Foment in the mid-to-low-tier cable MSO ranks is moving rapidly from angry reaction to escalating programming costs to serious exploration of broadband-based business models that would afford operators flexibility to pursue much lower cost approaches to providing video services.
In a handful of cases operators are contemplating going so far as to abandon cable programming distribution altogether in favor of creating a broadband experience where consumers can tap OTT sources for their entertainment by paying for access rates that will support high-end HD and even UHD-caliber signals. More commonly, the inclination is toward leveraging a new generation of cloud-based platforms to deliver mixes of cable channels and OTT content that can be accessed through advanced universal navigation systems on virtualized set-tops, where cloud-based DVR and other functionalities could radically reduce CPE costs and help smooth the way to all-IP delivery over time.
Probably the biggest camp is occupied by those whose commitment to pay TV is tempered by the new headwinds but who have yet to determine what steps beyond current initiatives they might take to deal with what has become an impossible situation. These operators are more open to new ideas than ever before, including the possibility of eliminating cable channels and broadcast stations they deem too costly; dropping premium networks that choose to go direct to consumer; offering extremely cut-rate basic packages bundled with high-speed data, or moving to the all-broadband approach.
“The business certainly is going to continue to change,” said Atlantic Broadband president and CEO Ed Holleran, speaking at the recent SNL Kagan Multichannel Summit in New York. “Consumers’ wallets aren’t growing fast enough to keep up with the bundle.”
Much of the new thinking is driven by the ascendance of broadband as the cable service most in demand. “We now have a different perspective on how we’re viewing the business,” said John Pascarelli, executive vice president of operations at Mediacom Communications, another speaker at the SNL Kagan Summit. “It used to be our customers would buy video and we’d sell them other services. What’s happening today is consumers are buying Internet, and we try to add other pieces. People have to have an Internet connection, and video is becoming too costly and, therefore, less essential.”
Indeed, as observed by SNL Kagan and other analysts, the third quarter of 2014 marked the first time there were more cable broadband than cable pay TV households. Kagan’s latest measures and projections as revealed at the Summit vividly reflect both the stress operators are under on the pay TV side and the opportunities ahead in broadband.
For example, MSOs Comcast, Time Warner Cable and Charter have experienced a drop in weighted average estimated margins on pay TV services from 23.3 percent as of Q2 2012 to 16.1 percent in Q3 2014, noted Robin Flynn, research director at SNL Kagan “The economics of the industry have shifted,” Flynn said, which has put the spotlight on “the tremendous importance of the high-speed data revenue stream.”
While Kagan projects revenue from U.S. cable pay TV service will increase slightly as a function of rising prices over the next ten years, going from $56.6 billion today to $59.5 billion in 2024, the company predicts the number of cable pay TV subscribers will drop from 53.5 million today to 46.9 million ten years from now.
This isn’t just a cable phenomenon. U.S. multichannel household penetration, counting telco and DBS as well as cable, is projected to drop from 85.1 percent today to 76.7 percent in 2024. “This is a departure from our earlier projections,” Flynn said.
Broadband, especially for cable, is another story. Margins as tabulated for the aforementioned three MSOs have remained high over the past two years, registering 58.4 percent in Q2 2012 and 59.6 percent in Q3 2014, according to SNL Kagan. Looking ahead, the researcher predicts the cable broadband subscriber count will go from 54.9 million today to 63.1 million in 2024, with revenues over the same period going from $27.5 billion to $39.4 billion.
Those revenues and attendant margins could go even higher were operators to follow the advice of some Wall St. analysts, who believe the cable industry has room to raise prices either on a flat-rate basis or by setting usage fees to capture revenues from customers who exceed allotted monthly limits within their chosen broadband tiers. Operators have plenty of opportunity to increase monetization of broadband, but they’re “not doing it fast enough,” said Marci Ryvicker, managing director of equity research for media and cable at Wells Fargo Securities.
However, as Ryvicker and others at the Summit noted, the threat of regulation under Title II of the Telecommunications Act as promoted by President Barack Obama adds an element of uncertainty to the broadband upside. Operators, she and others suggested, may hesitate to take a more aggressive approach to monetization out of fear such steps will be used against them in the argument for tougher regulations.
It’s definitely a question on investors’ minds, said Craig Moffett, partner and senior analyst at MoffettNathanson. “Will there be an implied constraint on broadband pricing because everybody is walking on egg shells?” he asked at the SNL Kagan Summit. “It’s a very real question, and it could change the return perspective [on investments].”
