Come Together

Jim Cooper

As more cable companies merge more opportunities for consumers arise

In April, 1997 Microsoft chairman Bill Gates and Brian Roberts, president and CEO of Comcast, sat next to each other at a dinner for cable executives hosted by Gates in Redmond, Wash. By the end of that meal, the cable industry was well on its way to changing forever the way it does business.

Gates, who complained cable operators were taking too much time to upgrade their systems, was met with a challenge from Roberts to invest in cable. “It would make a strong statement,” Roberts said to Gates.

Ultimately Gates was convinced the white wire in 70 million homes was the conduit for next-generation media. That includes telephone service, digital television, e-mail, high-speed Internet access, interactive programming, e-commerce and who knows what else. Gates’ response to Roberts’ challenge took the form of a billion-dollar investment in Roberts’ cable company.

In hindsight, Bill Gates’ billion dollars seems more like an anointment than an investment.

At the time, cable stocks had been languishing for years. There were dozens of far-flung companies whose vision was limited to eking out more license fees from networks while raising cable bills without drawing the wrath of the Federal Communications Commission.

Two years after Gates’ commitment, the cable industry is in a vortex of consolidation and acquisition driven by the big plans of outside players such as AT&T, Gates and Microsoft cofounder and billionaire investor Paul Allen.

Large cable companies are also in the shopping spree, and Comcast, Cox and Adelphia have bought, swapped and sold cable systems at a furious pace. All this has rocketed cable’s stock prices as Wall Street finally senses vision behind broadband management, and Washington sees cable as fostering competition in local phone access and providing a valuable service to consumers.

According to Broadband Daily, a cable industry newsletter, there have been 20 broadband deals since April20 valued at close to $88 billion in all. In May alone there were 14 deals valued at $22 billion in all. As a result of these mergers, the top seven cable companies will serve 95 percent of the nation’s cable homes.

The big fish are getting bigger and the small fish are facing extinction.

While Gates’ investment was a flare signaling cable’s new future, several other catalysts are causing the recent frenzy. The March expiration of re-regulation, which long tainted the industry, was a major boost to cable valuations, and buyers started to come out of the woodwork. The world’s most influential and cash-rich media executives began to see the promise of services that had long been part of blue sky-projections as within their grasp.

“Now that they have cycled out of the regulation, free cash flow has become more abundant, and companies have deleveraged their balance sheets and are investing heavily in new services,” says Fred Moran, managing director of ING Barings, an international investment bank.

“AT&T’s and Allen’s rapid search for systems has accelerated a process that would have happened anyway and put pressure on the rest of us to do something if we want to stay,” says Michael Rigas, executive vice president of operations for Adelphia Communications. Rigas notes that Wall Street is increasingly hot for companies with as wide a footprint as possible.

Expanding that footprint to the point where it almost resembles the coverage area of a regional Bell operating company is a massive outlay. Cable homes, usually valued at $2,000, are now being bought for more than $4,000 each. AT&T, for example, paid $4,600 for each MediaOne cable home. However, the future revenue streams from these homes could be three or four times more than a traditional cable bill, and therefore worth the price.

“With the Internet and the migration to digital television, the technology is essentially driving a scenario where voice, data and video are coming together,” says Sandra Kresch, strategy partner in PricewaterhouseCoopers’ entertainment and media practice. “As that happens, it becomes more important to become a distributor for all the possible services so you can generate maximum revenue from a variety of different streams.”

“It’s really been in the past six months that people have said that these new services really do work,” echoes Dallas Clement, vice president and treasurer of Cox Communications.

While Gates may have started the ball rolling, Allen soon upped the ante.

Articulating a strategy focused on “a wired world,” Allen and his company, Vulcan Ventures, started to buy cable companies in April 1998 with a $4 billion deal for Marcus Communications. Three months later Allen bought Charter Communications for $4.5 billion. In January of this year, Allen invested in part of Intermedia Partners and bought Helicon Cable Communications in March. He has also bought both Rifkin Acquisition Partners and InterLink Communications for about $1.5 billion.

Allen’s May started with the acquisition of Avalon Cable Television and ended with the $3 billion purchase of Falcon Cable and the $2 billion acquisition of Fanch Communications. The Falcon and Fanch buys make Allen’s Charter Communications the nation’s fourth-largest cable operator in the country, with 5.5 million customers. However, Allen’s holding are not as geographically clustered as the other top five MSOs, which could be a problem in delivering and marketing services such as high-speed Internet access, although more acquisitions and swapping of systems could quickly solve that problem.

