Cable Talks, Wall Street Listens

After nearly three hours of fielding questions about new phone, data and video services at the industry's annual trade show last week, Comcast CEO Brian Roberts was surprised when he finally got a question on cash flow.

All through his talk on new voice-over-Internet-Protocol (VoIP) telephone services, more-advanced video-on-demand services and the continued successful rollout of cable modems, few listeners had any direct questions about finances. It was only at the very end that one institutional investor inquired, in effect, “Will these new services crunch cash-flow margins?”

“I think that's the first 'numbers' question to me,” Roberts said. “That speaks volumes. People are coming to this show and trying to 'look out' a little bit, which is what we try to do as business people.”

That is a dramatic change from only a year ago. At the 2004 convention, Roberts declared Wall Street to be in “crazy mode.” Cable and other media stocks were crashing, and investors spent the day hammering CEOs over downers like the loss of subscribers to DBS and the high cost of introducing new products.

Now the momentum of technology is clearly on cable's side. To be sure, Wall Street is still as skeptical as ever. But industry insiders—and, more important, outsiders—are wowed by the success some operators are having with lucrative VoIP telephone services, as well as with the wide rollout of video-on-demand services. Analysts expect cable VoIP to grow from around $700 million in revenue this year to as much as $6 billion by 2009. VOD revenues are expected to approach $1 billion this year and nearly $6 billion by 2013, according to estimates. Fees for new digital video recorders could hit $1 billion by 2009.

Industry executives worked hard last week to keep that excitement echoing off every wall of San Francisco's Moscone Center, which hosted the National Cable & Telecommunications Association's National Show. The fundamental theme: a $95 billion upgrade has made cable systems into a giant computer network, enabling a rich array of products—from elaborate telephone services to networked videogaming, in which players around the country can assault each other.

For a convention hosted by and for cable operators, the spotlight also went to outsiders: Google, Sprint PCS and Cisco, among others, emphasizing the increasing power and flexibility of cable systems. “This year's show is less about the cable industry talking to itself and more about having a real dialogue with the leaders of many industries whose future will be intertwined with ours,” said Steve Burke, chairman of the convention and COO of Comcast, at the opening of the show.

Several ideas seemed to hook the imagination of panelists and attendees, such as how cellular customers' ability to watch TV on their flip phones will affect cable operators. One immediate need for many cable systems: a Google-like search engine for video-on-demand, a simple way for viewers to navigate through what could soon be a daunting array of 10,000 shows and movies. Seagate Technology showcased its removable hard drives that attach to set-top boxes to let video junkies offload shows recorded on their overloaded DVRs.

But cable's technology boom doesn't mean everyone profits. Programmers complain that the operators are obsessed with products that provide no obvious way for them to make money but threaten to disrupt their existing businesses. DVRs let viewers readily skip commercials. High-definition may be great for operators catering to high-end customers, but it creates high costs for programmers.

Moreover, operators want networks to give them VOD product for free, and it could take years before both sides design an ad model that might meaningfully offset losses as viewers turn away from the mother network. “You can't put any food on the table now from VOD,” said Bob Wright, chairman and CEO, NBC Universal.

“We ought to figure out a way to grow the opportunities faster than the disruption hurts us,” says News Corp. President Peter Chernin.

But many programmers are exploiting the changes. Disney's ABC is pushing its ABC News Now, which was designed to be distributed on digital broadcast, Internet and even cellphones. “We're dealing with media companies that have skin in the game on all platforms,” says ABC News President David Westin.

Much to the delight of the biggest operators, the opportunities overshadow—for now, at least—the kinds of issues investors were riveted on a year ago: the threat of competition from DBS, and how telcos would counterattack cable's push into the telephone business. Those threats still exist but aren't as dominant.

The excitement over cable's technology is in many ways the upside of Wall Street's love-hate relationship with cable; investors love the promise of new technology but hate heavy spending to develop it.

Comcast, Insight Communications and Cablevision Systems have each jumped by more than 20% since last year's National Show. Charter Communications and Mediacom, however, have fallen because of significant operating problems. Still, the cable sector is doing far better than TV and radio stocks, which have dropped in the past year.

Perhaps the hottest product for cable operators is VoIP, which gives an immediate financial kick. With the cost of Internet-phone technology dropping and the quality rising, cable systems offering high-speed Internet can get into the phone business for relatively little capital. Cablevision now offers VoIP to all of its subscribers, and around 15% of them are expected to sign up by year-end, says Morgan Stanley Media Analyst Richard Bilotti. Time Warner, another company aggressively rolling out VoIP, should have similar penetration by the end of next year. Cox Communications has been offering traditional circuit-switched phone for six years and is expanding into VoIP. It should sell into 25% of its subscribers homes by year-end.

Because the current pipeline is essentially built, the $35-$40 in monthly revenue could be immensely profitable. Asked during a panel session where he would invest money other than his own company, Mediacom CFO Mark Stephan said, “I would invest in any cable company that's doing VoIP, because I think it's going to be a huge home run.”

Operators are also riveted by VOD, because it's something they can do on their advanced fiber networks but DBS rivals can't truly match. Comcast is particularly aggressive, offering programs to digital subscribers for free. The company is buying a piece of MGM to get VOD rights to older movies and is even starting its own VOD networks. At the show, Comcast debuted on-demand service PBS Kids Sprout, a joint venture with Sesame Workshop and HIT Entertainment aimed at preschoolers.

Bilotti estimates that VOD services will be available in 25 million homes by the end of 2007. But established programmers still don't see the upside. They lose viewers from their main channels, but there's no way to readily sell advertising into VOD, partly because there are no Nielsen ratings. Says David Zaslav, president of NBC Universal Cable, “Right now, the question is: What's the model?”

Cable's excitement over DVRs is also a competitive response to DBS. The satellite companies have been marketing combo receivers and DVRs for more than three years. Now that cable-equipment companies are supplying DVRs with integrated cable tuners, operators are deploying them as quickly as box makers Motorola and Scientific-Atlanta (S-A) can supply them.

Cable should have around 7.5 million DVRs deployed by 2008. That is just 12% of their subscriber base. Since they charge $8-$10 monthly, that is not a huge financial kick, but it might keep DirecTV from stealing more customers.

Manufacturers from S-A to Samsung see the cable DVR (which, after all, is essentially a video computer) as the hub for a home-media network, using cable wires to deliver video and music throughout the house—even uploading movies to iPod-like devices.

Cable's broadband systems enable videogamers across the country to face off and increasingly interact, yelling at each other through their Xboxes while battling in a virtual martial-arts death match. Says Bing Gordon, chief creative officer of videogame maker Electronic Arts, “You'll pay some money to reach out and touch someone, but you'll pay a lot of money to reach out and kill someone.”