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Sink Or Swim

Small Cable Operators Tread Water over High Programming, Hardware Costs 2/03/2013 7:00 PM Eastern

After more than a decade in the rural cable trenches, Trust Cable president Steve Inzinna threw in the towel last March, selling his 2,000-subscriber cable system in Mississippi to a neighboring operator after rising programming, equipment and regulatory costs became too much to bear. He was one of the lucky ones.

Over the past five years, small cable operators across rural America have been shuttering systems that they simply can no longer afford to operate. For them, the growing national debate over escalating fees for cable and broadcast channels isn’t an exercise in semantics. It’s a real survival issue.

Inzinna, now a real-estate developer in Jackson, Miss., said in an interview that while costs have risen across the board for rural cable operators — he also noted rising pole-attachment fees and regulatory requirements that forced him to purchase expensive equipment as adding to his decision to sell — nowhere has the increase been more dramatic than in programming.

For example, programming costs made up about 20% to 25% of total operating costs in 1998, Inzinna said. By 2012, that percentage ballooned to nearly 60% of total costs.

“We can’t exist like that,” Inzinna said.

In contrast, for some of the bigger operators, programming costs make up about 30% of the total cost of doing business.

Those rising programming costs — and a sense that things won’t get any better — forced the Trust Cable president to the negotiating table with a neighboring operator, Bailey Cable. Ironically, Inzinna said that he had attempted to purchase Bailey a few years prior, but couldn’t get a deal done.

“We all knew that one of us had to sell to someone eventually to make a better go at it,” Inzinna said. “It was a good fit.”

Inzinna’s story is becoming increasingly common, as small cable operators either sell or shut down systems they can no longer afford to operate. According to the American Cable Association, a lobbying group for about 850 small, independent cable operators across the country, since October 2005 the number of cable systems has declined by 26% from 7,208 to 5,312, including sales, shutdowns and headend consolidations. For systems with fewer than 10,000 subscribers, the percentage drop has been even greater, according to the organization.

A GATHERING STORM

A separate study by the National Cable Television Cooperative, a programming buying group for small operators, said its members have closed a total of 793 small and rural cable systems in the past five years, representing more than 35,000 customers. According to the NCTC, 304 small operators shut their doors between June 30, 2010, and June 30 of last year, with 282 closing in 2009 — the height of the transition to digital TV broadcasting — and 208 in 2008, the coop said.

While some may argue that fretting about the demise of small, rural cable systems is making a mountain out of a particularly tiny molehill, smaller operators say their plight is a window into what could be in store for larger cable systems if the programming problem is not addressed soon.

“We’ve often called ourselves at ACA, on these issues, the canary in the coal mine,” said ACA president Matt Polka. “The storm is coming. This is something that is without question going to happen where these cost increases are going to begin to legitimately affect small operators and what they can offer in their markets. We’re now starting to see the impact of it.”

Larger operators are already gathering up their foul-weather gear. In December, Time Warner Cable chairman and CEO Glenn Britt said the nation’s second-largest operator would take a closer look at the relationship between ratings and affiliate fees, adding that the MSO could drop those channels it believed were underperforming. On Dec. 31, it made good on that threat, dropping arts and entertainment channel Ovation.

DirecTV chairman and CEO Mike White has publicly come out against high sports costs, and last year, the nation’s largest satellite-TV service provider implemented a $3-per-month regional sports network surcharge in markets that have multiple RSNs, such as Los Angeles and New York. White has said that practice will expand to other markets this year. Telco Verizon Communications this month began adding its own RSN fee of $2.42 per month to customers in several FiOS TV markets.

In surveying small operators on why they closed up shop, NCTC spokesman Dan Mulvenon said the reasons ranged from programming costs to high pole-attachment fees to the expense of buying expensive equipment to satisfy Federal Communications Commission regulations for the Emergency Alert System (EAS) and the Commercial Advertising Loudness Mitigation (CALM) Act, which requires all advertisements — including locally inserted ads — to have the same average sound volume as the programs they accompany.

“It’s a mixture,” Mulvenon said of the reasons for operators closing their doors. “Programming was No. 1 or No. 2 on their list.”

BROADBAND EASES THE PAIN

Despite their size, most small cable operators are thriving, providing video, telephony and high-speed data services to areas that otherwise would either have no service at all or little choice among providers. According to the National Cable & Telecommunications Association, while the top five multichannel videoservice providers account for 82% of the 56.8 million cable households across the country, the remaining 10.5 million homes are served by more than 1,000 cable operating companies across the country.

For the most part, small and even ultrasmall cable operators are eking out a living in markets that would otherwise be left to satellite-TV providers. But they are not doing it with a video product alone. Indeed, each operator interviewed for this article said that the one product that is holding everything together is broadband.

“If it wasn’t for the Internet, we would have had to make some tough decisions in the last 10 years,” said Floyd Grocholski, general manager of Parish Communications, an Auburn, Mich., operator with about 900 customers in rural areas in the state. “I’ve known operators that have closed their systems down because they couldn’t afford to expand and had no way to offer Internet. Survival only exists in the ability to offer high-speed Internet for any small system.”

Broadband’s healthier profit margins — for large operators, they can be as high as 80% or 90% — can offset some programming costs increases. But even at those rates, smaller operators are feeling the pressure.

Polka agreed, adding that programming expenses are beginning to eat into broadband margins significantly.

Said Sweetwater Cable TV president Al Carolla: “We’re actually subsidizing our cable plant with the Internet, which is unfortunate.”

