Cable Rushes The Net

The industry dives into telecom and reinvents itself for the Internet Age

Not that long ago, the cable-TV industry looked like such a poor bet that the leading company, TeleCommunications Inc., figured the best way to boost profits would be to sell off stakes in local operations across the country. Cable losses were deepening as regulators tried to limit rate hikes even as programming costs soared. The vision that John C. Malone had painted in the early 1990s--a 500-channel "Information Superhighway"--crumbled. At their depths, in early 1997, cable stocks were off about 40%.

But that grim picture has changed. Shaken cable execs went to work cutting costs--even as they plowed billions into new fiber-optic wiring. With a prod from William H. Gates III--who pumped $1 billion into Philadelphia-based Comcast Corp. in 1997--they began to think of their new infrastructure as a route to the Internet, rather than just a way to jam more TV programming into homes more reliably. Companies began merging to grab more customers and cut costs. Then, in June 1998, Malone agreed to sell TCI to AT&T--specifically to take advantage of the new "broadband" capabilities that would allow the combined company to serve up a digital stew of video, Web-surfing, and Internet telephone service.

By March 22, when Comcast CEO Brian L. Roberts and his father, Chairman Ralph J. Roberts, announced a massive merger with Englewood (Colo.)-based MediaOne Group Inc., the cable industry had--at least in the minds of investors--taken on the tantalizing traits of the Internet itself. They anticipate a flood of new broadband services that will eventually overtake conventional TV, which will account for only about a third of revenues. Indeed, says David Nagel, AT&T's chief technology officer: "The new world of communications promises to change the landscape of society. It really is ushering in a new age."

Even better, the new services--including electronic commerce--could be far more lucrative than TV. That prospect has given cable issues a bit of Internet pixie dust: Comcast's share price has tripled in the past three years. That enabled the company, which saw operating profits increase 12.9% last year to $601 million, to use its stock as cheap funds to buy MediaOne. The deal has Roberts paying a staggering $4,000 per household, a third more than AT&T paid in the TCI deal. But Roberts says the payoff is not in doubt: "We're not just in the cable television industry anymore," says Roberts. "We're becoming telecommunications companies."

Coming on the heels of the AT&T-TCI deal and amid a flurry of acquisitions by rising cable mogul Paul Allen, the $54 billion Comcast-MediaOne merger brings the industry's new Internet future into focus. Now, Roberts, Allen, and other leaders must prove their businesses can justify the new valuations--by delivering the high-speed data connections that will turn all those Internet services from strategic talking points into real revenue spinners.

Analysts are optimistic: Sharon Armbrust, an analyst with Paul Kagan Associates, says the average $45 a cable subscriber pays monthly could rise by another $40 for cable modem service and $50 for internet telephony. Compared with Internet stocks, says John Tinker, an analyst with NationsBanc Montgomery Securities, cable issues "are still a bargain. We're in the middle of a paradigm shift for this industry."

Isn't that exactly what Malone said when he talked about the 500-channel future? Sure. But this time it looks like the cable companies can reinvent themselves and even beat local-phone monopolies to the broadband market. This year, in fact, the cable industry will likely generate $432 million in Internet fees from 1.2 million users of cable modems, according to investment bankers Veronis, Suhler & Associates, compared with virtually nothing in 1997. Some 2.6 million homes will have Internet phone service, provided over the broadband cable, by 2002, figures consultants Yankee Group Research Inc.

By late in 2000, the industry will have largely finished the $20 billion job of rewiring cable systems, giving 96 million homes the potential to receive digital services offered through fiber optic wires. Will they sign up? AT&T is betting billions they will. In addition to the $55 billion TCI acquisition, which gives it a chance to offer Internet telephony service to 33 million homes, the phone giant is cobbling deals with other cable companies. Chief Executive C. Michael Armstrong says the company wants to be able to reach two-thirds of cable households. Between TCI and a deal with Time Warner Inc., it will be able to sell local phone service over the cable network to 38 million homes. Both Comcast and MediaOne are talking to AT&T about a phone-service deal.

Meanwhile, the consolidation drive that AT&T put into high gear continues. Comcast's deal with MediaOne gives it access to 18% of U.S. homes--and also gives it at least 60% of the market in most of the eight largest cities. "You cut down dramaticaLly on the costs of everything you do, from marketing to your sales force, when you cluster," says Jimmy Hayes, chief fin- ancial officer of Cox Cable, which has 3.8 million subscribers and has been busy buying up systems throughout the southwest.

A BINGE. Plenty of deals are still to come. Paul Allen's Charter Communications, which has struck five deals in the past year and now has 3.4 million subscribers, was among the losing bidders on MediaOne, according to industry insiders. He's expected to soon offer a piece of Charter to thepublic, and could get as much as $3 billion to continue his acquisition binge. For Allen, who also owns pieces of more than 50 Internet companies, including major stakes in online service provider High Speed Access Corp. and computer goods retailer, cable is a crucial part of his so-called "wired world" strategy, in which he aims to connect all his Internet holdings to the broadband cable. With most of his system clustered in rural areas of the southeast, he might want to buy Cox, say industry insiders. Allen declined comment.

Given the complex relationships between cable companies and between them and content companies, these deals can become quite dicey. As a legacy of a previous relationship between Media One's former parent, USWest, and Time Warner, MediaOne owns a 25% stake in Time Warner's Home Box Office and Warner Bros. studio units. In turn, Time Warner contends it has a right to veto certain MediaOne transactions. Brian Roberts says he has run the deal by Time Warner Chairman Gerald M. Levin, and is confident it will be approved. But Roberts may still have to offer Levin something. One possible scenario: switching Comcast from the At Home Network Internet-over-cable service, in which Comcast has a stake, to Roadrunner, in which both Time Warner and Comcast have one-third interests. That, in turn, could hasten a merger of the rival services.

While the cable industry reshuffles itself, telephone company rivals are also charging the Net. In North America, local telephone companies have switched on 142,000 high-speed Digital Subscriber Lines, figures Dataquest Inc. That compares to 600,000 cable modem users.

The numbers could grow quickly for DSL. Dataquest projects DSL modems will outsell cable modems, starting in 2000. Telecoms tried to get into high-speed service with ISDN but priCed the service high. With DSL they're smarter. SBC Communications Inc., for one, is offering lines for as little as $39 per month--about the same as cable modem service. "The cabLe companies should be scared," says Dataquest analyst Patti Reali.

If cable companies are nervous, they aren't showing it. Indeed, cable operators are sounding downright ebullient these days. "Sure we have to deliver, we've always had to deliver," says Marc B. Nathanson, chairman of Los Angeles-based Falcon Cable. But Falcon is benefiting from the new view of cable. Last year, it formed a joint venture with TCI and now has two AT&T execs sitting on its board. It also has an AT&T phone-service contract in hand and has begun the costly task of upgrading wiring for its million subscribers in such tony areas as Malibu and Santa Barbara. By this time next year, Nathanson figures he may be able to start offering cable modems as well. "We're now in the teleco business," he says. Spoken like a true cable executive.

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