Hard Work Ahead in the Heartland
Nice Tries, Bad Buys
Kevin Kramer is one of Insight Communication's best customers—but he's also the cable operator's worst nightmare. In 2002, Kramer's wife, Julie, signed up for Insight's 200-plus channel digital service instead of DirecTV, largely out of inertia—she knew
cable but not satellite.
But today, the 44-year-old Louisville, Ky., schoolteacher and father of two children is not sure his wife would make the same decision.
That is because, in the past year, DirecTV added local-to-local service in Louisville so viewers could get local signals over satellite. "Since we've signed up, cable prices have continued to go up, which is a source of frustration to me," says Kramer, also a council member in the Louisville-Metro County Government, which means he is not an unimportant person in town.
Insight is lucky the Kramers didn't switch, but thousands of others did, thanks in part to an ill-timed $2 rate increase the operator enacted on its analog service just as local-to-local kicked in last spring.
In 2003, the MSO lost about 9,000 Louisville subscribers, nearly 3% of its customers in its largest market. It also earned the enmity of then-alderwoman Barbara Gregg, who lashed out at the operator in a letter to the local paper.
Nationally, Insight did recover somewhat in the fourth quarter after suffering a net loss of 2,200 subscribers over the summer. That spooked analysts. For the year, Insight gained 4,800 customers through an acquisition but lost 6,800. And the company is advising Wall Street to expect a 1% decline this year on its 1.3 million-subscriber base. More ominous is that cable giant Comcast owns half of Insight and could trigger a provision next year to acquire most of the company outright, leaving Insight much smaller than it is now.
|Where the Subscribers Are|
|Source: Company report|
It is not that investors consider Insight a basket case. The country's sixth-largest cable company expects to report positive free cash flow in 2004 after being $14 million in the red for 2003. Further, the company exceeded analysts' revenue and cash-flow expectations in the fourth quarter, which led many of them to raise Insight's estimates for this year.
Operating cash flow grew by 8%, after two quarters of sluggish expansion, a sign that Insight had momentum entering 2004, new Chief Financial Officer John Abbott told analysts in February.
"The goal is to hang onto our base and fuel the growth of the company with additional services," says CEO Michael Willner.
But even the encouraging quarter could not persuade analysts to change their largely neutral ratings on stock.
The consensus short-term forecast for its shares hover at $11 compared with the mid-$9 range Insight has been trading at recently. Analysts regard the stock as expensive versus its cable peers.
The gain of only 100 customers in the fourth quarter—compared with 600 the year before—was made even more bitter with the departure of President/COO Kim Kelly, who left under pressure in September. That has shaken analysts.
But the company is excited over last December's launch of Motorola DCT-6208 boxes in 12 of its 14 markets. The new boxes offer digital video recording and high-definition services for an extra $5 over the $7.95 price of Insight's lowest-cost digital tier.
Without providing specifics, new COO Dinesh Jain told analysts in February, "Our sense is that DVRs and HD television sets are hitting that point in the hockey stick in the consumer market. … We're seeing very, very solid increases of about 800 a week in the high-end digital product."
But, while executives are counting on these services to cut churn and boost margins, they concede that the company fell down last year by ignoring the basics.
In Louisville, "we got caught, and we also had slowed down our marketing due to the volume of phone calls we were attempting to manage. We realized very quickly what some of our mistakes were and got back on track," says Pam Euler-Halling, the MSO's senior vice president for marketing and programming.
Then there is Insight's 900-pound gorilla that nobody in the room wants to recognize: the Comcast partnership that began in 1999. There's a huge upside to the alliance. It allows Insight to benefit considerably from piggybacking on the massive volume discounts Comcast muscles when negotiating rates with cable networks.
Despite its modest size, with operations in small to mid-size cities like Columbus, Ohio, and Rockford, Ill., the Comcast connection allows Insight to reap broad economies of scale and sizable cost savings in launching new services through efficient head-end management that reduces the MSO's per-home capital investment. Each headend serves an average 100,000 customers, considerably larger than the industry average.
The nasty side of that gorilla is that, after Dec. 31, 2005, either company has the right to dissolve the partnership and buy out the other through a complex asset-provisioning process.
Analysts worry that, if Comcast buys out Insight, the latter could remain as a quaint 650,000- customer operator with little clout and much higher programming costs.
Insight and Comcast are also partners on telephony, the result of a deal Insight cut with AT&T Broadband in 2000,
which has the MSO leasing capacity on its network to Comcast for a fee and both companies sharing the capital costs and divvying up other expenses.
Insight introduced telephony to four markets but lost momentum when Comcast bought AT&T and killed all voice expansion. Resolution of that partnership is also on investors' minds.
