What TV Nets Can Learn From AT&T: Get In Digital Gear

Marc Andreessen, co-founder of Netscape Communications and more recently of Ning, did not mince words this week when he warned moguls attending Allen & Co.'s Sun Valley annual retreat that non-digital, old media newspapers, TV stations and movie studios should be sold. It is no accident that the entrepreneur did not include telephone companies in his indictment, according to attendees.

Although telcos are in a tumultuous transition and their wire line businesses are in a death spiral, they have an iPhone-led wireless back-up plan that also lends itself to related WiFi and Hollywood content ventures.

AT&T especially is well-positioned with its exclusive service pact for Apple's iPhone, the 3G version becomes available today. In fact, Bernstein analyst Craig Moffett says the valuation implications are "profound" in that each incremental 1 million iPhone subscribers AT&T subsidizes generate about $1 billion in incremental enterprise value after the cost. Its iPhone alliance also offers AT&T valuable insulation from deceleration pressures of the domestic wireless market overall.

Still, Moffett has published a somber comprehensive, state-by-state examination of the once-core wire line business of the largest telco companies coming "unplugged." The dilemma is one that surely will plague television station and newspaper owners for years: even as their traditional core business falters, fixed legacy costs remain and cannot quickly be offset by new digital revenue streams. This unsettling dichotomy will become starkly next year, after the federally mandated digital conversion. Group broadcasters do not have as effective a collective new business strategy as the telephone companies, which face rough seas despite their defensive measures.

Even as access line losses have mounted and variable costs are shed, fix costs remain to be spread across a smaller base of lines, boosting the average cost per access line.

The loss of revenues is resulting in the precipitous decline in wire-line margins, despite aggressive forays into video, where high start-up acquisition costs yield inherently lower margins. Bernstein sees accelerating erosion in an already declining wire-line margin, despite Wall Street consensus to the contrary. "The wire-line problem is poised to get worse before it gets better" as cable system operators begin to encroach on telephone companies' small and medium business franchises which have traditionally been the highest margin part of the telecos' business, Moffett says.

The parallels with television broadcasters don't stop there. Wire line telco remains a critical driver of profitability, in the same way broadcast TV advertising remains the core driver of broadcast earnings. In both cases, those profit and revenue streams are on a sure path to eventual extinction, particularly on the local market level.

Wire line that encompasses residential as well as small and medium-sized businesses represents about one-third of AT&T's overall revenues and a significantly higher percentage of earnings than its big company enterprise or wireless endeavors. "Unfortunately, trends in the wire-line telco are nothing short of dismal," says Moffett.

Although Moffett does not make the point in his telephone company analysis, the same dire conclusions are being drawn about the future prospects of pure-play television broadcasters. The similarities are even more pronounced on the local level. Access line losses show "no signs of relenting" despite the maturation of cable VoIP threat or the broad deployment of FiOS, which means a precipitous decline in wire line margins and overall telco earnings.

In essence, TV broadcasters need the same kind of life preservers AT&T created for itself in the transforming telco space. By hitching its wagon to the Apple iPhone, AT&T is in the enterprise market in a big way, positioned to siphon more of the corporate smart phone market away from Blackberry leader Research in Motion. The maximum cost reductions cannot begin to make up for the new and sustained revenue growth that the iPhone partnership represents.

The scenario could play out for solid TV broadcasters with valuable local franchises and original content that can secure relations with cable operators, Internet service providers and companies seeking to get create an interactive digital home hub with their equipment and software applications, from Apple to Hewlett Packard. TV broadcasters looking to remain in the game must aggressively develop services and products for their new digital spectrum before trying to hitch their fortunes to the next generation smart interactive devices.

Indeed, AT&T threatens to sabotage its own fortuitous ties to iPhone if it fails to set up a reliable 3G network to meet consumer demand. About one-third of the applications are games, and about 25% are free with the remainder price at not more than $10 each, driving the business for both Apple and AT&T. All of it is supported by the free iPhone 2.0 upgrade.

In the first quarter, AT&T grew its wireless business faster than expected by 6% over the prior year to nearly $31 billion on a base of more than 71 million subscribers. With mobile phones already the screen of choice, outnumbering all other devices three to one globally, AT&T's opportunistic ties to Apple are supported more by digital consumer spending and venture capital's iFund than fluctuating ad dollars.

It's not a bad Plan B. TV broadcasters, are you listening?

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