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Small Ops Find Ways To Cope With Digital Costs

The early returns on digital TV are promising. The big guys-- including Tele-Communications Inc. and Cox Communications Inc. -- reported niceincremental cash-flow bumps and healthy customer demand.

Some smaller operators, like Buford Television Inc., alsosaid their digital TV launches are promising.

But for many small, rural systems, which are highlyvulnerable to direct-broadcast satellite rivals, the capital costs of digital can seemdaunting.

Austin, Texas-based Classic Cable islaunching a digital service using TCI's Headend in the Sky in its5,000-subscriber system in Woodward, Okla., this spring, in a market where it competesagainst a wireless cable operator. Steve Seach, the MSO's chief financial officer,said the upfront costs for headend equipment and the subsequent costs for $350 digitalset-tops are tough to recoup for small systems.

"Our numbers show that based on the cost of the boxmore than anything else, you've got to have at least 2,000 subscribers on aheadend" to make HITS work, Seach said. Some other operators figured that you need3,000, or maybe 4,000, he said.

That figure would eliminate the majority of cable systemsin the country. According to Warren Publishing Inc.'s latest Television &Cable Factbook, about 61 percent of the 10,943 cable systems in the country have 1,000or fewer subscribers, and another 18 percent have between 1,000 and 3,499 subscribers.

Even at the 2,000-subscriber level, payback can be tough.At a recent Kagan Seminars Inc. conference, Laura Clifford, senior vice president atcable-oriented investment bank Daniels & Associates, ran the numbers for a2,000-subscriber system launching HITS.

Clifford's model projected $50,000 to $75,000 forheadend gear and $300 each for digital boxes. She plugged in a monthly $10 payment fordigital basic and $3 in equipment charges, and she assumed a lift in pay-per-view revenue,arriving at a cash-flow figure of $14 per month, per subscriber, or $168 per year.

At that rate, if HITS penetrated 10 percent of the system,it would take three-and-a-half years to recoup the capital costs, she said. At 20 percentpenetration, the payback would take two years and nine months. "That's the kindof reason why you haven't seen HITS roll out more aggressively," she concluded.

Those economics aren't lost on TCI, Rich Fickle, vicepresident of marketing and new-business development for HITS, said last week. That'swhy TCI is moving to cut some HITS affiliate costs and even arranging to help systemssecure financing for HITS headend and digital-box orders.

Fickle said TCI is working with several financialinstitutions to provide HITS-equipment financing on better terms than were previouslyavailable. He added that TCI would help small operators to find the money that they needto launch HITS, but it would be up to the systems themselves to pay it back.

Just as digital cash-flow results might entice smallsystems to launch HITS, those results have also helped to persuade lenders that digital isa good business to get behind, Fickle said. Up to now, lenders have wanted to charge highrates for such financing, figuring that the business was risky, he said.

Further, TCI is now offering discounts on theprogramming-transport fees -- normally 3.5 cents per channel -- that it charges itsaffiliates. For most affiliates, the volume discounts would translate to about a 40percent savings off the flat rate, he said.

Some programmers already absorb the transport charge inorder to get carriage, Fickle added.

So far, TCI has 30 HITS affiliates under contract, and itis negotiating with another 30. Those affiliates are providing the service from about 420headends, according to Fickle. Small systems wanting to add digital product are exploringother options, as well, including DBS providers.

A committee of small-system operators -- all believers indigital -- are trying to negotiate a digital overlay product for their systems of lessthan 2,000 customers.

Ron Martin, president and chief operating officer ofBuford; Tom Gleason Jr., chairman and CEO of Galaxy Cablevision; and Jack Pottle,president and COO of Fanch Communications Inc., are in negotiations withdigital-programming suppliers for a small-dish delivery system for the smaller communitiesthat they serve.

Gleason said such towns are served by 450-megahertz orlower plant with, on average, capacity of 25 to 30 channels. It is uneconomic to eitherrebuild or install digital headends in these areas, which, in the case of Galaxy,represent 50 percent of its 200,000 homes. But operators need some kind of advancedproduct. DBS poaches 1 percent to 3 percent of the customer base in these towns, dependingon the aggressiveness of the local Digital Satellite System retailer, Gleason said.

The draw of digital has already been proven to Gleason inhis Booneville, Miss., system. The 5,000-subscriber system has hit 11 percent digitalpenetration in 90 days of availability. Gleason attributed part of the fast growth to TimeWarner Cable, which has rolled out digital nearby. Galaxy is leveraging off the giantMSO's advertising, he laughed.

A digital direct-to-home product could cost theparticipants $400 to $500 per home for the digital box and mini-dish, Martin said.Although it's a high per-home cost, the expenditure would be only on proven customerhomes, and not on basic-only or nonsubscribing homes, as is the case with an upgrade or acomplete rebuild.

"We could have done this before, but we want to brandthe product and do the billing ourselves," Martin said. He wants the DTH customers toidentify their provider as his Friendship Cable.

"We want them to be our customers," Gleasonagreed. "It took us four months to build the [billing] interface with HITS.That's the holdup."

The negotiators said they have one proposal in writing, butthey declined to identify the supplier.

Seach said he has approached DBS providers about possiblycooperating on an analog-digital hybrid. The response from them has been "lukewarm tointeresting," he said.

"I think that there is real opportunity, and I thinkeventually, somebody is going to do it as an experiment, and perhaps we'll seegreater cooperation" between the competing industries, Seach added.

And Classic is not alone in exploring digitalpartners that would offer a direct-to-home solution. 

O 1998 Multichannel News

- 3/30/98