RUNAWAY FEES

Small operators aren’t just crying wolf. Affiliatefee increases have accelerated dramatically in the past several years — according to SNL Kagan, rates for general-entertainment programming networks have increased about 23%% over the past five years, while retransmission consent fees have risen nearly tenfold and charges for sports networks were up about 42%. And that trend doesn’t appear to be letting up anytime soon.

According to Kagan estimates, overall cable programming rates are expected to rise 31% between 2012 and 2016, with general entertainment networks up 34.5%, sports channels up 43% and retrans fees expected to double.

Small cable operators aren’t totally alone in their negotiations with programmers. Most belong to the NCTC, a group that represents about 24 million cable subscribers across the country and negotiates national programming contracts for operators as small as 50 subscribers and as large as 5 million. The NCTC has managed to lessen the blow for small cable companies — all interviewed for this article said they wouldn’t be able to survive without the organization.

IT’S THE BUNDLE, BABY

Some small operators can be stymied by the bundling of smaller networks with larger, more popular channels and the broad carriage requirements of many deals. Most programming contracts call for a distributor to carry all the channels owned by a programmer on their most popular tier, usually expanded basic. Many smaller systems don’t have the channel capacity to do that with everyone.

“That’s where a lot of guys throw in the towel,” Mulvenon said. “They just feel like they have no say in what content they can provide their customers.”

For very small systems, the NCTC has worded contract language to give them a little break, senior vice president of member services Frank Hughes said. Most deals will state a channel has to be distributed on the expanded basic tier for systems that are at 750 MHz or greater, Hughes said.

Taking channels off the lineup is an option that several small operators are beginning to entertain more seriously.

“We’ve got several on the list that we’re questioning,” Buford Media Group CEO Ben Hooks said. Buford has about 6,000 customers in Texas, Arkansas, Alabama, Oklahoma, Louisiana and Mississippi.

“We’ve done massive rate increases in the last couple of years and fortunately our customers have pretty much hung in there with us,” he added. “But it’s all because of programming, retrans and pole rates.”

POLE FEES ON THE RISE

Programming rates aren’t the only culprits in a decision to shut down systems.

Hooks said he has had to shut down about four systems in Texas and Arkansas in the past few years because of high costs for pole attachment fees, literally charges from electric cooperatives to collocate cable wires on their utility poles. Those systems, he said, had a total of 783 subscribers and passed nearly 5,000 homes with 188 miles of plant.

In some areas, Hooks said, pole fees have more than quadrupled from the $3 to $5 range per pole, per month to $20 per pole.

These fees have forced some small operators to be creative. At Sweetwater Cable TV, which has about 7,000 video customers, the rural Wyoming operator has taken to building its own poles.

Others, like Grocholski, have started to eliminate plant in parts of its franchise area where there are only a few customers, in an effort to save money. “If we have to close up shop on some of these areas, we’ll already be partially ahead of the game.”

Some small operators, like Parish Communications and others, are fighting back by offering customers a choice of either paying more for a channel or doing without.

“We’re starting to tell customers, here are the contracts that are coming up this year and next year, how important are these channels?” Grocholski said. “Do they justify a $2 or $3 increase?”

Grocholski said that on average he has raised video rates between 5% and 8% annually for the past few years and even that hasn’t been enough to cover his costs.

Programmers are in a tough spot as well, forced to collect the most value for their content while at the same time wanting to foster distribution diversity. And local broadcasters simply want fair value for what is usually the most-watched programming on a cable system’s lineup, said National Association of Broadcasters spokesman Dennis Wharton.

At ESPN, which has long been the target of small cable’s ire as the most expensive cable network ($5.26 per subscriber per month, according to SNL Kagan), spokeswoman Katina Arnold stressed the value of the network and its ability to drive acceptance of other products.

Arnold pointed to ESPN’s authentication products like Watch ESPN, which have driven high-speed data subscriptions across the country. Small operators that are a part of NCTC “get to have the benefit of being a top-10 operator, so a lot of the flexibility and the different things we offer them, we offer through the NCTC agreement,” she said.

RELIEF ON THE WAY?

Not every network is part of a co-op agreement, and the priciest channels — local broadcasters and regional sports networks — have been outside of the NCTC agreements from the beginning. That is beginning to change.

Already, the NCTC has inked retrans deals with NBCUniversal — its recent comprehensive carriage agreement with the programmer included its 10 owned-and-operated TV stations across the country. And NCTC’s Hughes said that its upcoming negotiations with The Walt Disney Co. will probably include retrans for its eight O&O stations.

That could expand to include independent station groups as early as the end of next year.

“It’s hard; it’s not impossible,” Hughes said of broader retrans deals. “I think if we can get a couple of O&Os under our belt, then we figure out a way to do some of the larger station groups.”

Small operators may also get some regulatory relief from another issue they say is costly: the practice of local broadcasters banding together for retrans negotiations.

Hooks said that he has faced such a unified front — three broadcasters in one of his markets demanded he pay $2.20 per month, per subscriber for each station, a total of $6.60 in retrans fees alone — or risk losing all of them.

The ACA is pushing the FCC to stop the practice in its new media-ownership rules, which could be decided in the next few months.

Until relief does arrive, small operators will lean on broadband revenue, and prepare for video losses.

Small operators continue “to look to see whether it becomes more feasible and less headaches to drop the programming side and stay with the Internet,” Grocholski said. “I think the day will be coming. The business model is broke.”

September