Small Operators Place Big Bets

When Bill Bauer decided to build his WinDBreak cable system in Lyman, Neb., in 1985, he spent his days stringing wire to build out the system and his evenings going door to door to sell the service, he recalled. Then he’d install his new customers.

Today, his two systems in Lyman and Harrison, Neb., have only 200 customers, giving him the distinction of being the smallest member of CableLabs. “In the mid-1990s, I happened to walk into a meeting at the Western Show at the same time as John Malone,” then running the nation’s largest multiple-systems operator, Tele-Communications Inc., Bauer recalled. “Dick Green [the president and CEO of CableLabs] turned to us and joked, 'You guys are the bookends of the industry,’ ” the biggest and smallest operators.

Today, the bookends of cable are in some ways further apart than ever, as the biggest operators have grown and the smaller providers have struggled against the massive challenges of a rapidly consolidating and increasingly competitive industry.

Operating in smaller, less densely populated rural markets, many have traditionally found it difficult to upgrade their systems so they can effectively compete against the direct-broadcast satellite providers that have been poaching customers at an alarming rate.

A slew of regulatory issues, including the Federal Communications Commission’s July 1 ban on integrated set-top boxes, negotiating retransmission consent for broadcast-TV stations and the February 2009 transition to all-digital television transmission also impose hefty costs that threaten their future. (See “The Triple Regulatory Whammy,” page 34.)

Despite those handicaps, however, small operators have shown remarkable resilience and continue to embrace newer technologies.

Bauer, for example, chaired the high-speed data working group at CableLabs in the mid-1990s, helping to lay the foundation for the Data Over Cable Service Interface Specification. His WinDBreak also rolled out a high-speed Internet product in 1997, a move that helped it survive the loss of video subscribers to satellite.

Today, he’s working with two other indie operators, Buford Media Group chairman Ben Hooks and Tele-Media Broadband CEO Tony Swain, to launch Beyond Broadband Technologies (BBT), which has been developing a low-cost set-top box.

Bauer is currently beta-testing the equipment in his small Nebraska systems.

“We realized that to survive in the small cable world, we needed a low-cost box that can eventually cost under $50” and handle the advanced services operators need to compete, Bauer said.

The venture will face stiff competition from giants like Motorola and Cisco Systems unit Scientific Atlanta. But the tradition of innovation and gutsy entrepreneurialism that Beyond Broadband reflects goes a long way towards explaining the resurgence of independent cable.

Surveys by the National Cable Television Cooperative of its members — 1,117 independent operators — offer evidence that small cable systems continue to invest heavily in their operations.

Only 2% to 3% of those companies are not upgrading their systems, said NCTC CEO Jeffrey Abbas. “Of the nearly 12 million-sub base of our members, 85% is served by 550-Megahertz plant or better,” with the number of subscribers served by 750-Mhz systems showing significant growth.

Thanks to those investments, equipment purchases through the co-op climbed from $88.8 million in 2003 to $273.8 million in 2006. The NCTC estimated that independent operators are now spending $1 billion to $1.2 billion per year in capital expenditures.

“We are seeing members as small as a few hundred subs investing in launching the triple play,” added Matt Polka, CEO of the American Cable Association, small cable’s main Washington, D.C., lobbyist. “Once they have the bundle, they can compete very effectively with satellite and telephone.”

Added Abbas, “The triple play is making this a great time to be a small cable operator.”

That optimism can also be seen in a slew of deals for smaller systems. At least seven independent operators interviewed for this special report have acquired systems in the last four years or are looking to buy.

For example, Ben Hooks, a cable veteran and chairman of Buford Media Group, sold his systems in the late 1990s. But he got back into the business in 2004, acquiring subscribers in six smaller markets that now serve about 70,000 subs, and he said he is close to acquiring another property that has about 40,000 subscribers.

“I believe very strongly in the business and continue to look for ways to expand,” Hooks said.

Said Pat Thompson, managing director of Denver-based cable-centric investment bank RBC Daniels, “There is a lot of interest in smaller systems.” (See “Shopping for Systems,” page 33.)