Like Allen, AT&T chairman Michael Armstrong has plans for cable wire into the home but is aiming for bigger targets. Shut out of the local telephony business since 1984, when regulators forced AT&T to spin off the Baby Bell phone companies and pay them for local calling, Armstrong concluded that his cash-rich company could offer local phone service via cable if enough of its broadband pipe could be consolidated. In the past year, Armstrong has successfully acquired TeleCommunications Inc. for $48 billion. Then, in a down-to-the-wire bidding war with Comeast, he bought MediaOne for an eye-popping $56 billion.

In buying MediaOne, which owned 25.5 percent of Time Warner Entertainment, AT&T has closer ties to the No. 2 cable company, an alliance that could possibly lead to a merger of @Home and Road Runner, AT&T’s and Time Warner’s respective high-speed Internet access companies. In the meantime, AT&T now has a potential universe of 25 million homes and will start to knit them together into a broadband network.

“Together, AT&T and MediaOne will bring broadband video, voice and data services to more communities more quickly than we could separately,” said Armstrong in a statement after acquiring MediaOne.

In closing the deal, Microsoft, which is eager to provide the software for the wired world, bought a part of AT&T for $5.5 billion in exchange for access to at least some of its cable infrastructure.

“Our agreement today represents an important step in Microsoft’s vision of making the Web lifestyle a reality,” said Gates at the close of the AT&T! Comcast/MediaOne/Microsoft pact.

In an interesting twist, AT&T is now looking to shed some of its ownership in cable holdings in order to shrink its coverage area from almost 60 percent of cable homes to a percentage that makes antitrust lawmakers less nervous.

While Comcast didn’t win the MediaOne prize, it did survive the bidding war to fight another day. As part of the deal, AT&T gave some subscribers to Comcast, which also formed an alliance with AT&T to deliver telephony and other services to its customers. It will also manage Lenfest, a Philadelphia-based cable station bought by AT&T in the midst of its deals with Comcast and Microsoft, starting in 2002.

Comcast, which, now has 8 million subscribers, also continues to consolidate its markets. In late May, it swapped systems with Adelphia and created one of the largest market clusters in the country Its service area on the East Coast now stretches from northern New Jersey to Washington, D.C. It also controls about 80 percent of the Philadelphia market where it is based.

Coudersport, Pa.-based Adelphia has gone from the No. 8 operator in November last year to No. 5 by way of an aggressive acquisition and system-swap strategy In the past year, Adelphia has bought Century Communications for $8.6 billion and Harron Communications for $1.2 billion and, most recently, swapped systems with Comcast, giving it a 1.1 million customer base in the Los Angeles area. Adelphia also purchased Frontier Vision’s 702,000 subscribers for $2.1 billion.

Asked whether Adelphia plans to continue to acquire or swap more systems, Rigas says his company will continue to look for opportunities to further consolidate and cluster its systems. Adelphia already offers digital cable and a high-speed modem service called Power Link, and is doing a trial of residential telephony.

Run by the Rigas family, the company has recently been rumored as the next possible acquisition target for Allen or other would-be broadband players, although chairman and CEO John Rigas has stated vehemently on various occasions that there are no plans to sell.

While Cox is the most conservative of the large consolidation players, it has still spent billions to remain in the game. The company which has some of the most sophisticated cable lines in the country, has already started to offer telephony to its 5 million subscribers, and is broad enough to continue to cluster its systems and acquire new ones. Most recently, Cox acquired TCA Cable in Tyler, Texas, for close to $4 billion and the Fairfax County, Va.-based Media General Cable for $1.4 billion.

“We are willing to take risks on technology and new services because we have a long-term view,” says Clement.

The two major players that haven’t factored into the multibillion-dollar acquisition story in a big way are Time Warner and Cablevision.

Time Warner, which does have a deal in place with AT&T for telephony, is still the No. 2 cable company behind AT&T with 13 million customers. At the end of May, Time Warner and AT&T completed a large system swap to further cluster their respective system holdings. Time Warner now has huge clusters serving key upscale demographics in at least 10 major markets.

Like Time Warner, Cablevision has aggressively swapped in the past two years, but recently has concentrated on its lock on the New York metro area. Beyond most of the cable customers ringing New York City, the company also owns key content and sports rights and will likely function in the future more as a one-system operator than a multimarket cable company. Cablevision will also strive to become the premier entertainment provider in the No. 1 market in the country. Along with Adelphia, analysts say Cablevision could be the target of either Cox, Comcast or Allen.

