Although the stock market periodically gets jittery over the prospect of cable operators being forced to allow rivals to operate on their high-speed data networks, the financial downside of open access might not be that bleak.
That's the assessment of Ray Katz, media analyst for Bear, Stearns & Co., who has drafted one of the very few-perhaps the only-models of the economics of open access for cable operators. He established a series of schemata that he believes might emerge as cable operators, rival Internet service providers and, of course, regulators hash out the terms under which MSOs would be compensated by outside ISPs offering service on their cable systems.
In his recent 208-page report on cable, "Byte Fight!," Katz concludes that, under the three open-access scenarios he compiled, cable operators' return on investment (ROI) in high-speed would actually go up to as high as 62% because outsiders would bear so much of the marketing, cable-modem and some networking costs.
ROI is an absolutely critical measure of any operation, but it's not the only one. The bottom line is the actual value of a cable-modem customer. Under two possible open-access outlines that involve tough regulation, that value would be rather small.
There's a bright side under a third model, based on commercial negotiations between the operator and the ISPs. Not only could an MSO's return on capital be better, but also each subscriber could be worth $1,536, 18% more than under a straight retailing model.
"From a stock point of view," Katz points out, "what you want to see is the largest value."
Open access turns cable operators from retailers into wholesalers. On the video side of the business, for example, cable subscribers with a Britney Spears jones don't pay MTV. They're customers of Comcast or Cox Cable, which buy the programming from MTV, HBO and ESPN, mark it up and take a profit. Anyone else wanting to sell MTV in the same area would have to build a video system.
In the nascent high-speed Internet business, however, open access changes that arrangement. Operators had expected to simply be retailers: selling Web service to subscribers for $30 to $40 per month at a cash-flow margin around 46% and pocketing a $14 to $18 profit. That would make each Internet subscriber worth about $1,306.
But operators are under pressure to allow other retailers to buy capacity on cable systems and resell it to consumers.
Developing an open-access financial model is difficult because there's not a lot of data to go on. Even some cable operators acknowledge that they haven't worked through the equations Katz has.
Companies that have been clamoring for open access, such as ISP Mindspring and telco GTE Corp., haven't even begun to hammer out terms with cable operators, much less actually cut any agreements.
Katz has found a way to construct a framework: deals involving telephone companies' wholesaling high-speed digital subscriber lines, or DSL, service. Because telephone companies are common carriers with a history of allowing multiple companies to resell their capacity, major markets have several companies reselling DSL service, heavily marketing the service and handling installations. "I just tried to apply similar economics," Katz says.
The bad scenarios are brutal. Adapting a Minnesota state regulatory model for "line sharing" of telephone capacity, he estimates that operators could collect just $6.05 a month per subscriber. On the plus side, he figures the outside ISP would be responsible for virtually all marketing and modem costs, plus sharing about half the costs of headend equipment and technical service. While that yields a 59% cash-flow margin, 13% more than the retail model, it creates very little value for the operator: An Internet subscriber would be worth just $211.
A less draconian, "unbundled loop" pricing method calls for operators to bear more of the capital costs but also to receive $14 in revenue per month at a really fat 72% cash-flow margin. The return on investment falls slightly, but the value of each wholesale subscriber increases to $576. Still, that's far short of the value created by the retail model.
There's precedent for another model that looks far better: the deals AOL has been cutting with telcos to market a high-speed DSL service. In one, it is paying Bell Atlantic a bonus for the right to market AOL DSL. If that were applied to cable, operators would bear all the equipment costs and none of the marketing costs but collect $35.92 monthly. It's a total win for the operator: Cash-flow margin (74%), cash flow per sub ($26.58), return on investment (60%) and value per sub ($1,536) are all higher than the retail model.
Most important, he doesn't account for how much higher the penetration of high-speed data might be with multiple vendors marketing essentially the same product.
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