Time Warner Cable and Cablevision customers: Is Charter Cable in your future?

The best way the cable industry can grow revenue in the lucrative broadband business is to bring back the same type of collusion and control cable companies maintained over video programming 20 years ago.

Dr. John Malone did not want to sound nefarious in his recent interview with CNBC’s David Faber, but the new part-owner of Charter Communications has built a reputation as cable’s Darth Vader over the last 30 years. His detractors consider his way of doing business akin to a nationwide cable mafia, complete with exclusive, non-competitive territories that assure operators can charge sky-is-the-limit prices.

Malone is now back in the cable business in a big way, and analysts expect he will quickly amass influence in an industry he once led as CEO of the nation’s then-largest cable operator — Tele-Communications, Inc. (TCI).

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Why is John Malone back in the cable business and why buy a piece of Charter Cable? Malone tells CNBC’s David Faber Charter is a company with enormous growth potential through mergers and acquisitions. CNBC says Malone could be targeting Time Warner Cable and Cablevision for acquisition by Charter as early as next year. “There is consolidation yet to be done,” Malone hints.  (7 minutes)

Malone notes the cable industry is on the cusp of transformative consolidation through collaborative agreements, mergers, and outright acquisitions both here and abroad. CNBC speculated that could begin with efforts to further reduce the number of cable operators in the United States, perhaps beginning with a deal by Charter Communications to acquire both Time Warner Cable and Cablevision, which could combine under Malone’s stewardship and Charter’s executive leadership to “compete” with Comcast.

Dr. John Malone

CNBC reporters note Malone has high praise for Thomas Rutledge, CEO of Charter Communications. Rutledge’s earlier experience working for both Time Warner Cable and Cablevision could be an asset in combining all three companies into one. Analysts speculate such a deal could be pitched as early as 2014 when Time Warner Cable will undergo a management makeover with the departure of CEO Glenn Britt. CNBC also noted Cablevision’s imminent sale has been rumored for years, and current leader and family patriarch Chuck Dolan is 87 years old. With cheap credit and Malone’s business savvy, both companies could find themselves part of a Malone-engineered takeover that would vastly expand Charter Communications into the second largest cable operator in the country.

Malone sees the days of traditional cable television coming to an end as consumers turn to “over the top” online video for an increasing share of their viewing time. As cable television rates continue to increase, customers are cutting the cord. Malone believes today’s bloated cable packages are ripe for an upheaval from a-la-carte pricing or theme-based programming bouquets that break expensive sports programming or movie channels out of the traditional basic cable lineup. Malone even suspects a challenge to the industry’s current price models could surprisingly come from the programmers themselves.

Sports networks will be among the first to notice their affiliate revenue collected from cable and satellite companies (and passed on to customers in the form of higher rates) will stagnate as customers drop cable television. Declining viewer ratings also mean lower ad revenues. Malone believes at some point sports teams and/or programming networks will decide that the biggest barrier to winning new viewers is the $70-80 asking price for basic cable. If sports programmers find they can reach new audiences selling their programming online, direct-to-consumer, for $5-10 a month, the basic cable all-for-one-price model will quickly collapse.

“As the cable guys and the satellite guys start to lose customers to the over-the-top guys, some of those economics will be reflected back on the sports guys,” Malone said. “They’ll start losing advertising revenue. They’ll lose affiliate revenue. And they have to face reality that maybe you need to segregate your market like everybody else.”

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John Malone predicts the demise of the traditional bundle of cable television programming within five years. The future is streamed video online, declares Malone, so it is important the cable industry move to manage that competitive threat by acquiring streaming competitors or launching their own services to assure video programming revenue can be protected.  (5 minutes)

Malone sees the future sustainability of the cable industry dependent on the high revenue broadband business.

“I think it is at a point in history when the most addictive thing in the communications world is high-speed connectivity,” Malone told CNBC. “Everywhere in the world that we operate, we’ve just seen the public want more and more data rate. Whether it’s wireless or wired. There’s a big appetite for it. Cable technology right now is the most cost-effective way to deliver that growth in speed.”

Malone believes there is also plenty of room for revenue growth and cost-cutting, which he said can best be accomplished by getting other cable operators together to “cooperate” and “coordinate” broad scale broadband projects that counter competitive threats from third parties.

Malone helped pioneer the cable industry business practice of “don’t compete in my backyard and I won’t compete in yours,” an informal agreement among operators to stay within their own specific territories, safe and secure from competition. In the 1980s and 1990s, Malone’s TCI was one among many cable operators buying and swapping cable systems to build large, regional system “clusters” where only a single cable company provides service, winning economy of scale and a formidable presence that discouraged other wired competitors from entering the business. In most cities, only the deep pockets of AT&T (U-verse) and Verizon (FiOS) have managed to shake things up.

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Bring back the cable mafia? CNBC’s David Faber gets John Malone to admit vertical and horizontal integration — controlling the content and the pipeline — are important factors to protect cable revenue and expand American dominance in cable internationally. Malone is also a big supporter of industry consolidation and believes mergers and acquisitions are necessary to shrink the number of cable operators in the United States. (5 minutes)

The cable mafia?

