WILLNERS INSIGHT: GO Interactive

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It wasn't too long ago that Michael Willner wanted out of cable. In 1991, he put his company, Insight Communications, up for sale. But he balked. Again, in 1998, he considered taking advantage of surging prices. And again he had second thoughts. Instead of selling, he started agressively acquiring cable homes. Through system purchases and partnerships with AT & T, Willner will have expanded his portfolio from around 170,000 subscribers two years ago to more than 1.5 million by year-end and become the eighth-largest MSO. He has been re-energized by the promise of new technologies, particularly interactive services.

Willner sat down with Broadcasting & Cable Deputy Editor John M. Higgins to talk about why he thinks operators not pushing headlong into new services will suffer. An edited transcript follows.

The big thing right now is the stocks. The cable stocks are depressed. You went public recently. What does this mean for the industry right now? Is there enough capital in the industry, or is this going to cause problems?

It's always a problem when stocks are down, because there is less equity supporting the debt that you want to use in order to rebuild the system. But I think that fundamentally the industry is capitalized in a very healthy way. It's changed dramatically from 10 years ago, when the Bush administration decided it was going to focus on highly leveraged transactions and squeeze the debt out of the economy.

Those pesky Republicans.

Well, you know, those things happen, and it's a good thing it did happen, actually. In 1992, when we fell victim to re-regulation, this industry could have gone belly-up if we had the same debt levels that we had back in 1988.

The big thing for you in the last year is that you have grown dramatically.

When we started in 1998, we had 170,000 subscribers. When we finish 2000, we'll be at 1.5 million. That's pretty close to tenfold.

It's a huge increase. How do you manage that?

We add people, good people. We had a good core management team, who you remember was focused not only on our domestic operations, but also on Insight UK out of this office. So we had the gray matter here, and, when we decided to grow the company again, we had a corporate office, a senior management team, prepared to run a much bigger asset.

Instead of buying in 1998, why didn't you join all the other companies that were rushing out the door?

It's certainly a thought that crossed our minds. But I think this industry has so much potential over the next handful of years, there's still even more money to be made than if we had sold as prices were soaring.

We knew that the public market was as aggressive as it had ever been for the cable industry, and it just seemed that it was a pretty good hedge for our investors, that we could gain them liquidity by going public and, at the same time, give them the opportunity, without the tax event, to continue to be invested in what we continue to feel is a marvelous industry. So it just seemed like it was the logical thing to do.

You've been particularly aggressive in rolling out new services, especially for a company your size. You are bullish on video-on-demand. With your Source Media investment, you are bullish on the interactive services. What do you see?

I think, first of all, if we are not doing those things, we're just handing the satellite guys our customers. We made the decision that we were going to focus on launching new services over a technology platform that would leapfrog the competitors'platforms. And the [General Instrument] DCT-2000 box was the right enabling technology to do lots of stuff.

So our view originally was operators would have 5 million to 7 million of the low-end 2000s deployed, and that even that limited box would be good for most subscribers. The next generation, the smarter DCT-5000s, would go out only to customers who chose more advanced services: open access to the Internet, picture-in-picture video applications and such.

Source Media lets you pack more products into the lower-end box.

How many digital converters do you figure you will have deployed by the end of the year?

Digital converters? Probably 150,000.

What do you have now, do you know?

57,000.

Start with VOD. The technology works, but is the lift in sales really that much better than using lots of channels for near-video-on-demand?

It's one of the sexiest products we have to offer, and will have to offer, for years. And we don't have any idea how much impact that business is going to have on our industry yet, because there hasn't been a full deployment. Hollywood is still holding product back for a long period of time between video store release and pay-per-view release. But we also know that, once we have VOD out there in enough markets, that window will be shortened.

What kind of results are you getting?

Buy rates have increased about 75% over NVOD.

To what?

Just about two buys a month. Now, remember, we launched our digital product on a node-by-node basis in every market where we've launched it. We are in three markets now. We have not done any mass marketing yet anywhere.

We just started in Rockford, [Ill.,] this month, because it's the only system that has been completely rebuilt now. You can't go on television, full-page newspaper ads, when 40% of your customers can receive the service at 60Q.

We bought Rockford from Cablevision and proceeded to lose 2,000 customers in two years, just like that. I remember, the first summer we owned it, the local management team was getting very nervous because they were losing subscribers, and I went out there for a meeting one night and said, "Listen, we have consciously chosen a strategy to not be aggressive in retaining customers right now, because we'd be retaining them for the wrong reason-by lowering prices."

What we really wanted to do was spend $30 million as fast as we could. We told them that we'd have it done in three years. We finished in two. If we lost a couple thousand subscribers while [rebuilding the system], so be it. We really believe what we were strategizing to put together, a full-service interactive digital product, was going to be the technological winner in the competition against satellite.

So what's the growth in that system?

