Commentary

Telcos To Cable: You Can Hear Me Now

Comcast and AT&T are taking their fight for bundled consumer and small business services straight to the people with humor-laced advertising. But the intense competition between cable and telecom over a maturing broadband market is becoming no laughing matter.

Comcast's Broadway musical production in a 30-second TV spot warns consumers about the exorbitant charges from the BOE (big old expensive) Phone Company. An AT&T radio commercial makes acerbic light of Comcast's low introductory fees that eventually "go through the roof," dramatized by zany sound effects. They are but two in the rival sectors' marketing arsenal.

But truth be told, even Comcast--the largest domestic cable provider--has begun to look vulnerable in what Pali Capital analyst Richard Greenfield has characterized as "an all-out war."

"Investors are no longer trying to project whether the competition will have an impact; it is now exceedingly clear from third-quarter results and management body language that competition is negatively impacting the cable industry"--which has been genuinely surprised by the amount of the telephone companies' aggressive marketing spend, Greenfield says.

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But there are plenty of threats and challenges to go around these days. A slowing economy, the growth of wireless data, shifts in return on extensive capital build-out, and mounting pressure from unlikely competitors such as Google and its Android mobile applications are among the challenging trends cited by analysts. While cable and telcos have relatively little advertising exposure (it counts for 5% of all cable revenues), the players have bundled together home telephony, data and video services that might have contrasting sticking power in protracted economic downturn.

Telco's Internet video services are taking hold just as cable adoption and subscriber rates are flattening out--and in some cases, declining. Cable system operators are in transition from decades of price competition to beating rivals with speed and service compression. Gross additions and data additions growth are declining as broadband penetration levels out to about 80% of online households. By 2010, roughly 40% of cable revenues will be generated by non-video products, spurred by operators' move into small and medium enterprise business to offset core business losses and the maturing of its telephony offerings. Morgan Stanley analyst Benjamin Swinburne estimates that cable will have a 20% share of the business market by 2012, generating more than $5 billion in collective cable revenues against what could be higher-than-anticipated capital expenditures.

Telephone giants that are investing upwards of $70 billion (the same that ad cable did when it upgraded its infrastructure) will have limited reach, with its bundled products concentrated in key population hubs that still are in a position to make a dent in existing cable subscriber bases. Swinburne conservatively estimates about a 40% AT&T coverage overlap for Comcast and Time Warner Cable, or less than 1% annual triple-play subscriber losses for cable over the next several years. But the telcos are expected to lose five lines for every TV subscriber gained. In fact, Comcast insists that for every video customer it loses, it gains about 10 new highly profitable telephony customers who are serviced off of cable's already rebuilt infrastructure.

While cable voice over Internet protocol VoIP additions reach a record 1.2 million (63% of which comes from Comcast), and telco TV continues to post 30% sequential growth to 265,000 net adds (in a footprint of about seven million households), both industries are being confronted by such exterior threats as the possibility of a recession. In other words, as "telco video ramps up and cable telephony bites back," both rival sectors could be in for some unexpected financial twists and turns.

Therein lies potentially the biggest problem in the ongoing telco-cable war. Wall Street analysts, investors and even company officials have failed to alter their outlook for new and competing services based on quickly changing realities. The fact that cable's long-standing rivalry with satellite service providers suddenly is taking a backseat to the telco wars is evidence of just how quickly things can change in the digital interactive marketplace. The state of satellite competition itself is in flux as DirecTV is preparing to be flipped to John Malone's Liberty Media and AT&T ponders an acquisition of its only rival EchoStar Communications, which would heighten the scramble for broadband video subscribers.

Swinburne contends that cable is becoming victim to misplaced expectations. Investors have been too bullish on 2008 broadband additions, and ARPUs remain too high. The impact of AT&T's U-Verse and Verizon's FiOS video service penetration--however small initially --has been underestimated. The small and medium enterprise business just getting underway will not be enough to maintain the revenue and earnings that cable has enjoyed in recent years.

As telephone companies become more like video companies and cable becomes more like telephone companies, they will find themselves equally challenged by the fearless bravado of Google and other Internet players, who want a seat at the digital wireless table.

Although online advertising is on track to comprise 10% of total advertiser spending in 2008, that does not fully reflect the mobile advertising and marketing opportunity that abounds with cell phones outnumbering personal computers by at least three to one. Wireless broadband will open up a new playing field.

Unless cable makes some aggressive moves, in addition to simply gobbling up bulk spectrum, it may miss participating in that revenue's growth stream. In fact, it remains dumbfounding that cable could so grossly underestimate the importance of transferring its bundled services outside of the home. Cable operators' generally lame wireless mobile efforts are compounded by the increasing doubts around the as-yet undelivered wireless enterprise Comcast and Time Warner have long planned with Sprint. While the absence of wireless services may not be adversely impacting cable fundamentals today, they would most definitely hurt them in the future--which is why AT&T has been quick to recast itself as a "wireless-first" telco as it separates its future from a declining wire-line business. But even the wireless carriers are at risk in light of Google's new open mobile platform--which is designed to be media-agnostic, as content and functionality more often will drive consumer demand rather than devices and platforms.

The final kicker may be the dependence both cable and Telco companies have on content they do not control or own to drive their new platforms. Like the broadcast television networks, film studios and Internet, an overreliance on recycled television series and films, user-generated content, and live unscripted events could shift consumer and advertiser attention to more compelling interactive platforms such as video games and video-supported social networks. There is no history of how well live sports, video-on-demand TV and films, and niche program networks perform in a tumultuous digital market brimming with consumer choice. The scramble to keep consumers engaged would be the one place where cable and telecom rivals could stand on the same ground, wondering how sure their footing is.

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