Hey, big spender…(2)

Sun, 03/31/2002 - 7:00pm
Leslie Ellis, Technology Analyst
Like graduates thumbing through their first student loan payment booklets, sometimes, it doesn't seem possible to see the end of a huge financial obligation. The same is true of the cable industry's decade of big spending on plant rebuilds and upgrades–except instead of writing a monthly check for $114.68, the nation's seven largest operators wrote up several billion dollars worth of checks per year. And instead of sending checks to a loan service center, they sent them to the suppliers of fiber, coax, enclosures, tools, pole-line hardware, passives and actives–the stuff that collectively makes up a cable plant. As readers of this publication acutely know, cable broadband networks need lots of stuff to be considered modern. At the very least, they need two-way signaling, with 750 MHz to 860 MHz of capacity, fed to 500-home, sub-dividable nodes. With few exceptions, cable's boom time for aggressive capital spending on plant seems very close to a long-anticipated conclusion. Every major U.S. operator except AT&T Broadband, which is catching up from a capital spending cutoff last year, aims to be at least 89 percent upgraded by year-end. But whether or not plant spending ever really ends is an area where reasonable people can, and do, disagree. For MSOs, being done with plant spending is good. For the suppliers that serve them, it's not. Reality is tipping toward the wind-down, but probably not as dramatically as MSOs hope–and suppliers fear. Most senior cable executives spent the early months of 2002 assuring the investment community that the big spend on plant upgrades is nearing the end. But others quipped that just as the unemployment rate never quite gets to zero, plant upgrades never quite get to 100 percent finished. Suppliers fervently hope that's true. If nothing else, the year-end upgrade statistics will produce ample fodder for the cable capital carousel: Wall Street financial analysts who cover cable want to see the end, so that the tens of billions of dollars previously allocated to capital can be poured on debt, or used to improve cash flow. But, the financial analysts who cover cable's publicly traded equipment suppliers don't like the notion of an end in spending, for reasons that are just as obvious. By all accounts, there's at least another solid year, perhaps two, of substantial plant-related spending–and lots of years for variable capital spending, the type that's used to buy digital boxes and cable modems. The plant spending is rooted in the fact that many MSOs are still unifying the systems they added through consolidation and cluster-oriented swaps with their brethren. But, as time wears on, a larger percentage of overall capital spending–upwards of 80 percent–will go toward the things needed at either end of the plant itself. Cable modems, set-top boxes, telephony units and all related headend equipment will continue to be high on cable operators' shopping lists. In the case of AT&T and Adelphia, capital spending will increase by 30 percent and 11 percent this year, respectively, which includes vastly intensified plant work. Those levels are offset, though, by a 41 percent capital spending dip from Comcast, a 19 percent reduction from Cox, and a 17 percent drop from Charter. In aggregate, capital spending for the top seven MSOs will drop by 6.3 percent this year, to a total of $14.8 billion, down from the $15.6 billion spent in 2001.What's in capex? For cable operators, there's more piled into capital spending than the materials required for plant rebuilds and upgrades. The capital expenditure (or "capex") line contains the costs for analog and digital set-tops, cable modems, network interface units, and any other in-home devices used by basic and advanced service customers. Accountants identify these items as "variable" costs because they only occur when someone orders a service that requires them. (A new synonym for variable costs–"success-based capital"–is the newest word springing up to identify these costs. Engineers will be heartened to know that financiers apparently have their fair share of buzz-phrase creators, too.) Capex also includes inventory needed for line extensions into new customer areas, and the day-to-day items needed to maintain existing customers. Drop cable and F-connectors, for example, will remain staples, regardless of how quickly major plant construction projects wane.MSO-by-MSO trends Adelphia. An acquisitive spree of mostly smaller MSOs is what's pushing Adelphia to plow $2 billion into capex this year, as the MSO dashes to get 90 percent of its passings upgraded for higher-capacity, two-way traffic (from 60 percent two-way activated at year-end 2001). Right now, the MSO is upgrading about two percent of its plant per month toward that goal, executives told financial analysts last month. Next year, with the bulk of its plant work completed, Adelphia's capital spending will drop to the $1.7 billion range. In 2004, executives estimate, spending will settle to around $900 million to $1 billion. As for advanced service additions, Adelphia's goal is to add another 600,000 digital video customers for this year, as well as another 325,000 high-speed Internet customers. Adelphia, among other MSOs offering service bundles, says that its customers are four times more likely to buy a new service if it's packaged with something else. AT&T Broadband. Despite its pending merger with Comcast, AT&T Broadband executives spent the early months of 2002 talking up a five-point plan to improve operational efficiencies. One of the five points, and a big one, is to kick-start its dormant plant rebuild and upgrade activities. Of the $4.2 billion to $4.4 billion AT&T Broadband allocates to capital spending this year, $1 billion to $1.2 billion will go toward plant work. That's double 2001 spending on the category. Figure 2Chicago, Dallas, Denver, Seattle and parts of Boston, picked up in a swap with Cablevision Systems last year, will get the most attention. The goal, besides getting caught up with the rest of the industry in 750 MHz/two-way activation percentages, is to make as many homes as possible marketable for advanced services like telephony, high-speed Internet and digital video. With the increased plant attention, AT&T Broadband aims to be 70 percent upgraded for 750/860 MHz capacity, with bidirectional signaling, by the end of this year. On a marketable services basis, that translates into the ability to sell digital video to 100 percent of its homes passed, high-speed Internet to 70 percent, and telephony to 40 percent of homes passed. Operationally, AT&T Broadband, in