Cable Tv: A Crisis Looms
James L. Dolan, chief executive of Cablevision Systems Corp., professes not to have a care in the world. The head of the country's sixth-largest cable operator, based in Woodbury, N.Y., on Long Island, says he's not worried about satellites, telephone companies, debt, or any of the ominous forces that he and other industry executives are battling.
A tanned, cheerful man, who recently took over day-to-day management of Cablevision from his father, industry pioneer Charles F. Dolan, Jim Dolan reaches for his remote control. He is about to show off the latest cable gizmo, the digital set-top box that will enable cable operators to offer many more channels and new, revenue-producing features like movies on demand. But Dolan has trouble working the device. "I'm not doing it now," he says, fumbling with the buttons as he points the remote control toward the unresponsive Sony television set in his office. But "I'm giving you a vision of the future." After a concerted effort, Dolan does successfully order up Mr. Smith Goes to Washington.
STARTING TO DELIVER. If only all the glitches at Cablevision were as easily solved. Its stock has slipped 29% in the past year, and 1995 operating cash flow didn't cover even a third of its debt-service payments and capital expenditures. Worse, just to have a chance of surviving in the nasty competitive environment for cable, Dolan says he'll spend $460 million this year to upgrade his systems. Nonetheless, he says: "We're on the offense."
If it is true that the best defense is a good offense, then cable certainly needs the best offense it can muster. To be sure, cable companies have always faced high debt levels and tough fights with regulators. But now, regulations are being rolled back, and cable's monopoly-like hold on 67% of U.S. households is being seriously threatened by an array of new competitors. And the worst may be yet to come, as fearsome rivals such as Rupert Murdoch's News Corp. and MCI Communications Corp. work to launch American Sky Broadcasting, yet another direct-broadcast satellite service, in late 1997 or early 1998.
At the same time, many cable operators are suffering weaknesses in their operating results, which harms their ability to roll out quickly new technologies that require hugely expensive upgrades to their existing wires. How expensive? Schroder Wertheim & Co. cable specialist Philip Sirlin estimates that together they have to spend about $25 billion just to install hybrid fiber-coaxial cable and interactive capabilities. That is roughly equal to the industry's entire annual revenue. To date, he estimates, only about 25% of this work has been done.
That huge cost helps explain the string of delayed or never-delivered new services, such as interactive TV, cable modems, digital set-top boxes, and telephone service, that has left the industry with little credibility on Wall Street. A three-year index of the stock of large cable operators trails the Standard & Poor's 500-stock index by 60%.
The only way cable moguls such as Dolan, Tele-Communications' John C. Malone, and Time Warner's Gerald M. Levin can wriggle clear of their current predicament is to roll out their long-promised new services--fast. The two most viable are cable modems, which deliver high-speed Internet access to PCs, and digital set-top boxes, which transmit better sound and pictures and allow cable operators to offer many more channels than in the past. Those new revenue streams are "there for us to take," says Continental Cablevision President William T. Schleyer. Those who can't move quickly "will have blown it," he says. "As an industry, we'd just hand over our business to the telephone companies."
This fall, most major cable operators are finally beginning to deliver the goods--though with limited offerings in only a handful of markets. Time Warner Inc. launched its Road Runner cable-modem service in Akron, Ohio, in early September, and Tele-Communications Inc. began offering cable-modem service to customers in Fremont, Calif., that same month. TCI will launch the first digital cable service on Oct. 21 in Hartford, Conn. Cablevision already provides telephone service to 350 commercial customers on Long Island. Also this month, Philadelphia-based Comcast Corp. will begin offering cable modems to nonpaying customers in a Baltimore test, with actual commercial service planned by yearend.
With new products coming to market, most in the cable industry don't accept forecasts of their decline. Even if new revenue streams are slow to emerge, there is still growth potential from traditional cable subscribers, they say. Currently, only two-thirds of the 95 million cable-ready homes subscribe, and Time Warner, especially, thinks it can find new customers as young people, more accustomed to paying for TV than their parents, increasingly head their own households. "This industry has been pretty scrappy, pretty nimble," says Time Warner Cable Ventures CEO Glenn A. Britt--the most senior executive at that company willing to speak about cable's prospects. "We are going to do a lot better than people think."