Malone wants broadband to be carefully managed under the industry’s own control and direction.

Faber asked if Malone wanted to bring back the days of the “cable mafia.”

“Yes, I think we do want to bring back the days of @Home, the days of Ted Turner, the days when we all got together, because together we provided national scale,” Malone said. “Now I think we have the opportunity to create global scale,” he said. “The goal is not to be bigger. The goal is to be more cost-effective.”

Dr. John Malone’s Liberty Media will buy a 27.3 percent interest in Charter Communications with a $2.62 billion investment in America’s fourth largest cable operator.

Liberty will buy the stake from investment firms Apollo Management, Crestview Partners, and Oaktree Capital Management.

“We are pleased with Charter’s market position and growth opportunities and believe that the company’s investments in its high-capacity digital network which provides digital HD and on demand television, high-speed data and voice, will benefit its customers and shareholders alike,” Malone said in a statement.

Malone is no stranger to the cable industry, having been at the helm of Tele-Communications, Inc. (TCI), the largest cable operator in the country in the 1980s and 1990s. TCI systems were sold to AT&T in 1999, which eventually spun them off to Comcast and Charter Communications, which still run them today.

Dr. John Malone

Since Malone’s exit at TCI, he has been in charge of Liberty Global, which owns cable systems overseas and controls several U.S. cable programming interests through his Liberty Media operation. The investment in Charter represents Malone’s return to an American cable industry he helped pioneer.

The agreement requires Liberty to acquire no more than 35 percent of Charter until January 2016, at which point Liberty’s maximum allowable controlling interest rises to 39.99 percent. Liberty also wins four seats on Charter’s board of directors. But many industry analysts predict Malone will not be satisfied with anything less than eventual full control.

Malone often takes an initial minority interest in the companies he later intends to acquire outright. Macquarie analyst Amy Yong told Reuters he employed a similar tactic to gain control of SiriusXM, the satellite radio company.

“He’s probably going to have a pretty big say in the company’s future over the next few years. This will accelerate capital returns and take advantage of Charter’s tax assets to consolidate the cable industry some more,” Yong said.

Malone is attracted to investment opportunities in companies with high marketplace leverage opportunities and exploiting potential revenue from captive customers in the rural, less-competitive markets Charter has traditionally favored.

Here today, gone tomorrow: Bresnan Communications that was Optimum is now Charter Cable.

Malone also has a strong philosophy towards marketplace consolidation, something ongoing in the cable industry, particularly among smaller cable operators serving less-populated areas.

Under the leadership of ex-Cablevision executive Thomas Rutledge, Charter Communications recently acquired the interests of Cablevision West — former Bresnan Cable systems in the mountain west. Malone sees considerable opportunities expanding operations in smaller communities that have either received substandard cable service, or none at all.

Malone has recently been stockpiling available cash for investments, spinning off his former cable programming properties Starz, a premium cable channel, Discovery Communications, which runs the Discovery Networks, and Liberty Interactive, which owns the lucrative home shopping channel QVC.

Charter Communications has had a difficult history. Microsoft co-founder Paul Allen bought a controlling interest in the cable operator in the late 1990s, primarily because he saw cable broadband as a natural fit for his vision of a future wired America. Allen’s weighty investment was used to jump into a cable industry consolidation frenzy still underway more than a decade ago. Cable operators claimed consolidation was necessary to increase efficiency by building up regional clusters of cable systems. Before consolidation, it was not unusual for two or three different cable operators to serve customers in separate parts of a metropolitan area. Often one operator would serve the city with one or two other cable companies offering service in suburban and exurban communities nearby.

In 1999 alone, under Allen’s leadership, Charter Cable acquired 10 cable companies.

By 2005, Charter Cable had amassed millions of new subscribers, but not as many as company executives claimed when they artificially inflated subscriber numbers to protect the value of the company’s stock. Four executives were indicted that year for criminal accounting fraud. By 2009, with $22 billion in debt, the company declared bankruptcy, eventually wiping out shareholders.

The court’s decision to forgive 40 percent of the company’s debt angered creditors but opened an opportunity for private equity firm Apollo Capital Management to gain control by ending up with the majority of shares in the restructured company.

For years, the company has continued to receive some of the worst customer satisfaction ratings in the industry, usually ranking at or near the bottom. But many Charter customers stay because there is little competition from other players, especially telephone companies. AT&T’s U-verse is the most likely triple-play competitor, but AT&T has avoided introducing U-verse in many of Charter’s service areas because they are deemed too small.

Malone sees Charter’s future revenue potential grow as a broadband provider, considered both a money-maker and must-have service. Analysts say that Charter is well-positioned to poach more customers from phone companies, which typically only offer slow DSL service in much of Charter’s rural footprint.

Gore: Malone is the Darth Vader of cable.

But customers may find with Malone’s involvement, that service may come at a price. Malone was criticized heavily in the 1980s and 1990s for leading the charge for customer rate increases. TCI’s captive customers in Tennessee found their cable bills increased between 71-116 percent in just three years during the 1980s.