Citing the need for usage-based billing to deal with high-level congestion in peak hours, Vin Zachariah, senior vice president of residential services of Vyve Broadband acknowledged there was “some trepidation” over whether such pricing strategies could be impacted by new rules. Atlantic Broadband’s Holleran voiced the industry consensus on the proposed Title II approach when he said, “The idea of broadband becoming regulated under a 1930s telephone regulations framework is unimaginable in terms of what it could do to the business.”
But setting aside such concerns, Holleran suggested the broadband opportunity was strong enough to offset setbacks on the pay TV side. “Broadband service providers will continue to grow,” he said, noting the opportunity rests on adding more subscribers as well as generating new revenue from higher prices. “We’ll be fine unless regulations upset things.”
Indeed, how big an impediment the regulatory threat might be remains to be seen. As Moffett observed, final resolution on the regulatory question could take five to six years before any FCC decision is fully vetted in the courts. And there could be legislative shoes to drop with Republicans taking over both houses of Congress and a presidential election just two years off.
Moreover, if operators move to really big broadband pipes any Title II restrictions on attempts to collect “fast lane” fees form the likes of Netflix will be mitigated by the success of best effort in sustaining high levels of consumer experience with all Internet-delivered content. “I assume net neutrality whether it’s through the FCC without Title II or with Title II or a new Cable Act,” said Steven Weed, CEO of northwestern U.S. operator Wave Broadband, which is predicating its aggressive expansion strategy on a pure broadband play offering 100 megabit and 1 gigabit access options in the residential and commercial markets. “It’s built into our models, so it doesn’t change our business at all.”
“I agree,” said Stephen Jeschke, vice president of GTCR, the investment group behind Rural Broadband, another acquirer of cable systems that is building its future on 1-gig connectivity. “As long as we provide the best and biggest pipe into the home, the rest is noise. Nothing built into our models is expecting anything different [from strong net neutrality regulation].”
Where traditional pay TV is concerned, two major trends have combined to put the squeeze on the business: rising programming costs and consumers’ willingness to substitute OTT content for pay TV. Making matters worse from the OTT side are moves on the part of HBO Go, CBS and others to offer direct-to-consumer subscriptions without requiring sign-up with a pay TV distributor.
While there have been long-running disagreements in cable and analyst circles over how big a threat OTT will turn out to be, confidence among the optimists is clearly waning. Referring to TV programmers who have long expected that Millennial generation “cord nevers” would become pay TV subscribers once they start their own families, Moffett commented, “Based on my conversations with media companies over the last six months, their conviction [that aging Millennials will become pay TV subscribers] is a lot shakier than it was six months ago.”
“There’s not enough data on this question,” said Wells Fargo’s Ryvicker. “This is why programmers are experimenting with direct-to-consumer. They don’t want to disrupt the pay TV marketplace, but they want to be out there if the Millennials don’t come back.”
SNL Kagan predicts there definitely will be an impact from the substitution of OTT viewing for pay TV subscriptions. Within four years, 12.5 million or 10.2 percent of U.S. households will be substituting OTT for pay TV compared to 6.8 million or 5.7 percent today, Flynn said. Cord cutting was a major factor in the researcher’s previously cited revised projections for multichannel penetration over the next ten years, she noted.
Meanwhile, the immediate pain incurred from rising programming fees has become the primary driver behind the search for alternative business models at the Tier 2 and 3 levels. “You can’t even recapture all of the increases from consumers,” said Mediacom’s Pascarelli. “If I passed on 100 percent of my wholesale cost increases, we would see a significant increase in the disconnect rates and a more immediate consumer shift to OTT services.”
Echoed Atlantic Broadband’s Holleran: “We can’t pass through all the expense increases. High-speed data with the wide margins we have there has been subsidizing the margin erosion in video. I know if I didn’t have the HSD business, the whole video thing would have come to a head long ago.”
This has led to fairly radical action in some quarters with threats of more to come. After CableOne earlier this year took what other operators saw as the courageous step of dropping all Viacom properties from carriage, the notion no longer seemed so improbable. Vyve Broadband decided to follow suit and has so far had no reason to question the decision, Zachariah said.
“We as a company made the second national decision not to carry Viacom,” he told the Summit gathering. Noting that whatever subscriber losses have been incurred must be weighed against money saved, he said, “We’d do it again. In most markets we’ve added more channels than we took off. Viacom in our markets is not a particularly good brand.”