After all, the upgraded cable systems, with their huge capacity, offer many advantages over the wires owned by the telephone companies. "Cable operators have a distinct advantage because they are the ones with the fat pipe," says Motorola Inc.'s James M. Phillips, a vice-president with the company's Multimedia Group, which supplies cable modems to Time Warner. "In the digital world, speed defines everything. The more you [can] flow, the better your multimedia, video, graphics." Unencumbered by financial constraints, cable as a technology is a winner. And major banks appear comfortable with the industry's prospects. Says James B. Lee, head of global investment banking at Chase Manhattan Corp., the largest commercial lender to the cable industry: "Cable companies have always run very comfortably at these debt levels. They have almost infinite liquidity in the bank market."
But access to more debt capital certainly isn't the answer to the cable guys' troubles. They have plenty of other worries. Consider the two largest--Tele-Communications Inc. and Time Warner. TCI's Malone energized the industry in 1992 by predicting a world of 500 channels by 1994. That never came to pass, and a $35-a-share acquisition offer from Bell Atlantic Corp. fizzled as well. TCI now trades at about 14 1/2, and the wily cable mogul is finding himself uncharacteristically boxed in. He has to spend billions to upgrade TCI's network--$1.9 billion in just the past year--even though continuing such spending will likely depress the stock price further.
Given this, TCI has no plans to rush forward with new services in most of its markets until there is proven customer demand. "The market will tell us when it is ready for the services it wants," says Brendan R. Clouston, CEO of TCI's cable systems unit. Over the past few years, TCI has quietly scaled back its once ambitious expansion and now will spend only in areas where it can expect a quick payoff. "We have all the money we need [for our plans]. We're not running around in any kind of a panic," says Clouston.
But some in the industry believe Malone is looking for a way out, most likely by spinning off TCI's sexier divisions, such as satellites and programming, and selling the core cable systems--if he can find a buyer. Malone "has made the decision that the cable business is not where he wants to be," notes Schroder Wertheim media analyst David J. Londoner. TCI declines to talk about its plans.
PHONE-COMPANY INCURSIONS. Time Warner is perhaps in worse shape. CEO Levin gambled in 1995 by expanding Time Warner's cable holdings by paying $5 billion to acquire cable systems with about 4 million subscribers. In late 1994, he spent an estimated $100 million in a splashy debut of a trial interactive-TV service, called the Full Service Network, in Orlando. The network has never been rolled out elsewhere.
Now, the anchor of the cable systems is dragging down the entire media conglomerate. Time Warner's 1995 operating cash flow from cable was $3.3 billion, but it spent about $1.5 billion in debt payments and $1.4 billion in cable-related capital expenditures. Its operating margin has slipped from 10.3% in 1992 to 8.6% in 1995--to just 4.4% in the first quarter of 1996, says Moody's Investors Service. Analysts, shareholders, and some company executives have been pushing Levin to sell off cable assets to lessen the company's huge debt load and lift its laggard stock. It now appears that Levin may finally be giving in.
Surely no one could be blamed for wanting to avoid the coming crunch of competition. Direct-broadcast satellite, or DBS, is growing increasingly popular as providers such as DirecTV Inc. slash prices for a service of 175 or so digital channels that far outstrips what is now offered by cable. Rapidly growing DBS already lays claim to some 5 million U.S. TV sets. As the price of the equipment plummets and a customer's local TV stations are eventually included in the service, Donaldson, Lufkin & Jenrette Securities Corp. media analyst Dennis H. Leibowitz expects DBS will have 19 million subscribers by 2000. By comparison, growth of cable subscribers has flattened out at about 64 million--rising only 1.1% in the first six months of 1996.
