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Cable Operators

Bundling Up To Survive

7/28/2006 8:03 PM Eastern

As a kid, Martin Brophy remembers working with his father on the small cable system his dad started in 1951 in Shenandoah, Pa. If a channel went out, he’d often tag along when his dad went up to make repairs; in the 1960s, during the summers, he and his brothers helped with system upgrades.

Today, Brophy, CEO of Shen-Heights TV Associates Inc., works with two of his three brothers at the system. One is the engineer; the other heads up construction. There are only five other employees and the company serves only 4,000 subscribers.

Being small isn’t easy in a world dominated by big media and telecommunications companies, Brophy admitted. His video and data products compete against the likes of DirecTV Inc., EchoStar Communications Corp.’s Dish Network and Verizon Communications Inc., and local broadcasters increasingly want cash for agreements to retransmit their signals.

Small Cable, Big Ambitions
Percentage of American Cable Association members offering advanced services:
Product Percentage
High-Speed Internet 64%
Digital Video Recorders 35%
HDTV 29%
Wireless Services 17%
Voice-Over-IP 17%
Video On Demand 11%
Interactive Gaming 1%
Note: Some respondents indicated they are offering more than one of the above services, therefore the sum of all services offered exceeds 100%.
SOURCE: Copyright 2006 The Carmel Group

Nexstar Broadcasting Group Inc. recently prevented Shenandoah, Pa.-based Shen-Heights from carrying two local TV channels — WBRE and WYOU — when Brophy refused to meet their demands. Meanwhile, the big cable programming groups use their market muscle to demand hefty double-digit increases in license fees.

“It’s like gas prices,” he grumbled. “They never stop going up.”

Yet the company has managed to stem sub loses to satellite by adding a high-speed Internet product and new programming. “High-speed data has been very important,” Brophy said. “It’s kept some of our customers from switching to dish.”

Next year he hopes to further strengthen Shen-Heights’s competitive position by adding voice-over-Internet Protocol telephony and high-definition TV programming.

Lacking market power and financial resources, experts have been predicting the demise of small operators like Shen-Heights TV for decades. Yet many of the Davids manage to survive in a telecommunications business dominated by Goliaths.

Matthew Polka, CEO of the American Cable Association, which lobbies for independent smaller operators, noted that in recent years, the group’s membership has remained fairly constant at 1,200 members. And the total number of subscribers served by ACA members has actually grown to somewhere between 12 million to 14 million cable homes.

“The rumors of their demise are grossly exaggerated,” quipped Polka.

One key reason for their survival has been the rollout of triple-play bundles and advanced services, Polka and many operators argued. “If you want to survive, you have to have a competitive level of service in video, high-speed Internet and voice,” Polka said. “The companies that have done that have brought back the subscribers that they had lost to satellite.”

The Carmel Group’s Jimmy Schaeffler, senior analyst, and Robb Hawkins, an associate analyst, agreed. “If they can roll out advanced services and get a bundle in place, they’ll be ahead of the competition for the next few years,” Schaeffler said. “Satellite doesn’t have a bundle and the telcos are just getting started.”

Many operators have taken that advice to heart. The Carmel Group’s survey of ACA members, scheduled for release later this summer, found that about 59% of the trade group’s members offered digital cable in 2006, up from about 51% in late 2002, and 64% now offer high speed Internet, up from 52%.

Even bigger increases can be seen for deployment of other advanced services. About 35% now offer digital video recorders, up from only 1%; 29% offer HDTV, up from 1%; and 11% provide VOD, up from only 1%. About 17% offer VoIP.

The revenue potential of these advanced services has also attracted the attention of cable veterans like Bill Besnan, Steve Weed and Ben Hooks. All sold systems in the late 1990s, but in recent years, they’ve been acquiring and upgrading small or midsized systems, often with the backing of private-equity groups.

In 2003, Bresnan Communications acquired AT&T Broadband systems serving about 300,000 customers in Montana, Wyoming, Colorado. It quickly embarked on a program to upgrade those properties.

High-speed Internet is now available in about 96% of the old AT&T territories, digital phone in 85% and VOD in 70% of those households.

“The systems had been losing quite a lot of subs to satellite,” said Bresnan executive vice president of operations Steve Brookstein.

Since the upgrade, however, basic video-subscriber rolls are again on the upswing, and aggressive promotion of the bundle has helped Bresnan add 100,000 new revenue-generating units, including 40,000 phone customers.

The phone service, launched earlier this year, has been particularly helpful in bringing back homes lost to satellite, added Leonard Higgins, the company’s senior vice president of advanced services.

“Nearly one-third of the phone customers (32%) hadn’t subscribed to the video package in the last six months,” he noted. “About 80% of the phone customers also take video and data; 97% take at least two services.”

Among midsized and smaller operators, Bresnan is something of an anomaly: It is part-owned by Comcast Corp., the No. 1 U.S. cable MSO. Although it is independently managed, Bresnan can draw on Comcast’s clout to negotiate programming deals.

