The entrance of the regional Bell operating companies into the video business usually gets evaluated in terms of its impact on cable. But according to one analyst, the true loser in the RBOC video wars could be direct-broadcast satellite providers DirecTV Group Inc. and EchoStar Communications Corp.
In a 100-page report issued last week titled The Couch Potato Wars: Assessing the Impact of Bell Entry Into the Consumer Multichannel Video Market, Sanford Bernstein & Co. cable and satellite analyst Craig Moffett opined that MSOs should actually come out ahead in the battle for voice, video and data customers.
Verizon Communications Inc. and SBC Communications Corp. have announced aggressive plans to build fiber to the home in selected markets within their respective footprints over the next 10 years. While BellSouth Corp. has not yet announced such plans, Moffett wrote that it is widely known the phone company, which serves customers mainly in the Southeast, is actively testing video service.
6% SHARE BY 2010
Moffett estimates the RBOCs should attract about 6.3 million video customers by 2010 — about 6% penetration of multichannel-video homes.
At the same time, the overall multichannel market is expected to expand by 10.6 million customers, leaving room for DBS and cable to grow as well.
But the bulk of RBOC video growth should come at the expense of cable and satellite, Moffett estimated.
And the RBOCs are expected to have a minimal effect on cable’s existing basic subscriber declines while seriously affecting DBS subscriber growth.
Moffett estimates cable subscriber losses will remain fairly steady over the next five years (peaking at 1.4% in 2007 and leveling off to 0.6% in 2010).
DBS gains, though, will steadily decline: According to Moffett’s estimates, DBS subscriber growth will fall from 14.8% in 2004 to 2.1% in 2010.
Verizon is expected to come fastest out of the gate, adding about 121,000 video customers in 2005, according to Moffett’s estimates. But that growth is expected to be surpassed by SBC, which will grow from 70,000 customers in 2005 to 576,000 in 2006, passing Verizon’s 488,000 customers.
By 2010, SBC is expected to be the king of RBOC video, with 2.6 million customers, compared to 2.3 million for Verizon and 1.5 million for BellSouth.
Verizon, mainly because of its concentration in major urban markets like New York, is expected to have the highest penetration, rising from 4.2% in 2005 to 16.5% in 2010.
REVENUE IMPACT
Moffett added that Bell video also should have little impact on cable revenue during the period. He estimates MSO revenue will decline an incremental 100 to 200 basis points at the expense of the Bells over the next five years, but that gains in broadband, telephony and new services like digital video recorders should continue to push revenue growth in the mid-to-high single digits through the decade.
Putting the RBOCs’ video market share into perspective, Moffett notes that cable is expected to achieve telephony penetration of 15% to 20% during that same time frame.
The outlook for DBS is different, though, mainly because satellite growth is hinged on subscriber growth and pricing, both of which will see pressure from the Bells.
Moffett believes that will result in higher churn and higher subscriber-acquisition costs for DBS.
While the rural base of DBS companies — especially EchoStar — should remain intact (the RBOCs are initially concentrating on more dense markets), they could see a major decline in suburban areas. According to Moffett, it is in the suburban markets where both DirecTV and EchoStar have experienced their highest recent growth.
“It is exactly these markets — where telephone plant is aerial rather than buried — where the RBOCs will focus their efforts,” Moffett wrote.
Cable’s saving grace will be the triple play of voice, video and data, something the DBS companies cannot provide, at least for now. Moffett added that even those customers that don’t switch because of convenience will find more attractive video rates from the RBOCs because of the cross-subsidization possible from providing additional services on a single platform.
“As a final blow, the Bells intend to discontinue their partnerships with the satellite operators in areas where they market their own video services; thus EchoStar and DirecTV will lose important distributors at the same time they gain new competitors,” Moffett wrote.
The growth in RBOC video will not come without a price, however. The Bells are expected to price video at a discount to help drive penetration. But given the variable cost structure of programming, the Bells will likely have to survive on thin margins.
Moffett estimates that programming costs for the Bells will be about 15% higher ($3 per customer) than the average for MSOs. Assuming video pricing at a 15% discount to cable, the Bells will have to operate on margins under 30%, compared to 45% for cable. Moffett estimates that each RBOC fiber customer will generate between $150 and $200 in annual cash flow. Cable is expected to generate between $250 and $300 in annual cash flow from voice services alone.
Adding to the RBOC cost structure is the strong possibility that they will have to pay programmers cash for retransmission consent. While cable operators have managed to avoid cash for retrans so far — programmers have instead used it to secure channel space for their less popular networks — the RBOCs don’t have that kind of leverage.
Moffett estimates that conservatively assuming an average of 50 cents for the four major networks would add an additional cost of $2 per month per subscriber to the RBOCs’ cost structure.
“This would have a significant impact on video margins for the Bells, since they are already starting with high programming costs,” Moffett wrote.
Moffett estimated that with a 15% pricing discount and including cash for retrans, RBOC video margins would fall to 24%.
But aside from the economic difficulties, Moffett said execution would be the biggest hurdle for the phone companies and mapped out four key operational challenges: managing programming cost structures and ongoing content cost escalation; gaining access to video-on-demand rights and offsetting incumbent exclusive programming arrangements; attracting and retaining personnel; and securing or avoiding franchise agreements to offer video.
FRANCHISE QUESTIONS
The franchise question is particularly thorny, as Verizon and SBC were said to be lobbying to eliminate franchise regulations in Texas last week. To date, Verizon and SBC have argued that franchise agreements are not required for incumbent phone companies — although Verizon has played both sides, securing video franchises in four cities in Texas and one in California already. Verizon was expected to secure another franchise in Florida last week.
While the franchise controversy is expected to play itself out this year, Moffett said that if the RBOCs are required to pay franchise fees like cable does — representing about 4% to 5% of gross revenue — the economic picture gets even worse for RBOC video.
And more important than the added franchise fees, municipal agreements will likely require the phone companies to make the service available throughout the franchise territory, not just in the most affluent areas.
“Doing so could drastically alter the economics of their fiber projects — especially when the economics rely heavily on incremental revenue from new services,” Moffett wrote. “Furthermore, the Bells’ fiber buildouts will occur central office by central office, not along franchise-area boundaries — making it logistically difficult to comply with franchise agreements to completely cover entire franchise areas.”