Former Sen. Al Gore, Jr., at the time called Malone the head of a “Cable Cosa Nostra” and the Darth Vader of big cable. The cable executive was a frequent target of lawmakers flooded with constituent complaints about poor cable service and accelerating prices.

In 1999, The Guardian noted Malone was an admirer of telecom oligopolies:

He is scathing about regulatory attempts to prevent monopolies and mergers. Governments, he says, are “antediluvian” in their approach to the emerging new world economic order. Instead of trying to prevent mergers and collusion between media and communications companies, Malone says governments should actually promote the creation of “super-corporations” (such as his own) with enough capital to exploit the potential of new technology.

That attitude may soon be back in play with the cable industry’s increasing focus on expanding broadband service as their new primary revenue generator.

Malone

Dr. John Malone is a force to be reckoned with and the British are about to get an introduction with this morning’s announcement Liberty Global has acquired Virgin Media in a blockbuster $16.3 billion acquisition deal that will make Malone and Liberty one of the biggest broadband providers in the world. (The deal is valued at $23.3 billion after Liberty agrees to take on Virgin Media’s existing debts.)

Malone will take control of Britain’s largest cable operator and will now also control another 18 million broadband customers in Europe, particularly in Germany and Belgium. His biggest rival will be News Corp.’s Rupert Murdoch who controls BSkyB, Britain’s largest multichannel provider.

Malone’s reputation for ruthlessness precedes him. In the early 1990s, then Sen. Al Gore, Jr., called Malone the Darth Vader of the cable industry. Gore also referred to Malone as the head of a mafia-like “cable industry Cosa Nostra” best known for customer abuse, cold-hearted mergers and acquisitions, and endless rate increases. In the 1980s and 1990s, Malone appeared regularly at congressional hearings to discuss cable industry abuses. At the time, Malone was CEO of America’s largest cable operator Tele-Communications, Inc. (TCI). Today, most of those cable systems are known by another name — Comcast.

In the late 1980s, TCI got the ball rolling on massive rate increases for basic cable service. Other operators quickly followed. As rates exploded upwards, the phones began ringing in Washington from outraged constituents. Gore recounted several recent rate hikes in his own home state of Tennessee in one hearing:

• In three years, rates increased 71% in Memphis,
• 99% in Crossville,
• 113% in Nashville,
• 115% in Chattanooga,
• and 116% in Knoxville.

Under Malone’s leadership, TCI Cable raised rates 60 percent in 1992 alone, helping drive the enactment of the 1992 Cable Act which began to slow the pace of rate hikes. The bill was vetoed by then President George H.W. Bush but overridden in Congress after tens of thousands of constituent complaints poured into Washington. It was sweet justice for many elected officials who were on the receiving end of Malone’s hardball tactics for nearly 20 years. Malone was well known for retaliating against local officials who opposed his unfettered rate increases by suddenly cutting off service to customers and putting up on-screen messages in the place of favorite channels with the names and phone numbers of elected officials Malone claimed were responsible.

Under Malone’s leadership, city officials and consultants working to bring a competing cable operator into Jefferson City, Mo., got a taste of TCI’s ruthlessness when Paul Alden, TCI’s vice president and national director of franchising personally threatened the mayor and a consultant working on the project.

“We know where you live, where your office is and who you owe money to. We are having your house watched and we are going to use this information to destroy you. You made a big mistake messing with TCI. We are the largest cable company around. We are going to see that you are ruined professionally.” Alden warned.

TCI later also claimed it had a First Amendment right to provide service wherever it wanted, with or without a cable franchise. It also threatened any would-be competitor with ruin. In Jefferson City, that would-be competitor eventually won $35 million in damages in a jury trial over TCI’s tactics.

Malone has made no secret he believes government officials are simply getting in his way. In 1999, The Guardian noted Malone is a big believer in telecom oligopolies:

He is scathing about regulatory attempts to prevent monopolies and mergers. Governments, he says, are “antediluvian” in their approach to the emerging new world economic order. Instead of trying to prevent mergers and collusion between media and communications companies, Malone says governments should actually promote the creation of “super-corporations” (such as his own) with enough capital to exploit the potential of new technology.

Malone has plenty of money to throw around. He engineered the sale of TCI Cable to AT&T and personally earned billions from the transaction. Three years later, AT&T sold those systems to Comcast.

Liberty Global has stayed on the sidelines of the cable business domestically, preferring to invest in cable networks and programming. Malone’s firm owns Starz!, which gave Netflix considerable trouble when the online video service lost the rights to a large number of recent movie titles. Netflix had negotiated a $30 million yearly deal with Liberty in 2008 which expired in early 2012. Renewal talks fell through when Liberty demanded $200 million annually to let Netflix keep streaming its movies.

Consumers in the United Kingdom may experience Dr. Malone’s idea of finesse soon enough, if shareholders and British regulators approve the buyout deal.

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BBC News reports the blockbuster deal will pit Dr. John Malone against his biggest rival, Rupert Murdoch. Virgin has five million customers in the UK and provides the country’s fastest broadband service. (2 minutes)