up from $63.4 million this year. Combined, revenue from digital cable and high-speed data should total $1.3 billion in 2005 for Charter, about 20% of his $6.2 billion revenue projection for that year.

Revenue increases from these new services should certainly off-3set any basic cable subscriber erosion to new pay TV services, says Solomon at Moody's.

Adding to the bullish case for cable operators is an indication of somewhat slowing growth at satellite companies.

Satellite providers grew revenue at a searing pace in 1999, outpacing MSOs by a wide margin. In 1999, combined revenue for satellite providers leapt 55.7% to $5.9 billion, according to Veronis Suhler Associates, an investment bank focused on the media and communications industries. That's an eight-fold increase since 1995.