Moffett

Wall Street is worried the cable industry will not be able to report major subscriber gains going forward because just about every middle/upper-income customer that wants broadband within cable’s footprint already has the service from either the phone or cable company.

Cable analyst Craig Moffett from MoffettNathanson Research predicts singing up the last 20% of Americans who don’t subscribe to broadband service will be challenging. As of today, 73% have the service, up 2.5% from last year. An increasingly anemic growth rate is a sign the marketplace is getting saturated, with only low-income Americans underrepresented, primarily because they can’t afford the asking price. Most of the rest don’t own or want computers or Internet access or live in a rural area where the service is unavailable.

Under these circumstances, it is no surprise broadband providers are reporting lower new customer gains. Time Warner Cable and Cablevision actually lost broadband customers in the third quarter, mostly to Verizon FiOS. For the last five years, the cable industry has picked up most of its broadband customers from phone companies offering only DSL service.

“To be sure cable is still taking share [from telco DSL] but it is doing so at a much more modest pace,” Moffett said.

The industry’s best chance for new subscriber growth appears to be bundling computers or tablets with an entry-level broadband offering targeting the poor.

Although cable companies are not supplying free PCs just yet, many are introducing relatively slow, budget-priced broadband tiers to attract lower-income subscribers.

Time Warner Cable introduced a $14.95 2/1Mbps broadband tier this month the company hopes will attract price-sensitive customers, especially those now subscribed to low-speed DSL.

Comcast has Internet Essentials, a $10 slow speed broadband service for families with children enrolled in the federal student lunch program. It is also rolling out a “prepaid Internet service” directly targeting low-income customers. Prepaid customers pay $69.95 for an activation kit containing a DOCSIS 3 modem and a month of broadband service. Renewals are priced at $15 for a week or $45 for a month for 3Mbps service with a 768kbps upload rate.

Most other cable providers offer entry-level broadband speeds, but usually only as a retention tool. Even if the industry custom-targets low-speed tiers to low-income homes, many customers may never make it past the cable industry’s credit check procedure. Comcast’s prepaid offering avoids that problem.

Phillip “Reality Check” Dampier

The city of Los Angeles believes if they ask for it, they will get it – gigabit fiber broadband, that is. It is too bad we have to run a reality check.

In December, the city plans to issue an ambitious Request for Proposals (RFP) inviting at least one private company to run fiber service to all 3.5 million residents (and businesses and public buildings) within the city limits. The idea, which won unanimous support from the City Council, does not exactly come with many risks for the city. The Council acknowledges the project is likely to cost up to $5 billion (we suspect more), and the city has made it clear it won’t be contributing a penny.

“The city is going into it and writing the agreement, basically saying, ‘we have no additional funding for this effort.’ We’re requiring the vendors that respond to pay for the city resources needed to expedite any permitting and inspection associated with laying their fiber,” Los Angeles IT Agency general manager Steve Reneker told Ars Technica. “If they’re not willing to do that, our City Council may consider a general fund transfer to reimburse those departments, but we’re going in with the assumption that the vendor is going to absorb those up-front costs to make sure they can do their buildout in a timely fashion.”

That is wishful thinking.

The winning vendor is not just on the hook for the cost of building the network. It also has to comply with a city requirement to give away basic 2-5Mbps broadband service, possibly recouping the lost revenue with advertising. Customers wanting faster access will pay for it. Although not required to offer phone or television service, Reneker anticipates the winning vendor will offer both to earn more revenue to pay off construction costs.

Greater Los Angeles is now served by a mix of AT&T, Time Warner Cable, Verizon, Cox, and Charter. Only Verizon has a history of providing a significant fiber optic broadband service, but it has suspended further expansion of its network. AT&T is the dominant landline provider, but considers its U-verse fiber-to-the-neighborhood design adequate for southern California. It seems unlikely any incumbent provider is likely to seriously contemplate such an expensive fiber project, especially because the city requires the winner to build an open access network that competitors can also use. Cable operators have also stated repeatedly that their existing infrastructure is more than adequate. The question providers are likely to ask is, “why do we need to partner with the City Council to build a fiber network we could build ourselves, on our own terms, that we ultimately own and control?”