A system that had just lost 2,000 [customers]-we bought 67,000 customers, we were at 65,000-increased 2.5% in basic subscribers over the last six months. In the areas where the digital service had been launched for a couple of months, we increased by 3% in six months. Now, I don't think that'll be recurring. I think we are winning customers back.

We had a focus group with 12 former customers in Rockford. We described the local store product with the restaurant guide, personal guide and cinema guide-all Rockford-oriented. And we showed them VOD. We showed them Diva and how you could fast-forward the movie and rewind the movie and watch it over and over again for 48 hours. We showed them the EPG, the IPG, all the bells and whistles, and we asked them two questions, when we were finished showing them the product: One, how much do you think the cable operator is going to charge for this? Which was really a better way to say, how much would you pay for it, because, if we asked them how much would you pay for it, they'd say $2 and try to influence your decision.

They thought we were going to charge $40 incrementally over the cable bill for the product we had just shown them. The answer was $16.85, and, when we told them the answer, we asked them how many of you would actually come back to cable, and 11 out of 12 of them said they would take their dish down.

Now remember, in the last two years, while we were losing those customers, the dish prices and the installation of dishes went from $500, $600, down to $99 specials. A $600 installation cost is very sticky. You're not going to get those guys back, not easily anyway. But $99? That guy is an easy target.

So what's DBS penetration in Rockford?

It's in the low teens. And it went up from the mid-single digits in a couple of years. If we don't, as an industry, get out there and start marketing these advanced services, we're handing the customers over. It all goes back to owning large headends. There are seven digits in the number we spent for the equipment in Rockford. If Rockford didn't have 65,000 customers being served off one headend, I don't know how you would do it.

How many headends were there when you started?

In Rockford? One. But if you look at Indiana, advanced services would never happen with the 75 headends we had. But we brought it down to three. You put in three of these servers, for 450,000 subscribers, it becomes very affordable.

Why are you the only guy in cable that really seems to believe in this stuff?

I don't think I am. Very few operators have moved as fast as we have into the multifaceted interactive digital world that we've moved into, but I think that more and more of them are going to be there later this year and next year.

Skip DBS for the moment, and let's talk about some of the wired competition. How scary is it?

Competition is competition in every form that it takes. I don't think we were any less subject to competition in Rockford when we were losing customers to satellite dishes than we are to competition by losing customers to another wireline cable operator.

I don't think we have lost any more customers as a result of our wireline overbuild in Columbus, Ohio, than we did to a satellite competitor in Rockford. From what I understand, from some of the reports that I see, the guys who really have a significant different level of market share in Columbus than they do elsewhere in the country are the satellite guys.

Now that customers have two wireline choices, the thing that they are not doing is going out and buying dishes.

Ameritech seems to be on its way out of the overbuilding business. But there's RCN and four or five other companies that look a lot like RCN. They're doing essentially the same thing. Are you nervous, and how nervous should your peers be? Are these going to take another 15% or 20% or 30% of penetration out of the cable business? The way the satellite guys have taken about 15, right?

The overbuild strategy has some very serious challenges, because you do have to get to a very significant penetration to be able to not only service your debt but also to give a fair return to the equity investors.

So I have some difficulty understanding why so much money is being thrown at the overbuild model. Now, I know that one of the arguments is that the hotel communication pie is getting much bigger. They're not just focused on video. They want to do telephony and high-speed data. If that's the case, then we probably have more to gain than we do to lose as the incumbent cable operator, as long as we're out there selling these services, which we're going to be doing very aggressively. We're not going to be waiting around.

Going into the future of our business, looking at all the places I'd want to move from the present starting gate to the future, I would want to be exactly where I am today as the incumbent. I wouldn't want to be the RBOC. I wouldn't want to be the satellite guy. I wouldn't want to be the new guy building a cable system. We also have a base of operations with cash flow. So this is the place I'd rather start from.

How about telephony? How much do you expect to deploy?

One hundred percent of this company will be telephony-enabled and offering service in the next 18 months.

You're going to move that fast?

Absolutely. Our U.K. experience has helped us to solidify our view that this is a very important part of the whole bundle that we're putting together.

Would you have done that deal if AT & T weren't such a big investor in you?

I can assure you that the management team of this company worked a very long and tedious process to come to the business agreement that we came to at AT & T. It was our view that, if this relationship in telephony doesn't at least keep us even with doing it alone, then we're not going to do it. We've reduced capital expenditures significantly. We've reduced the revenue-per-subscriber expectation. But we've increased the margin. Overall, it's just a better deal for us. And that doesn't take into account the fact that AT & T is the premiere name in telecommunications in this country, and we think we're going to sell more telephone subscriptions because of it.

How much will they be managing your network?

Well, the lines are very clear. Basically, we own the headend to the subscriber, and they own the headend back to the backbone or oversee it. We're going to have the relationship with the subscribers. We're going to market it; we're going to build it.

You handle customer service and billing, etc.?

