Some small cable operators looking to build their customer bases for future high-speed-data services have long believed that the solution was to buy small dial-up Internet-service providers in their operating areas.
That way, they could learn the business, build a customer base that could be upsold high-speed service later and, critically, obtain employees who know how to run an ISP.
Although the early buying frenzy has waned in recent months, some small operators are still following that course and beginning to reap the benefits.
Perhaps the most active small MSO in that arena lately has been Millennium Digital Media, the St.-Louis-based start-up with about 250,000 subscribers.
In late March, Millennium bought its seventh ISP-ShutterNet in Madison Heights, Mich., which provides Web-hosting and access services to business customers in the Detroit and Lansing areas.
The ShutterNet acquisition is a continuation of Millennium's long-term ISP strategy-acquiring established companies within its service territory that have strong business-customer bases.
Former ShutterNet president Jim Weyand said the combination with Millennium was a good way to accomplish what both companies were trying to do. Millennium wants to break into the business Internet market, and ShutterNet wants a partner with ample resources.
"Our sweet spot was small and medium-sized businesses," Weyand said. "This [acquisition] gives ShutterNet more marketing capability and more strength."
ShutterNet was carved out of Weyand's computer-networking and training business, Computer Data Inc. Weyand still heads up Computer Data and serves as a consultant to Millennium.
STRATEGY SHIFTS
Millennium vice chairman Jeff Sanders said that when the MSO first started out buying ISPs, the catalyst was to take the installed base of dial-up Internet customers and transition them to high-speed cable-modem service once it became available.
But that approach quickly changed when Millennium discovered that the market for high-speed data for midsized businesses was being underserved, at least in its territories.
Today, Millennium has about 115,000 residential and business Internet customers. And although cable-modem service is important, the bulk of its revenue is coming from business subscribers taking digital-subscriber-line service.
About 70 percent of Millennium's DSL customers are coming from its existing dial-up base, Sanders said, adding that revenue from high-speed Internet-both residential and business-averages about $50 per subscriber, per month. Millennium has done 10 ISP deals-five that have closed and another five that will close within 45 days-he said.
Millennium hasn't had to spend a lot for that customer base, either, Sanders said, adding that Millennium's investors allocated about $60 million for ISP acquisitions and "a substantial amount of that has not yet been invested."
Growth rates have been through the roof for the service, topping 40 percent annually, Sanders said. "The appetite for service in our target markets has been phenomenal," he added.
Deep pockets have been a boon to the acquired ISPs, allowing them to expand and add services that they never would have been able to do on their own.
David Stoddard, vice president of US Net Inc.-an October Millennium acquisition that provides service in Baltimore, Washington, D.C., and Richmond, Va.-said Millennium was all business with its new acquisitions, requiring each ISP to submit a regular quarterly budget and to track churn rates.
He added that Millennium also required its ISP companies to look at the business from a broader perspective-how each company was doing from a profitability standpoint and how it stacked up against the competition in the area.
"It was probably the best thing that ever happened to us," Stoddard said. "[Millennium is] a progressive company with a lot of money. There are a lot of companies that ISPs are selling [out] to that don't have the financial resources. That's a tough way for them to go."
Stoddard said Millennium also realizes that the ISP business is very different from the cable business, and it allows its ISP managers to do what they know best.
"Rather than simply acquiring an ISP, they allow us to keep our independence," he said. "We don't have interference. We've actually added some services by being part of Millennium."
Morgan Keegan Inc. analyst Murray Arenson said that business-centric approach to Internet service is a logical one for small cable operators to pursue.
Arenson said a few years ago, when TCA Cable TV Inc. (now part of Cox Communications Inc.) began buying ISPs to offer dial-up Internet service, the most lucrative portion
was its business-to-business service.
"They were excited about building their residential business, but when you tried to pin them down, the real money was being made more on the business-to-business front," Arenson said. "With business-to-business, you can jack up the price, and there are more limited points of presence. It makes sense in light of the fact that today, cable operators have to perform and generate numbers."
Sanders said Millennium has recently been acquiring ISPs that are also data competitive local-exchange carriers. This opens up a whole new opportunity-telephony services.
But he added that Millennium is holding off on telephony for the most part-there are a few customers-because of the difficulty in getting business customers to switch telephone providers.
Sanders said relatively few small cable operators are attacking the business high-speed-data market because it is difficult to get into. Many business customers are still wary of cable quality issues and reluctant to turn over their data networks to cable-television providers.
"This is a fundamentally different business," he said. "It's a real business with real competition. You don't have the franchise asset and the degree of monopoly power that you have in cable. There is a lot of upside, but it's a much riskier business."
He added that business customers are used to 99.99 percent reliability from their telecommunications providers, and they are still a little skeptical that they can get those same results from a cable-service provider.
Sanders said it helps that most of the business customers have had prior relationships with the ISPs, but it is still a tough sell. "There is going to be an upside having the ISP, but even though there is that obvious affiliation, business customers are more apt to turn over their telephone systems to a telephone company," he said.