The city can offer some incentives to attract an outsider, such as promising a lucrative contract to manage the city government’s telecom needs. It can also ease bureaucratic red tape that often stalls big city infrastructure projects. But Los Angeles is not exactly prime territory for a fiber build. Its notorious sprawling boundaries encompass 469 square miles, with many residents and businesses in free-standing buildings, not cheaper to serve multi-dwelling units.

Google avoided California for its fiber project reportedly because of environmental law and bureaucracy concerns. Even Google cherry-picks neighborhoods where it will deploy its fiber project in Austin, Provo, and Kansas City. The Los Angeles RFP will likely require universal coverage for the fiber network, although it will probably allow a lengthy amount of time for construction.

The City Council’s RFP comes close to promising Gigabit Fiber-to-the-Press Release.

Private providers govern their expansion efforts by an increasingly stiff formula to recover construction costs by measuring potential Return On Investment (ROI), which basically means when a company can expect to earn back the amount initially invested. Spending $5 billion on a fiber network that could actually cut expected Average Revenue Per User (ARPU) with a free broadband offer is going to raise eyebrows. Convincing investors to chip in on a fiber network “open to competitors” will also elicit a lot of frowning faces.

Wall Street analysts rolled their eyes when Verizon rolled out FiOS. It was “too expensive” and provided too few avenues for a quick ROI. ‘Verizon built a Lamborghini Aventador fiber network when a Honda Accord would have done just fine in the absence of fierce competition,’ analysts complained. Why spend all this money on fiber when fat profits were waiting to be harvested from high-ARPU wireless service? Verizon got the message and ceased expansion. AT&T never walked that Wall Street plank in the first place, delivering a less capable Chevrolet Spark network known as U-verse.

The city is likely to be disappointed with the proposals they receive, in much the same way local governments begging for competition from other cable companies get no positive results. The economics and expectations of today’s private broadband market makes it extremely unlikely an incumbent provider is going to rock a boat that has delivered comfortable broadband profits with a minimum of investment.

Breaking the broadband duopoly of high prices for slow service is only likely in the private sector if deep-pocketed revolutionaries like Google can self-finance game-changing projects. Los Angeles will likely have to sweeten its invitation to attract interest from players serious enough to spend $5 billion. It will likely have to invest some money of its own in a public-private partnership. Perhaps an even better idea is to take control of the city’s broadband destiny more directly with a community project administered by a qualified broadband authority with proven experience in the telecom business.

There is no reason private companies cannot be active participants in whatever project is ultimately built, but these companies are not charities and if their financial backers don’t see a pathway to profit running fiber rings around LA today, an RFP to build a fiber network with city strings-attached isn’t likely to garner serious interest tomorrow.

Set-top box-less Time Warner Cable subscribers in parts of New York City will find more than 90 percent of the basic cable lineup missing from their QAM-equipped televisions as the cable company completes a transition away from analog cable television and begins encrypting almost all its digital channels.

The Federal Communications Commission changed the rules last year allowing large cable operators to begin encrypting basic cable, requiring customers to rent cable boxes or CableCARD units to keep watching.

Time Warner Cable began the all-digital, encrypted channel conversion earlier this year in Mount Vernon, Staten Island and Bergen County, N.J., and is now switching on encryption in the New York City region on a neighborhood-by-neighborhood basis.

The switch renders televisions useless for receiving cable channels without extra equipment supplied by Time Warner Cable. Encryption is deployed as an anti-theft measure, but it also inconveniences customers who have to rent equipment for each of their televisions. Encrypting basic channels also benefits Time Warner Cable by allowing service authorizations and disconnects to be handed from the office, reducing in-home appointments.

Customers will need a traditional set-top box, a Digital Transport Adapter (DTA), or a CableCARD to get the channels back. DTA boxes are being provided at no charge until 2015, after which they will cost $0.99 a month each.

Some customers also complain Time Warner is testing “copy protection” permissions, preventing some channels from being recorded. In Queens, one customer noted copy protection was active on C-SPAN, preventing recordings of the network. Some programmers may insist on copy protection technology being implemented as part of future cable carriage contracts. Most expect pay-per-view and on-demand events will be the first blocked from recording, potentially followed by premium movie channels.

At this time, Time Warner Cable says its encryption initiative is limited to the New York City area.