Even TCI is trying to make a big push into DBS. In May, it allied with Canada's Telesat to launch two new services to beam programming to homes in the U.S. and Canada. But the Federal Communications Commission has objected, and the venture is now in question.
At the same time, incursions from telephone companies are under way across the country. The phone companies have a reputation for being slow and bureaucratic, but their healthy cash flows and blue-chip debt ratings make them a real threat to pinched cable operators. This year, Chicago-based Ameritech Corp. began offering cable service in 12 different cities in Illinois, Ohio, and Michigan. In Toms River, N.J., Bell Atlantic claims its cable operator has more than 75% of the 6,400 Adelphia Communications Corp. customers to whom it has offered cheaper cable service since February. Southern New England Telephone Co. delivered a nasty shock to the cable industry on Sept. 25 when it was awarded the right to offer cable service to the entire state of Connecticut. SNET is spending $4.5 billion on the wiring that allows it to offer cable, and it plans to roll out its new service in the first quarter of 1997.
The phone companies' stodgy reputation won't spill over into programming--they'll be providing much the same fare that cable operators offer. The 1992 Cable Act made it illegal for most cable networks, such as CNN and Discovery Channel, to refuse to sell their programming to competing services. That's why DirecTV, for example, offers what many viewers think of as cable fare, such as HBO and CNN.
Also becoming a threat is wireless cable, a technology that several telephone companies are using to quickly and cheaply offer a service competitive with cable (box). Since it avoids costly wire installation, telephone companies can undercut existing cable rates and in turn force that market's cable companies to cut prices. That will hurt cable's cash flow and hinder its efforts to offer telephone services.
How will it all shake out? The likelihood is that the financially weaker cable operators will be gobbled up by other cable companies or by larger, better-financed communications giants. Glenn R. Jones, CEO of Jones Intercable Inc., based in Englewood, Colo., thinks that U.S. utilities and foreign buyers could begin buying up cable assets now that stock prices have fallen so low. For those players that cannot withstand huge operating losses as they battle for market share, it may come down to finding a buyer--or else. "There's going to be roadkill all over," says Robyn G. Nietert, a telecommunications lawyer at Brown Nietert & Kaufman in Washington, D.C. "There are no niches. There's no place to hide."
DEEP POCKETS. Continental's Schleyer says that it was the fear of thin resources in such an unforgiving environment that prompted the company to accept a $10.8 billion takeover offer last April from U S West Media Group, a separately traded division of Baby Bell U S West Inc. The deal is scheduled to close in November. Schleyer says his new parent's deep pockets will allow him to complete in two years the capital improvements that would have taken the company six years had it remained independent. And Jones made a deal with Bell Canada's holding company, BCE Inc., in late 1994. For $349 million, BCE got 30% of Jones and an option to acquire the entire company by 2002. Those Canadian resources enabled Jones to launch earlier this year a state-of-the-art system in Alexandria, Va., that offers cable, data, and phone service.
Jones's effort has taken a huge upfront investment. So far, it hasn't snared many customers, but it is being closely watched as other cable operators gauge the near-term consumer demand for these new services. Although faced with long periods before they can hope to see a return, the cable operators have to proceed. "The only way for cable companies to go forward is for them to spend what they have to spend. It's like they're stuck in a tunnel. [The competition] closes in around them to the point where they can't go backwards," says Lazard Freres & Co. media investment banker Steven Rattner. "If they don't [proceed], then they will perish."
Cable can blame Washington for a portion of its current troubles. Reregulation in 1992 cut into cash flows and may have slowed investments and new services. And for years, the big cable operators dithered by not demanding standardized cable modems and digital set-top boxes from outside manufacturers. Their indecision cost them their technological lead--of at least two years--over the telephone companies, acknowledges one longtime cable-industry executive.