That doesn’t mean that the industry isn’t facing a number of major challenges as it convenes in Monterey, Calif., for this week’s Independent Show. Programming costs continue to grow at an alarming rate, making video a low- or no-margin business for many operators and they face a host of regulatory issues.

Worse, the hefty competition they already face from direct-broadcast satellite providers is likely to increase in upcoming years, as phone companies begin to roll out Internet Protocol television services.

The double and triple play, however, are putting the industry on a better financial footing, operators said. Those bundles are allowing independent operators to shore up their competitive position against satellite and to strengthen their offerings for the upcoming battles against the telcos.

“The triple play is driving basic subscriptions and has reversed the decline from satellite,” argued Allan Block, chairman of Block Communications, whose Buckeye CableSystem in Toledo and Sandusky, Ohio, has about 147,000 basic-video subscribers, more than 80,000 high-speed data customers and more than 40,000 phone customers. “We still have to deal with competition and in the future [we] have to be prepared for the [regional Bell operating companies]. But we’ve been very successful and now have over 25% penetration [as a percentage of expanded basic subscribers] for the phone service.”

Added Bill Schreffler, CEO of St. Louis-based independent operator Millenium Digital Media, “If you look back four years ago, [high-speed data] was the savior of the industry that barred the door to further subscriber losses from satellite.”

As technology costs fall, according to Schreffler and others, it is becoming possible for much smaller systems to justify the investment in upgrading cable plant to offer high-speed Internet access and then telephony.

“You don’t really need to be in a big market like Chicago or New York to make those products work,” Schreffler said. “You can be in a secondary market and get a good return on your investment.”

After upgrading most of its systems to 550 Megahertz or better, MDM will be deploying full phone service in September and expects to have it available to 92% of its systems in the Northwest and Michigan by the end of 2007.

“We are growing basic subs, high-speed and overall revenue-generating units,” Schreffler noted. “The history of this sector has been one of decline. But once you start to water the plant, it starts to bloom, and that is what we are seeing.”

High-speed data and phone are particularly important, given rising programming costs. While operators praise the NCTC’s successful efforts to reduce the gap between what large MSOs and small operators pay for programming, the programming costs remain a major problem.

An NCTC survey of the monthly cost of a package of the 50 largest basic-cable networks finds that programming costs for members grew anywhere from 8.8% to 5.3% a year between 2004 and 2006.

Smaller operators can’t afford to pass those increases along to consumers without losing some subscribers to satellite. As a result, video is increasingly becoming a no-margin or low-margin product, with operators looking to make their money first from Internet access and then phone, several operators said.

“We make money on video,” said Buford’s Hooks. “But the margins are thin and going forward, that business couldn’t survive on its own. The additional services are very critical. We’re finding that the margins on Internet and now phone are very attractive.”

Some operators who have deployed triple-play offerings for several years report particularly strong results.

For example, Sunflower Broadband, a local phone company and member of both the ACA and National Cable & Telecommunications Association, installed a two-way, addressable plant in the late 1980s, rolled out a high-speed Internet service in 1995, added phone in 2001 and became the first operator to launch a dynamic insertion VOD system from SeaChange in June of 2006.

Thanks to those early rollouts, Sunflower currently has 45% penetration for its high-speed Internet service and 77% basic-video penetration, despite hefty competition from satellite and the June 2007 launch of AT&T’s U-Verse TV product in part of its footprint.

“As AT&T deploys, we are more thankful than ever that we’ve made the investments to have a competitive service,” said general manager Patrick Knorr. To maintain that momentum, Sunflower is now boosting their HDTV content and exploring the idea of deploying switched digital.

Another company that has seen much success with the triple play is General Communication Inc., which started in 1975 as a competitive long-distance carrier in Alaska. GCI, which is also a member of the ACA and NCTA, launched cable operations in the mid-1990s and currently has about 145,000 video subscribers, 90,000 cable-modem customers and 115,000 to 120,000 local phone lines.

While satellite has been hampered by lack of good coverage in parts of Alaska, the triple play has been a major factor in GCI’s success, according to vice president of product management for data and entertainment Terry Nidiffer.