Frontier Communications’ new simplified pricing with no equipment fees or surprise contracts was well-timed for the phone company as it picked up a growing number of disgruntled Comcast and Time Warner Cable customers fed up with increasing modem rental fees.

Frontier depends a great deal on its residential broadband service to win back revenue the company has lost from years of landline cord-cutting. The company reported slowing revenue losses, now down to less than one percent for the quarter ending Sept. 30. Frontier’s profits reached $35.4 million this quarter, reduced by increased investment in broadband upgrades and pension fund-related expenses.

The independent phone company is still losing residential and business phone customers, but those losses have begun to stabilize. Frontier has 2.82 million residential customers and 275,000 business customers. While Time Warner Cable lost customers during the recent quarter, Frontier picked up 27,000 new ones. For all of 2013, Frontier added 84,500 new broadband customers. Nearly 84 percent of them added broadband as part of a bundle, which leads analysts to suspect most of Frontier’s new broadband customers are located in rural areas that never had access to broadband speeds before.

Frontier’s greatest opportunity is in the rural residential broadband business, and the company’s investment in improved broadband speeds has made a major difference in growing market share especially where it has a cable competitor. Currently, Frontier has 20-25 percent market share in most of its service areas. It wants 40%, but is unlikely to achieve it selling broadband speeds that often top out at around 10Mbps. Winning customers back to a landline provider has also proved difficult without an attractive bundled offer. In all but a few cities, Frontier bundles landline service with DSL broadband and a satellite television package.

Wilderotter

In rural markets, Frontier has had better success, particularly in areas formerly served by Verizon.

With help from the federal government’s Connect America Fund (CAF), Frontier invested over $21 million to expand rural broadband service in 2013. In the third quarter, the company expanded service to another 37,000 possible homes and businesses, with 30,000 more on the way in the fourth quarter. The company applied for $71.5 million in CAF funding for 2014.

Broadband speeds have also gradually increased in an expanding number of communities. As of today, 45 percent of homes can receive 20Mbps or better, 58 percent are capable of 12Mbps. A year-end commitment to offer at least 3Mbps speeds to 85% of customers in the most rural areas also appears within reach. Customers can upgrade to the next speed level in $10 increments.

But not every customer has gotten speed upgrades. In their largest legacy market — Rochester, N.Y., DSL speeds have remained unchanged in many areas. At the headquarters of Stop the Cap!, Frontier pre-qualified us this afternoon for the same 3.1Mbps DSL speed they offered in 2009, despite being blocks away from the city line.

Those increasing speeds have led to more traffic on Frontier’s broadband network, but the company says it has enough capacity to handle it.

“The average usage of all our customers across both fiber and the copper has grown to about 24GB per month at this point, and we see that increasing and people are comfortable with [our] facilities as well as our backhaul to support that growth,” said chief operating officer Dan McCarthy. “We’ve seen that grow virtually every month as we move forward.”

Frontier analyzes what customers do with their broadband connection and found 30 percent of customer usage is online video. That number is growing. Customers upgrading to the fastest speeds are often telecommuters or have a home full of avid broadband users.

“On the residential side [these high-end customers] are usually working at home, they are VPNing, they are gamers, and they are very active on video services and social media as well,” said CEO Maggie Wilderotter.

The average Frontier DSL customer still subscribes to 6Mbps service, which Wilderotter said was adequate for Netflix, web surfing, and e-mail. But the company is preparing to market speed upgrades to these customers to earn extra revenue.

So far, Frontier’s broadband growth has gone relatively unnoticed by their cable competitors.

“We really haven’t seen any sustainable programs that cable has put against us in the market and we do know that several cable operators have said they’re going to do more in those areas,” said Wilderotter. “We are very well prepared for that. We are giving everyday low pricing to the customer that’s simple and predictable and there are no add-on fees or modem rental costs.”

Most Frontier customers are offered $19.99 or $29.99 broadband pricing that can be bundled with other products for discounts. There is no term contract.

“Time Warner Cable has increased their modem fees [to] between $6 and $9 a month,” said Wilderotter. “That’s a huge price increase for a lot of customers. You compare that with Frontier which has no modem cost and customers understand where price value lies.”

Wilderotter noted Comcast has raised rates as well. Frontier intends to remind cable customers they have a choice, and will tailor offers to continue to increase market share.