Adding to the fee crunch is a sharp rise in broadcaster retransmission fees, which by all accounts are likely to keep climbing. Pascarelli suggested it’s no longer automatic that his company will continue carrying the same number of broadcast stations as before. “We have to evaluate every deal as it comes across the table, and determine how much of the content is available to our customers from other sources,” he said.
“Underscoring the prospects for a wide-scale showdown with broadcasters, Zachariah said, “We expect multiple [retransmission] rate increases over the next few months. Operators feel pretty strongly that we’re going to stand up to this.” This could mark a sea change from the tendency to absorb some of the rate increases on the bottom line rather than passing everything through to the consumer. “Whatever rates we accept, we will pass through,” Zachariah said.
Another area where operator resolve is stiffening is on the premium channel front. By going directly to consumers with an OTT subscription offer, networks may be creating a disincentive for operators to keep carrying them.
HBO Go as an OTT offering may not be “the worst situation for us,” Pascarelli said. “We make very little money on the premium market. If anything it’s a loss leader.”
“Cable companies don’t make money off premium services,” Ryvicker confirmed. “Time Warner has to figure out how to price HBO Go without cannibalizing its traditional business.”
“If I’m not getting a return on our channel allocation for HBO, I’ll repurpose the capacity to something that makes money,” Pascarelli said. “The channels on our systems are valuable real estate,” he added. “If the premium services want to go direct-to-consumer, we can certainly use the bandwidth they occupy to launch faster and more profitable broadband services.”
Acting on that threat could result in far more damage to the premium networks than to the operators, he suggested. “Think of the costs they’ll incur,” he said. “We spend a lot of money to build that business. If they have to collect debts, market customers, connect them – it will take that experience with the cannibalization of their cash cow for them to look at it a different way.”
Battling back on all these fronts may net some protection from margin erosion in pay TV, but many operators are looking beyond such steps to explore what might be done through broadband to put them on firmer ground in the pay TV business. Atlantic Broadband, for example, has already begun offering a low-cost service package bundling HBO and local broadcast with high-speed data and “some OTT” video, something Comcast has done with its Internet Plus bundle, which is priced at about $50 per month.
“We took a page from the Comcast playbook,” Holleran said. “That’s an example of finding more affordable choices for consumers. I can’t say that won’t continue. We’ll all find our way through this, but that’s the direction.”
As previously reported, Midcontinent Communications, serving some 300,000 pay TV customers in the upper Midwest, has taken a first step in a direction that could well be taken by many other Tier 2 players. The company is testing a cloud-based middleware system supplied by aioTV which, in conjunction with use of a low-cost “pass-through” terminal that sits between the set-top and the TV, will allow the operator to offer a highly personalized blended service that makes OTT content available with traditional pay TV on a universal navigation system.
Adding to its flexibility to exploit broadband in the development of new service models Midcontinent recently announced a “Gigabit Frontier Initiative,” which envisions making gigabit access available to some 600,000 homes and 55,000 businesses within the next three years, starting in Fargo, Bismarck and Grand Forks, ND and Sioux Falls and Rapid City, SD . The company, already at the forefront of high-speed offerings with 200 megabit service available at about $106 per month in many markets, said broadband consumption has been doubling in its markets every 15 months.
Moving to broadband as a unified delivery platform promises to transform operators’ video service options as well as lower costs. By exploiting the power of IP cloud technology to support a highly personalized service of blended pay TV and OTT content that offloads the expense of supporting whole-home DVR while delivering a uniform viewing experience across all devices, operators have an opportunity to deliver a unique offering to subscribers where the perceived value could mitigate any fallout from the absence of certain channels or broadcast stations
This is why interest in cloud-based platforms on offer from a growing number of vendors is intensifying, said the head of an engineering company that provides technology selection and integration support for Tier 2 and 3 operators. “Our clients realize that have to change their approaches to the business,” the executive said, speaking on background.
Plus, by eliminating the need for legacy channel space, operators make it easier to expand broadband capacity. “If you can sell higher speed Internet for $60-$100 per month, you can fill in for a lot of what you’re losing on the pay TV side,” he noted.
Many companies, he added, are looking at ways to cluster together to share the “headend-in-the-cloud” and high-performance distribution costs that would allow them to stream content to their local distribution hubs, where signals could be distributed at TV-caliber quality to each subscriber for viewing on whatever device they’re using at the time. “These centralized strategies need to happen,” he said.