All this means that cable isn’t only for analog programming anymore. Today’s broadband players will still deliver popular video content such as SportsCenter on ESPN, Hollywood gossip on E! and Backstreet Boys specials on MTV. But that content will be only a part of a suite of services delivered to consumers.

High-speed Internet access and digital cable and telephony are available today in a small percentage of cable systems and will likely be the first services to get broad consumer attention.

“[Customers] are going to demand a large offering of video products, digital interactivity and, going forward, video on demand and home shopping and banking and they’ll be looking at high-speed modems and eventually some type of telephone offering as well,” says Rigas. The real sea change could come when these companies begin to deliver interactivity to the television, which, at 95 percent market penetration as opposed to 35 percent for PCs and even lower for Internet access, will be a big business.

“You have a huge market opportunity if interactivity to the television works,” says Cox’s Clement.

Of course all this is happening under the scrutiny of antitrust lawmakers in Washington. Both Rep. Billy Tauzin (R-La.) and Sen. John McCain (R-Ariz.) have said they will hold hearings on the AT&T merger. However, most cable executives seem unconcerned that lawmakers will get in their way and in fact will likely consolidate their companies further.

“The demand for and the economic value-added of consolidation justifies more still to come,” says Moran.

Moving forward, the massive cable companies will have to convince customers they need to send e-mail over their televisions and that it is safe to buy something with a “purchase” button on their remotes. In the meantime, AT&T, Paul Allen and others will have to spend billions on sprucing up their cable plants in order to deliver these new services.

The players left standing when acquisition runs its course will likely go through a very complicated period of mixing and matching their holdings in order to create as many market cluster as possible.

“They need to make big investments in consolidation and infrastructure without a clear return,” says Kresch. “Figuring out how to get sufficient revenue in a reasonable time frame to pay for these investments will be a very tough challenge.” Indeed, the brave new telecommunications world, frothed up into a meringue of hype by the media, won’t be a reality anytime soon.

Other hurdles are popping up. As this story neared deadline, a Federal judge in Oregon last week concluded that local franchise authorities have the right to force cable to open their broadband networks to Internet service competitors such as American Online. Cable stock prices dipped once investors heard this news.

Cable companies have stridently opposed carrying unaffiliated Internet providers that could compete with their own growing Web services. AT&T, which is appealing the rulings, has said if it is forced to open its cable connections, it can no longer justify spending billions to offer interactivity via cable.

However, if it were an easy row to hoe, MediaOne and Century would be going for it on their own rather than selling for huge profits.

In the distant future, wireless communications might be able to challenge cable’s robust broadband. Low-orbit satellites could be launched, and high-speed Internet and video interactivity could be available without a wire. However, even if that is 10 years away, cable will have a huge head start with its billion-dollar white wires on the ground.

Major cable consolidation

Date Buyer Seller Price

4/20/99 Adelphia Harron Comm. $1.2 billion

4/22/99 AT&T MediaOne $62 billion

4/22/99 Cox MediaGeneral $1.4 billion

5/4/99 AT&T Lenfest (50%) $2.2 billion

5/12/99 Cox TCA $4 billion

5/17/99 Charter Avalon Cable $845 million

5/25/99 Charter Falcon $3.6 billion

5/26/99 Charter Fanch $2 billion

Total: $77.2 billion

Source: Broadband Daily

Cable guy

Vulcan’s William Savoy predicts we’ll be shopping from our TV sets in no time

William D. Savoy is Paul Allen’s cable guy. As the president of Vulcan Northwest and vice president of Vulcan Ventures, the parent company of Charter Communications, one of Savoy’s key responsibilities is acting as steward for Allen’s vision of a wired world in which cable customers will use their television to surf the Net for recipes, buy movie tickets and call home on Mother’s Day. Since April 1998, Charter has become the No. 4 U.S. cable company–with 5.5 million subscribers–by spending more than $15 billion in seven major cable acquisition and consolidation deals. Charter will likely spend mere if the price is right, says Savoy.

Fresh from two multibillion dollar deals in as many days, Savoy discusses cable consolidation and its future impact on the industry and consumers.

Jim Cooper: Why is the rush to consolidate cable companies happening now, and why are cable homes worth $4,600 each?

William Savoy: There are two answers. First, once the cascade of events starts, the momentum just carries the consolidation. If you stop, you get left behind. Two, people have woken up to the fact that in a business where you used to have one service , now you’ll have at least three . Customers today will be worth so much more in the future, you might as well get as much cable as you can. Every customer you get new is just that much more when you layer on new services.