The next name of Time Warner Cable?

Charter Communications is laying the foundation for a leveraged buyout of Time Warner Cable before the end of the year in a deal that could leave Time Warner Cable’s broadband customers with Charter’s usage caps.

Reuters reported discussions between the two companies grew more serious after last week’s revelation a poor third quarter left TWC with 308,000 fewer subscribers.

Charter is relying on guidance from Goldman Sachs to structure a financing deal likely to leave Charter in considerable debt. Charter Communications emerged from bankruptcy in 2009 and is the country’s tenth largest cable operator, estimated to be worth about $13 billion. Time Warner Cable is the second largest cable operator and is worth more than $34 billion.

The disparity between the two companies has kept Time Warner Cable resistant to a deal with Charter, stating it would not be beneficial to shareholders. Charter executives hope to eventually win shareholder support for a buyout stressing the significant cost savings possible from a combined operation, particularly for cable programming.

The deal would likely end Time Warner Cable as a brand and leave Charter Communications CEO Thomas Rutledge in charge of a much larger cable company. Pricing and packaging decisions are usually made by the buyer, which could bring faster broadband speeds to Time Warner customers, but also usage caps already in place at Charter.

John Malone’s War on Customers

Malone

Cable billionaire John Malone, former CEO of Tele-Communications, Inc. (TCI) — America’s largest cable operator in the 1980s — believes consolidation is critical to the future of a cable business facing competition from phone companies and cord cutting. Malone’s Liberty Media, which now holds a 25% stake in Charter, is currently buying and consolidating cable operators in Europe. Malone’s post-consolidation vision calls for only two or three cable operators in the United States.

Malone’s quest for consolidation is nothing new.

Under his leadership, TCI eventually became the country’s biggest cable operator, but one often accused of poor service and high prices. More than a decade of complaints from customers eventually attracted the attention of the U.S. Congress, which sought to rein in the industry with the 1992 Cable Act — legislation that lightly regulated rental fees for equipment and the price of the company’s most-basic television tier.

Despite the fact consumer advocates didn’t win stronger consumer protection regulations, TCI was still incensed it faced a new regulatory environment that left its hands tied. One executive at a TCI subsidiary advocated retaliation with broad rate increases for unregulated services to make up any losses from mandated rate cuts.

A 1993 internal TCI memo obtained by the Washington Post instructed TCI system managers and division vice presidents to increase prices charged for customer service calls and add new fees for common installation services the company used to offer for free. TCI’s Barry Marshall recommended charging for as many “transaction” services as possible — like hooking up VCR’s, running cable wire, and programming remote controls for confused customers.

“We have to have discipline,” Marshall wrote. “We cannot be dissuaded from the [new] charges simply because customers object. It will take awhile, but they’ll get used to it. The best news of all is we can blame it on re-regulation and the government now. Let’s take advantage of it!”

Tele-Communications, Inc. (TCI) was the nation’s largest cable operator. Later known as AT&T Cable, the company was eventually sold to Comcast.

The FCC’s interim chairman at the time — James Quello, charged with monitoring the cable industry, was not amused.

“It typifies the attitude of cable companies engaging in creative pricing and rate increases to evade the intent of Congress and the FCC,” Quello said. “There is little doubt that the cable industry has an economic stake in discrediting the congressional act they vehemently and unsuccessfully opposed.”

Marshall defended his internal memo, although admitted it was inartfully written and was not intended for the public. Revelation of a damaging memo like this would normally lead to a quiet resignation by the offending author, but not at John Malone’s TCI, a company with a reputation for being difficult.

Mark Robichaux’s 2005 book, Cable Cowboy: John Malone and the Rise of the Modern Cable Business, was even less charitable.

Robichaux describes Malone as a “complicated hero,” at least for investors for whom he was willing to ignore banking rules and creatively interpret tax law. Robichaux wrote Malone’s idea of customer service was to ‘charge as much as you can, but spend as little as you can get away with.’

TCI’s top priority was to keep up the cable business as an “insular cartel.” The predictable result included accusations of “shoddy service” customers were forced to take or leave. In the handful of markets where TCI faced another cable competitor, TCI ruthlessly slashed prices to levels some would describe as “predatory,” only to rescind them the moment the competitor was gone. TCI’s intolerance for competition usually meant mounting pressure on competitors to sell their system to TCI (sometimes at an astronomical price) or face a certain slow death from unsustainable price cuts.