advance of the Comcast merger, is pushing as much control to field offices as it can. Only three drivers will encourage centralization, executives told financial analysts last month: Areas that benefit from scale economics, such as IT and procurement, Areas that require consistency, such as brand management, and Areas that require unique resources and expertise–meaning parts of engineering, provisioning, new product development, R&D, and some aspects of telephony. Cablevision Systems. In its demographically and geographically homogenous New York cluster, which it describes as the largest contiguous broadband aggregation in the U.S., with 3 million customers, 95 percent of Cablevision's plant will be two-way activated and bolstered to 750 MHz capacity by the end of 2002. Going forward, Cablevision's number-one priority is to increase penetration rates on all advanced services, including its renegade "iO" digital video package, and its high-speed Internet service–which is already enjoying penetration rates of 25 percent, on average. The flat spending rate from 2001 to 2002–about $1 billion allocated each year–reflects a shift toward more variable, "success-based" costs than plant activity. As it buys more digital boxes and cable modems to reach its service penetration goals, more spending tips toward CPE. Charter. Of the $2.5 billion in Charter's 2002 capex line, almost half, or $1.2 billion, will go to rebuild and upgrade activities. (That's more aggressive than even AT&T's bullish plant plan.) Another $400 million goes to "success based" capital–CPE equipment–and $400 million to maintenance equipment and activities. By the end of the year, Charter wants to be 90 percent upgraded for 750 MHz, two-way plant status–and then the fun begins. For Charter, that means a heavy emphasis on two-way interactive applications–especially once its interim advanced set-top, designed in combination with Motorola and Digeo, rolls out. Right now, though, it's rolling out services like Wink, VOD and virtual "i-channels:" Wink is currently used by 52 percent of 700,000 enabled subscribers every month, in 48 Charter markets, for an average of 2.5 hours per week. 300 VOD titles are generating a 0.75 percent peak simultaneous usage rate among 500,000 digital customers, in 12 markets, currently. Charter estimates the all-inclusive cost-per-stream to be between $525 and $610. VOD subscribers are buying about 2.5 titles per week, at about $4.25 per buy. Virtual i-channels, available to 500,000 digital customers, are used 10 to 15 times each week by 25 percent of the enabled base; the electronic program guide and local weather are by far the most popular. Virtual channels are easy to deploy, and can reduce churn by 50 percent, Charter executives submit. Comcast. With 95 percent of its plant upgraded to 750 MHz/two-way capacity by the end of 2001, the name of the game for Comcast–outside of figuring out how to swallow AT&T Broadband's massive subscriber base–is to layer in new products, one by one. The attention spent on plant between 1996 and now, and the 95 percent completion level, explains the 41 percent plunge in overall capital spending for the MSO, from $2.2 billion in 2001 to $1.3 billion budgeted for 2002. Less money is needed for the plant, but plenty is still required for variable costs–again, the CPE that drives new, advanced subscribers to digital video, high-speed Internet, and, ultimately, telephony. Comcast is aiming for a 30 percent increase in 2002 for digital video customers, seeking a year-end total of 3 million, from 2.3 million at the end of 2001. In high-speed Internet, Comcast is hoping for a 47 percent boost to 1.4 million customers by year-end, from 948,000 at the end of 2001. But the number-one item on Comcast's to-do list is VOD. Already available to 3 million customers in 16 markets, the plan is to put it in front of between 5 million and 6 million VOD-ready homes by the end of 2002. Cox. Another of the MSOs with a declining capex line, Cox plans to trim 19 percent of its capital costs in 2002 (down to $1.7 billion from $2 billion in 2001). The goal is to be 89 percent upgraded by year-end. Of the $1.7 billion to be spent, $150 million is earmarked for Cox Business Services, which sees the opportunities to serve small and medium businesses as particularly lucrative, given the collective meltdown of the CLEC (competitive local exchange carrier) community over the last several months. Another $150 million goes toward the MSO's "project self-reliance," an outgrowth of Cox's split from Excite@Home's backbone to its own network. Cox's capital spending for 2002 breaks out this way: Fixed/network-related spending: 27 percent Variable capital (set-tops, cable modems, network interface units): 35 percent Recurring capital (line extensions): 23 percent Other (Cox Business Services, self-reliance program): 15 percent. At the end of 2002 and beyond, more and more of Cox's spending will shift to the variable side, executives explain, which means money is only spent when someone wants to become a customer. Time Warner Cable. Perhaps nowhere is the shift away from "fixed" capital more prominent than with Time Warner Cable, the first of the MSOs to get to 95 percent completion of two-way, 750 MHz plant. From 2000 to 2001, the MSO's expenditures on fixed, plant-related gear dropped from $1 billion to $823 million, while variable capital bumped to $1.4 billion, from $1.1 billion. Last year, Time Warner's spend rate on variable items–mostly digital set-tops and cable modems–represented 63 percent of total capex. Where do the billions go? As plant expenditures wind down, what happens to the billions of dollars that no longer need to be spent? Cox CEO Jim Robbins quipped recently that while he doesn't know what he'll do with the spare cash, "it's no surprise that every investment bank in the world is wearing down our front door about how to spend it." While further acquisitions are one way to consider spending the "found" money from decreased plant spending, it's probably more likely that MSOs will concentrate on improving their operating cash flow figures, in an effort to please Wall Street. Another thing that would make financial analysts happy, of course, is debt reduction–and almost every MSO needs it. After all, the graduate who finally tears out, fills out and mails off that last payment coupon usually spends about 30 minutes daydreaming about how to spend that extra $114.68 per month, and then winds up plunking it down on other debt. Author Information Leslie Ellis is a Denver-based technology analyst, columnist and author. She can be reached at



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