“When satellite started, they made some inroads, but even then we had the triple play in many areas and that helped us a lot,” he explained. “Today, satellite has less penetration in Alaska than you see on a national basis.”

While other operators note that their bundles are too new to have boosted subscriber counts, they believe that network upgrades have helped stabilize their video subscribers, strengthened their overall financial results and allowed them to roll out additional services, like video on demand, that can differentiate them from satellite.

“In certain markets, we haven’t been able to completely turn around the phenomenon of losing subscribers to satellite,” said Bill Severn, chief operating officer of PG Cable, a 100,000-subscriber operator in Missouri, Arizona and California. “But where we have been aggressively marketing the double- and triple-play bundles, we have seen improvements.”

Thanks to those upgrades, the operator now offers digital phone in 93% of its footprint and Internet access throughout its territory.

Working with vendor SeaChange International, it also rolled out VOD to its St. Joseph (Mo.) Cablevision system in May.

“I wish I’d pulled the trigger on VOD a year earlier,” said Severn. “The usage rates we are seeing are just incredible.”

About 29% of St. Joseph’s on-demand enabled homes tried the service within three weeks of launch. Severn believes the usage rate is now up to about 40%.

Even better, VOD is becoming an important revenue generator. On-demand homes are currently buying movies and other content at 3.5 times the previous rates, he noted. “When you look at [return on investment], it’s much better than we expected,” he said.

Severn hopes St. Joseph Cablevision’s 25% penetration rate will hit 85% by 2008.

While a number of smaller operators still have serious bandwidth issues, most are working hard to overcome such problems, said Scientific Atlanta vice president and general manager, broadband-access unit Mark Palazzo.

“In some sense, the smaller operators are not different than the larger, public-traded MSO,” he said. “They are all facing competition from satellite and increasingly telcos.

“Everyone is to a certain extent under some bandwidth pressure and looking to find ways to carry more content and have a more competitive offering.”

That is driving some to consider IPTV, passive optical network technologies or even fiber to the home, according to Floyd Wagoner, senior manager of global marketing and marketing communications for Motorola Access Networks.

“My experience in the independent market is that they are very nimble, they have the resources and they are showing a willingness to move very quickly to replace their whole network architecture,” he said. In other cases, he added, systems serving real estate developments are building fiber to the premises.

For example, New Village Communications CEO Dan Ryan is managing a fiber-to-the-home deployment at Nevada’s Lake Las Vegas development, about 17 miles outside the Las Vegas Strip.

The exclusive community boasts such full- and part-time residents as Celine Dion and Arnold Schwarzenegger and will eventually have some 10,000 units when completed, Ryan said.

While they aren’t as yet offering a triple play, the system has 1,000 subscribers for video product and a high-speed Internet offering with speeds up to 15 Mbps.

While fiber and IP solutions aren’t on the immediate timetable for most smaller operators, many are looking for additional revenue streams from business services, local advertising sales and other areas.

“We’ve been very successful in the business market and see that as a major growth potential,” said Sunflower’s Knorr.

To expand its successful local-advertising business, Sunflower rolled out SeaChange’s dynamic insertion system for on-demand advertising in June of 2006. That has proved enormously successful, both as a way of bringing in new advertisers and to retain older sponsors, Knorr said.

Between January and April, they inserted more than 75,000 ads in VOD program, boosting ad revenue by 4% and increasing the client base by 10%, he notes.

In the end, though, independent operators’ biggest competitive advantages will be greater community involvement and better customer service, according to several such cablers.

“AT&T may be coming, but we have one thing that they don’t have,” said Block. “We’re local and we’re involved locally with all of our customers.”

Even though Buckeye Cablevision serves a relatively large base of about 147,000 subscribers, Block noted that he and his other top executives give out their home number to all their customers and that Buckeye has invested heavily in customer service.

“Surveys show that we’ve scored much higher than satellite and the other large MSOs in customer service,” said Block. “We may be too large to be a mom-and-pop operation, but we can act like one. If a customer is unhappy, they can call me directly. We can provide local, personal service that AT&T can’t.”