Among Malone’s most-trusted friends: junk bond financier Michael Milken and Leo Hindery, former CEO of Global Crossing.

Congressman Albert Gore, Jr., later vice-president during the Clinton Administration, was probably Malone’s fiercest critic in Washington. Gore’s office was swamped with complaints from his Tennessee constituents upset over TCI’s constant rate increases and anti-competitive behavior.

The cable industry’s biggest competitor in the 1980s-1990s was a TVRO 6-12 foot diameter home satellite system.

Gore was especially unhappy that TCI’s grip extended even to its biggest competitor — satellite television.

In the 1980s and early 1990s, cable operators made life increasingly difficult for home satellite dish owners, many in rural areas unserved by cable television. But things were worse for home dish owners that walked away from TCI and began watching satellite television instead. To protect against cord-cutting, the cable industry demanded encryption of all basic and premium cable channels delivered via satellite. It was not hard to convince programmers to scramble — most cable networks in the 1980s were part-owned by the cable industry itself.

To make matters worse, unlike cable systems that only leased set-top boxes to customers, home dish owners had to buy combination receiver-descrambler equipment outright, starting at $500. Just a few years later, the industry pressured programmers to switch to a slightly different encryption system — one that required home dish owners replace their expensive set-top box with a different decoder module available only for sale.

Gore was further incensed to learn TCI often insisted home dish owners living within a TCI service area buy their satellite-delivered programming direct from the cable company. Customers hoping to leave cable for good found themselves still being billed by TCI.

Sometimes the rhetoric against TCI and Malone got personal.

”He called me Darth Vader and the leader of the cable Cosa Nostra,” Malone said of Gore. “You can’t win a pissing contest with a skunk, so there’s no point in getting involved in that kind of rhetoric.”

“There’s a joke going around Washington,” John Tinker, a New York-based Morgan Stanley & Company investment banker who specializes in cable television said of Malone back in 1990. “If you have a gun with two bullets, and you have Abu Nidal, Saddam Hussein and John Malone in a room, who would you shoot? The answer is John Malone — twice, to make sure he’s dead.”

TCI itself was a four letter word in the many small communities that endured the cable company’s insufferable service, outdated equipment, and constant rate “adjustments.”

The New York Times reported John Malone’s TCI had a reputation for treating customers with “utter disdain,” and provided examples:

• In 1973, rate negotiations stalled with local regulators in Vail, Colo., the local TCI system shut off all programming for a weekend and ran nothing but the names and home phone numbers of the mayor and city manager. The harried local government gave in.
• In 1981, TCI withheld fees and vowed to go completely dark in Jefferson City, Mo., if the city failed to renew its franchise, while a TCI employee — “who turned out to have a psychological problem,” said Malone — threatened harm to the city’s media consultant. Again, a beleaguered local government renewed the franchise — although in a subsequent lawsuit, TCI was fined $10.8 million in actual damages and $25 million in punitive damages.
• In 1983, the small city of Kearney, Neb., also dissatisfied with poor service and rising rates, tried to give Malone some competition in the form of a rival system built by the regional telephone company. TCI slashed fees and added channels until the enemy was driven from the field.

“That’s the dark side, if you will, of TCI,” said Richard J. MacDonald, a media analyst with New York-based MacDonald Grippo Riely.

By mid-1989, Malone’s frenzied effort to consolidate the cable industry resulted in him presiding over 482 merger/buyout deals, on average one every two weeks. Among the legacy cable companies that no longer existed after TCI’s takeover crew arrived: Heritage Communications, United Artists Communications and Storer Communications.

To cover the debt-laden deals, Malone simply raised cable rates and shopped for easy credit. Bidding with others’ money, the per-subscriber price of cable systems shot up from $998 in 1983 to an astronomical $2,328 in 1989.

The General Accounting Office, the investigative arm of Congress, found deregulating the cable industry cost customers through rate hikes averaging 43 percent. In Denver, TCI raised rates more than 70% between 1986 and 1989.

Malone’s attempt to finance a leveraged, debt-heavy buyout of Time Warner Cable seems to show his business philosophy has not changed much.