It's so important to this whole strategy: one phone call and one bill. Once we start diluting that, we dilute our ability to really compete.

Welcome to open access. What's going to happen now?

We've always said that, when the exclusivity of these contracts with @Home and Road Runner expire, we will look for relationships with some number of ISPs. Frankly, for @Home or Road Runner to even exist today, they had to have some period of exclusivity, or the capital would not have been there to make the investment to build these companies up to what they are today. Nobody else was creating content that would fully exploit the high-speed capacity of the broadband network. To put a regular old telephone-based ISP on a broadband platform is doing our platform an injustice.

When your exclusivity goes, how do you envision a deal going with AOL or Mindspring, Earthlink or some other ISP that wants to go in and offer this service?

Well, we'd like to provide their service on a similar basis to the way we provide content in the video platform, in the data platform.

So how do you expect those deals to work? What do you expect them to look like?

I don't know yet. If you're talking about numbers, I don't know. But what I think should happen is that we should have a relationship with @Home and Road Runner and AOL and Mindspring that's based on a sound economic model, where both the supplier and the customer have a partnership in delivering the service. Frankly, we are not reinventing the wheel here because this is exactly what we do with video programmers.

You don't hand off the customer relationship ever?

No, we don't.

The Internet companies say the same thing: Why would they give up the relationship with the customer? That has been a major sticking point in all these negotiations.

I don't think they're giving up their relationship with their customers. I think that they would still have a relationship with their customers from a content side.

Do you believe in DSL?

I believe it's going to be a competitor in the high-speed data business, and I think we're going to have competition in our core video business, which we already have. I think we're going to be effective competitors in the voice telephony business.

That's the last piece of this pie that hasn't been fully converted to a competitive industry-the local phone business.

Right, and that's the one where you're the intruder?

That's right. It's also the biggest piece.

What worries you from the regulatory front? Digital must-carry is obviously the hot issue.

Well, that is an important issue. It makes the analog argument look minor in the overall scheme of things, for us to be compelled to deliver bandwidth to people who are going to use it to compete against our other services is something that, to me, sounds like a Fifth Amendment issue, frankly.

But, at least for now, I don't really think we're going in that direction. I think there's some logic to letting the business dealings between companies settle those issues. I think that's where we're going to go.

There's a clear right and wrong here, and I think the right answer is that we'll sit down with broadcasters and negotiate terms of carriage, just like we do with cable networks.

Your margins don't seem to be going down very dramatically in light of the ever increasing programming costs.

We're making it up in other ways. We are increasing revenue per subscriber by offering new services that customers volunteer to purchase from us. Let me give you the story in Columbus, all right? If you look at the digital customers, they're paying us an average of $26 a month over what they were paying us before. Currently, in all the areas that digital is available, we are now at 21% penetration in six months or less.

It went like wildfire through the market, without any mass marketing, without any newspaper, without any television advertising, just basically door-to-door, telephones, word of mouth.

Now take $26 incremental revenue per digital subscriber, multiply that by 20% penetration, and that is equivalent to a $5.20 basic rate increase for all our customers. But I don't have one politician calling me on the phone, one mayor, one congressman or one customer complaining.

If you look at 20% penetration in six months, we expect it to be there in a year. I think we're beginning to think more like 30% a year now.

What's your message for the cable programmers?

One of the messages that we keep trying to deliver to our programming partners is that they need to recognize the operators'critical need to put product on the digital tiers. And that the operators can't conceivably pass along rate increases to subscribers that are multiples in excess of inflation without creating another'92.

So I think that the smartest programming networks today are recognizing that they have to have a digital strategy and are offering cable operators the option to put these networks up on a digital tier.

What is a workable license fee for your average digital network?

It depends on the content and the importance of the network to the digital tier.

Is 20 cents a sub the answer?

It could be. It depends on the product. Ten cents. Five cents. It depends on the product. We certainly recognize that, to get analog carriage, a lot of people are throwing big bucks around upfront for our support. And maybe we won't have that kind of support by putting it up on digital, at least not to the same extent. There are a number of programmers who have come in recent weeks and months, who have looked for the happy medium: maybe they get some analog carriage in places where we might have a little less pressure to go digital, in return for giving us a decent digital deal in other systems.

The line heard most frequently these days is that cable has died. There are always outsiders with different agendas.

Let me go back to my analogy of 1977, that era from'77 to about'80. There were a lot of guys sitting around the barrooms of the convention hotels at the NCTA in 1979, 1989, lamenting this invasion of these new programmers into our convention, that they were taking over the floor and parties.

And whatever happened to the good old days when Jerrold and Scientific-Atlanta were the core of the industry, the people who really cared about the industry?

Somehow I think MTV throws better parties than Jerrold did.

They probably do. But you become a cable operator when you own cable systems, whatever your motivation.

So does that changes the industry?

Of course it changes the industry. The industry is always changing. It should change. If it doesn't change, it'll die.

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