Millennium's high-speed data-over-cable service-called "Millennium CableSpeed" -is available in most of its service territories. What makes Millennium unusual is that it also offers telco-like DSL, integrated services digital network and frame-relay services.
MEDIACOM SHIFTS, TOO
In Middletown, N.Y., Media-com Communications Corp. chairman Rocco Commisso said he is no longer in the market for ISP acquisitions after buying a couple in his cable markets two years ago.
One reason why: Mediacom opted for a strategic alliance with SoftNet Systems Inc.'s ISP Channel turnkey high-speed-data service last year. Under that agreement, ISP Channel will provide high-speed Internet access throughout Mediacom's cable systems.
Although Mediacom has dial-up Internet services available in several of its markets, it expects to go into the high-speed-data market in a big way in the next few years. As part of the 10-year SoftNet agreement, Mediacom will provide access to 900,000 homes passed for the latter's ISP Channel service.
In return, Mediacom received 3.5 million SoftNet shares, or 13.7 percent of its outstanding stock, worth about $112 million. Mediacom currently offers high-speed Internet access via ISP Channel in 13 markets, passing about 250,000 homes.
Commisso said Mediacom's brief foray into the ISP market was a valuable learning experience.
"At the beginning, it was fine," he said. "It gave us an entry into the Internet business and an understanding of it, and it provided us with a ready customer base that we could convert to high-speed."
Commisso said Mediacom bought two ISPs in January 1998, when Mediacom had a total of about 70,000 customers. Today, the MSO has expanded to some 750,000 subscribers, largely through acquisitions.
But the Internet business has changed rapidly since 1998. Customers are clamoring for high-speed-data connections across the country, and having that installed dial-up base isn't as important as it used to be, Commisso said.
Instead of buying an ISP and then switching customers to broadband, cable companies can get the same or better results just by stepping up their broadband-marketing efforts and accelerating deployment, some analysts said.
"It's pretty evident at this point in time that supply is the constraint for high-speed access, not demand," Arenson said. "If you can forge some kind of [high-speed] service, people will come to it."
While the need for an entrenched customer base is dwindling, acquiring established ISPs also brings another needed commodity-expertise in the Internet business.
Commisso said he has retained the employees of ISPs he has bought, and having that readily available Internet expertise has been a big help. "Our tech person who is heading up our high-speed initiative is the guy who founded an ISP," he added.
This has become an increasingly important factor as these small operators gear up to roll out high-speed-data services. Although the businesses may look similar, there's a big difference between operating an ISP and a cable company.
Sanders said one of the driving factors in Millennium's strategy with ISPs has been the management teams. And he added that Millennium has been able to retain most of the managers of its ISPs once acquisitions have been made.
"We've been able to acquire good expertise coming out of the gate," Sanders said. "In some cases, we have [ISP] founders who have realized substantial amounts of liquidity. We have worked out a transactional transitional system."
STILL BUYING ISPS
Doug Palin-who sold his ISP, Pacifier Inc., to Millennium in January-has stayed on as vice president of Internet operations for the West Coast.
Palin said the transition to his new owners has been a smooth one, and having access to Millennium's increased capital has helped with new acquisitions-especially ones where he would have had to take a considerable personal financial risk if he were still on his own.
"It's exciting to be a part of that," he said. "I could have done it [before], but there would have been a personal exposure."
Palin's situation is a little different in that about 70 percent of Pacifier's business is residential dial-up service. While Pacifier is transitioning some of those customers to high-speed service as it becomes available, Palin feels that dial-up will be around for a while. "We're chasing business customers, but the residential customers keep showing up," he added.
It also helps that Pacifier's network in Portland, Ore., and Vancouver, Wash., represents about one-third of Millenium's total residential customers.
"We use the experience we've had for years to apply to the cable customer," Palin said. "A lot of cable companies have tried to start up their own [ISPs], but they've had to go through a lot of growing pains. With us, they don't have to go through those growing pains."
Pacifier is moving customers to high-speed data when it can. But it is constrained somewhat by the unavailability of DSL service through the local telephone company.
Having those dial-up services up and running in the meantime also provides small operators with a revenue stream while they gear up their broadband-data services.
Commisso said the dial-up service contributes about $20 per subscriber, per month in revenue to systems that offer it. And these customers are also itching to get the high-speed service.
"If they don't want to convert, they're not going to convert," he said. "But there is pent-up demand [for high-speed-data service]."
He added that Mediacom has just begun rolling out the ISP Channel service in some of its markets, so it's too early to tell how many dial-up customers will wind up transitioning to the more advanced service.
But it is clear that although dial-up service will be around for a while, it makes little sense for cable operators with broadband capacity to hinge their entire Internet strategies on low-speed revenue.
Commisso said Mediacom had attempted a one-way high-speed service about a year ago, which required customers to retain a telephone line to upload data. That, he added, was not a successful business.
"Low-speed can't survive, given the ISP features of the cable modem," Commisso said.