JC: Charter has done seven deals since it acquired Marcus Cable in April 1998. Will this pace continue until there are only operators with 5-million-plus subscribers?

WS: Probably.

JC: How will the remaining operators coexist? Will they remain separate, or will deals such as the one between AT&T and Time Warner for telephony be common?

WS: If I knew the answer to that I’d be further ahead. But it’s too early to tell.

JC: Does any of the anti-trust rumbling out of Washington in the wake of AT&T’s acquisition of MediaOne concern you as you continue to grow?

WS: No. It doesn’t bother me. It’s probably a headache for Leo and the people ever at AT&T, but that’s their battle. They’re going to be watched, but as long as you’re paying what you’re paying for these things, I think you’re going to be able to continue. No one’s going to say that we’re slipping one in under the regulator’s eyes.

JC: In making his acquisitions, Paul Allen has referred to a “wired world.” What does that world hold for existing cable subscribers?

WS: We look at it in the following way: In consumers’ homes, there might be two streams. Thirty-three percent of the homes in the U.S. have a PC and a TV. In the other 67 percent of the homes there’s just a TV. Connecting PCs to the Internet over cable is an interesting business. However, the really interesting opportunity is when you take the interactivity and the best of the Internet and deliver it to a television using a high-end set top box. You could customize what you see, when you see, when you see it and how you see it. And, if if you bring transactions to the platform, who knows where it’s going to go. The remote control should have a buy button and a more information button. The notion of dialing an 800 number from here on out ought to be completely irrelevant.

JC: How soon will Charter subscribers have the option to buy these next-generation media services such as high-speed Internet access, telephony and Video-on-demand?

WS: You re going to see interim technologies and real market opportunities come. Things like Wink and Worldgate are available today, and they are examples of what this could be. You’ve got to let the marketplace determine how soon you spend the money to bring new technology and not deploy for the sake of deploying alone.

JC: Which of these services will your subscribers embrace first? Which will be the most profitable?

WS: We have notions of what they are, but we’re going to let the marketplace tell us.

JC: Can you expand on the notions?

WS: That’s my only trade secret.

JC: What role will Microsoft and other software companies have in this new telecommunications world?

WS: Microsoft has an opportunity to be a significant provider of software for the cable platform. From there, you’d have to ask them what they want to do.

JC: Does America Online have a role, or will @Home and Road Runner eventually make it obsolete?

WS: AOL has 19 million customers. That is a pretty decent head start.

JC: Will traditional analog programming remain on the broadband pipe or will it be switched to another delivery method, say satellite?

WS: Those brands sell cable today, and they’ll be around for a long time. To be at the forefront of customers’ minds for 30 years is probably a good thing for all the networks.

JC: Will the Direct Broadcast Satellite players ever be able to offer a wireless conduit that would compete with broadband?

WS: I don’t know what tricks they have up their sleeves, but last time I checked, the amount of band you could put through one satellite is pretty limited. If you’re telling me! should start worrying about it in 15 years, I’m going to breathe a sigh of relief.

JC: What are the most important technology hurdles Charter has to clear on its way to the broadband future?

WS: It’s all execution. It’s “How good are your people?” and “Can you actually do what you said you’re gonna do?” That’s been cable’s challenge for a long time; I don’t see any technology risks between here and there. There are a lot of execution risks.

JC: Other companies consolidating cable holdings are creating geographic clusters of systems, while your customers are located all over the map. Will that-be a problem in the future?

WS: I don’t think they’re that far-flung. Every cable operator has many subscribers that on a map might not appear to be cluster, but we’re [not] any more or dispersed then the next guy. If you look at a map and you lay over all these acquisitions, you’ll see that there are some really good clusters starting to come to mind I think that we’re going to continue to acquire where we need to acquire and maybe buy some more clusters. Then there’s a whole other cycle in the deal front that wont be acquisitions, but trades, like the one between Comcast and Adelphia. That’s not the last of its kind, I assure you.

JC: What is Charter’s ultimate goal in acquiring cable systems, and h many subscribers will it take to achieve it?

WS: Let me say it differently There is a price that I’m not willing to pay for subscribers Century traded above the price I was willing to pay, for example As long as I can make strategically positive acquisitions of subscribers at reasonable price points we II continue to be aggressive We stop when the pricing gets out of hand As long as there are subscribers out there that we can buy that add to our cluster, that are reasonably priced we II be in the market You always have to know when to say no and I said no on multiple occasions We re not afraid to walk away from a deal we think is overpriced.

COPYRIGHT 1999 BPI Communications, Inc.

COPYRIGHT 2000 Gale Group

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