But other investors in sectors are also bullish on the potential of triple-play bundles. “It was really the opportunity of high-speed data that brought me back to the cable industry,” said industry veteran and Wave Broadband CEO Steve Weed. In 2003, Wave raised about $70 million in private equity, primarily from Sandler Capital Management, and currently manages about 90,000 subs around Seattle, Wash., and in California.

About half of the systems didn’t even offer high-speed data when they were acquired, but all have been rebuilt to support the so-called triple play of services.

That has helped video subscriber counts to grow slightly over the last year and pulled in new customers for all Wave’s products. It now has 54,000 high-speed Internet customers and 14,000 homes with phone and average revenue per unit has increased by about $10 over the last year, to $90.

Another entrepreneur who saw an opportunity in the sector is Buford Media CEO Ben Hooks. With financial backing from private equity, Buford has built up a company that now serves about 50,000 customers in Texas, Oklahoma and Arkansas.

Many of the systems were small — serving an average of about 1,000 subscribers on a headend, noted Hooks. That made it harder to financially justify system upgrades.

To overcome that problem, Buford bought used 550-Megahertz equipment that the bigger operators were discarding and built fiber into the system. The strategy reduced capital costs by one-third to one-half, allowing Buford to improve its video offering and roll out high-speed data services. It is currently testing a phone service, in conjunction with telco Qwest Communications International Inc.

“The economics for small operators have always been difficult,” Hooks said. “But [with advanced services] the business opportunity is expanding. Everyone needs a phone and we all know how well high speed data is doing. But to succeed you have to have more than just plain vanilla video service.”

Hooks argued that prices for equipment and the costs of upgrades will continue to fall, making smaller systems even more attractive for investors.

Most small operators can’t tap into the private equity that is backing Buford. Yet many family-owned cable operators have also been aggressive proponents of advanced services. (See below.)

“The cable industry was built by entrepreneurs, and that spirit is still alive and well in the independent operators,” said LeaAnn Quist, director of cable television at Great Plains Communications in Nebraska. “A lot of them are family businesses. They are very committed to their operations, and they are flexible and lean enough to very quickly respond to the competition.”

Great Plains, for example, is owned by the fourth generation of a family that founded a phone company in Blair, Neb., nearly 100 years ago. About 26 years ago, it moved into cable and the system, which passes 18,000 homes and serves 10,000 basic video subscribers, now offers phone, video and high-speed Internet services.

Some of these family-owned businesses have long been on the cutting edge of technology.

Patrick Knorr, general manager of Sunflower Broadband, noted that the cable company was founded in 1970 by the Simons family, which has owned a newspaper in Lawrence, Kan., since the late 1800s.

“They’ve had a long tradition of innovation,” Knorr said. The company was one of the earlier systems to offer Home Box Office, in 1977; install a two-way addressable plant in the late 1980s; launch high-speed Internet service in 1995; and roll out telephone service in 2001.

Those upgrades are important because the company must battle DBS providers and AT&T Inc., which offers a heavily discounted digital subscriber line service, for as little as $12.99 a month. Kansas has also passed a statewide franchising law that would allow AT&T to get into the video business.

Even so, the system, which passes about 50,000 homes, has a basic video sub penetration of about 70%. It now has about 21,000 high speed Internet customers and 14,000 phone lines.

Knorr worries, however, about media consolidation and its impact on their future. “As a small operator, you don’t have a lot of control,” he said. “You are left to the currents and eddies of a rapidly changing media environment. Unlike Comcast, it is hard for us to influence our destiny.”

One major issue is rapidly rising programming costs and the potential price of retransmission consent agreements.

“There are huge challenges on the video side of the business, because the consolidation of programming content is in the hands of a few companies,” notes Weed. “There isn’t a free-market system in programming. They can force us to take whatever price increase and whatever channels they want. Video has become a low margin or no margin business.”

The Carmel study of ACA members found that 43% of the operators were spending 35% to 49% of their total expenses on programming; another 35% of the systems polled were spending 50% to 74% of their costs on programming.

Consolidation has also made retransmission consent an increasingly contentious issue. About 8 percent of all ACA members are already paying more than $1 million a year for retransmission consent and many members worried that those costs could rise dramatically, The Carmel Group survey found.

“The next round could be Armageddon,” Knorr said.

Such worries have made industry wide associations, like the ACA and the National Cable Television Cooperative (NCTC) increasingly important, operators argue. While the ACA has been heavily lobbying Congress on the issue of programming costs and retransmission consent, smaller operators are also trying to increase the clout in the marketplace through the NCTC.

Last year, the NCTC purchased about $1.3 billion in programming on behalf of 1,100 members who serve some 9.5 million subscribers.

“Without the aggregate buying power of the coop, a lot of the smaller entities couldn’t survive,” said Jeff Abbas, NCTC President and CEO, echoing the sentiments of many operators interviewed for this article. “By pooling our volume we’ve gotten a much better deal.”

Even so, however, most operators say they must pay 20 to 30 percent more for programming than the large MSOs and their DBS competitors. “Closing that gap is a major importance to us,” Abbas said.

September