Losing their lead was unfortunate. Had they been early to market with broadband technology and upgraded their systems to offer integrated digital-TV, data, and telephone service, the outlook for cable could have been quite bright. Yet even where cable operators started out ahead in the market, as with DBS, they lacked focus and speed. TCI, Time Warner, Cox Communications, Continental, Comcast, and General Electric started Primestar Partners, a DBS service, in 1990--four years before industry leader DirecTV was launched. But Primestar relies on a medium-powered satellite that requires a much larger dish and delivers fewer channels than the high-powered services offered by DirecTV, EchoStar Communications Corp., and others. Long hobbled by the lack of a focused, unified marketing campaign, Primestar has dishes in 1.3 million homes, compared with DirecTV's 2.1 million, according to Satellite Business News.
Now, cable is ahead again--in high-speed Internet access--and many leading cable executives acknowledge that the lead is theirs to lose. "We're competing with ourselves to get it launched," says Brian L. Roberts, president of Comcast, the country's fourth-largest cable system. The cable pipe is already capable of handling huge amounts of data that skinny telephone wires can't now offer, despite ongoing experiments with data compression. Yet not even 5% of cable households have had the wiring upgrades necessary to support the cable modems, estimates Schroder Wertheim's Sirlin.
Still, the race for cable modems is only part of the game. More important for cable operators is their gambit to head off the growth of DBS by offering digital set-top boxes to a significant number of subscribers. Although cable operators have signed contracts for two million boxes, manufacturer General Instruments Corp. has actually made only 20,000.
Another battleground for cable: winning customer trust. Cable has long been derided for poor customer relations and irritating service interruptions. Now, a recent study by consultants Yankee Group Inc. shows that most consumers are eager for one company to provide combined TV, Internet access, and telephone service. But for more than 55% of the consumers surveyed, the winning choice would be long-distance or local telephone companies. Only 4.4% of the consumers would choose their cable company.
The industry has worked recently to guarantee more responsive service, but consumers' memories of those shortcomings haven't faded. Few consumers are apparently willing to risk unreliable phone service. Even worse for customer relations, most cable operators have hiked prices in the past year. On average, the industry has jacked up prices by 10% or more this year, so desperate are they for increased cash flow.
Although they don't say so, the rocky road ahead leaves many cable operators eyeing the exits. Like Continental and Jones Intercable, some sell out. But that may be less of an option now, with cable companies needing billions more to stay viable. Says Lazard's Rattner, who represented Continental in its sale to U S West this spring: "It's clear that the number of [interested] buyers is limited. And it may at the moment be fairly close to zero."
The biggest, and oftentimes most troubled, cable operators are left with few attractive options. At Time Warner, the bulk of its 11.8 million cable subscribers is held by a partnership 25% owned by U S West Media. The two companies have long been at odds, and negotiations to reorganize the partnership have been stalled for months because Levin has been loath to hand over control of the systems to U S West. But with cable in deep disfavor with investors, jettisoning the cable systems could goose Time Warner's long-depressed stock price.
TCI is in a similarly tough spot, since there is no clear buyer for its 14.5 million-subscriber cable system. Malone isn't betting his personal fortune on the future of cable systems: He has trimmed his stake in TCI to less than 1%, while he holds 30% of Liberty Media Corp., TCI's separately traded programming arm. And three years after his failed attempt to sell out to Bell Atlantic, an industry source says he is talking to AT&T about a deal. Neither company will comment on the rumor. But recently AT&T CEO Robert E. Allen said: "You can be assured we are not in an acquisition mode."
The only person who knows the endgame for TCI is, of course, Malone himself. But the much-feared cable mogul has been almost invisible for nearly a year, and he declined to be interviewed for this story. According to the company, he has suffered from prolonged bouts of the flu, in addition to spending months at a time at his vacation compound in Maine.
Malone did make a rare, brief appearance on Sept. 25 at a glitzy annual industry dinner in Manhattan informally known as the "Cable Prom." But he ducked out early, hustled into an elevator by cable-unit head Clouston as a reporter said hello. The rest of the cable moguls--Glenn Jones, Brian Roberts, Jim Dolan, Ted Turner--remained behind in the hotel ballroom, along with about 1,800 other industry executives, sticking with the party until the end.