Insight plans to add voice-over-IP services later this year and convert to a "hybrid" VoIP/ switched-access system to provide the service to 56,000 customers, or about 9% of those with access to it.
With these matters hanging over Insight, "we think there's no rush to get into the stock," says Oppenheimer & Co. analyst Thomas Eagan. "They're trading at a high multiple." He estimates the stock was trading at about 10 times the estimated 2004 EBITDA (earnings before interest, taxes, and depreciation), partly because investors were expecting a "take-out."
No one is ready to talk about the partnership trigger, but Willner says analysts are overreacting to its Comcast dealings. Even if Comcast takes its half of Insight back, he argues, "we're looking out to '06 or '07 before any of it happens. To the extent we're being penalized in the minds of analysts now, it's probably premature and maybe a little of throwing the baby out with the bath water. The fact of the matter is, we're enjoying a tremendous relationship with Comcast."
Analysts worry that DBS providers have already launched local-to-local in more than 80% of Insight's systems, thus taking most of the cream off the top.
Moreover, SBC Communications will begin marketing satellite service across 30% of Insight's markets this year. Bell South also is getting into the business.
There are other problems: Insight disastrously tied its high-speed Internet fortunes to the ill- fated @Home service and had to unwind itself from that partnership in 2002. Today, its data penetration stands at just over 10%, far below the industry average.
The company is now belatedly focusing hard on its nuts-and-bolts marketing efforts. Insight earmarks only 1.2% of its revenues for marketing, compared with the 3% industry average, in a sector notoriously stingy in that area.
"We didn't have any discounting to analog customers who took high-speed Internet service," Willner notes by way of example. "We've come to the conclusion that we want to be more analog-friendly than we had been over the past couple of years as we're launching higher-end businesses." In other words, don't lose the analog customers while prowling for digital converts.
Discounting—or bundling—works, Euler-Halling says. Insight gives customers a $20 break if they buy video, data, and voice (in the four markets where Insight offers telephony), and a $10 discount if they take two services.
"We continue to see much lower churn for customers who have three products versus one and customers who have two products versus one," she said. "It's not only sticky, but it adds to the value proposition: one phone call, one installation, and one bill."
Getting back to basics also means being more aggressive with the cable bag of tricks: cross-channel promotion, targeted direct mail, and bill inserts.
To push analog and digital, Insight will likely boost its marketing expenses to 2% of revenue this year. That move both encourages and worries analysts, who fear diminishing margins and agree that the company paid too little attention to the nuts and bolts of the business while it was aggressively introducing two-way services.
"With a new team in place [under new COO Jain]," Eagan says, "they are making sure they are properly prepared to compete with satellite. One thing Dinesh is focusing on is improving customer service versus the competition."
Willner argues that service was never terrible and says it was an influx of new services in Louisville that produced a like influx of phone calls that customer-service representatives couldn't handle.
Insight's other major problem—one shared by most cable operators—is that customers and non-customers alike have only a faint awareness of the fancy new services the industry has spent billions of dollars rolling out over the past decade.
Kramer's Louisville family is not atypical. "We have yet to purchase a single movie that I am aware of," he says about his video-on-demand service.
"When we want to watch movies," he explains, "they are movies my daughter wants to see, and we go to the video store." She will watch the same film eight times in four days and then dismiss it forever from her life. His son rents videogames.
Insight executives cite statistics that customers who use on-demand services churn at half the rate of everyone else—but only 27% of its VOD-enabled homes used the technology in December, a 35% increase from a year ago but not enough to encourage investors just yet.
The company keeps trying. Besides offering premium networks on-demand, Insight has launched a children's VOD package for $6.99 a month and is planning to add a news and sports on-demand package for $4.99 that would incorporate the deal the MSO concluded with ABC News in March for special reports and excerpts from Nightline.
But getting back in Wall Street's good graces will not be easy.
Three years ago, Insight Communications, flying high on its quick rollout of advanced services, had more friends on Wall Street than detractors. With its stock hovering close to $30 a share, analysts as late as August 2001 were predicting it would reach $32.
But then the company suffered the post-Charter/Adelphia/Cable- vision hangover as investors began focusing on high debt levels, killer satellite competition, and the failure of well-hyped advanced services to deliver on their promise.
Moreover, early rollouts like the Diva VOD service and the CommerceTV interactive foray did not pan out. Those failures didn't cost money, but they wasted momentum.
Insight also invested more than $20 million into the Source guide, which included news and interactive service Local Source, but it's not a huge hit.
That was then, and this is the practical here and now, in practical no-nonsense cities. None of those fancy services matter to customers like Kevin Kramer in Louisville. In the months to come. Insight has to get him to buy into other services and stay away from competitors with dishes.