It used to be taboo to describe an upcoming construction year as "flat." Flat meant there was going to be hardly any growth. The environment was spiritless, or at least uninteresting. Bad news meant bad business.
Today, news of a flat construction year– which 2001 is showing every sign of being–is manna to cable's hardware suppliers, most of whom are still trying to escape from the cauldron of Wall Street anxieties. Flat business is still business, and these days, all business is good business.
Discussions with the nation's seven largest cable providers, which collectively service more than 75 percent of U.S. cable households, indicate at least two more solid years of plant upgrade activity, despite AT&T Broadband's dramatic and well-documented moves to find more cost-efficient ways to upgrade its networks.
This year, six of the top seven U.S. cable providers (excluding AT&T Broadband) will spend an aggregate $12 billion for capital expenditures, much of which is earmarked for plant upgrades. That's a lot of upgrade money, especially compared to the early '90s, when the aggregate number perpetually hovered in the $2 billion range. Clearly, there's still a lot of build budgeted for 2001 and 2002.
AOL Time Warner, Adelphia, Comcast, Cox and Charter are still digesting two years of system swaps and acquisitions, which always require some level of plant tweaking. That accounts for the bread-and-butter equipment spending levels for this year. Then, at some point, AT&T Broadband will again rev up its engines and spend heavily on plant infrastructure–slowing down doesn't mean stopping forever, and the MSO isn't lacking motivation to build out its systems in preparation for deploying new services.
Instead, it lacks funding, mostly because of debt and equity problems plaguing its parent company. Investors got nervous last year about the long-term growth potential of AT&T's long-distance segment just as capital markets were spiraling downward. Although there's no way to predict when AT&T will re-energize its plant upgrade plans, it's plausible to point to a late '01/early '02 timeframe. That alone would provide the market with significant upgrade momentum for '02.
Additionally, all MSOs continue dropping lines into new housing developments. Attracting new customers for video, high-speed Internet and, depending on the MSO, telephony, is a strong priority for everyone. Creampuff suburban households are an easy target. DSL and satellite providers know this, too, so it's safe to assume that line extensions for cable broadband plant will likely remain perennially important.
There is a potential logical flaw to this reasoning, however. Neighborhood-by-neighborhood competition for bundled broadband customers, instigated in 2000 by a rash of well-heeled overbuilders, will probably wane this year. Alternative broadband service providers–the likes of WOW, WIN, etc.–are finding it harder to secure financing in the capital-intensive broadband business. Most are scaling back the number of markets they plan to activate this year. The heat is off, or at least turned back. The history books for traditional cable providers show competition as a better motivator than opportunity; with competition in retreat, cable's big MSOs could upgrade with less intensity.Trendline: Spending patterns changing
Most MSOs now admit, at least conversationally, that the broadband business is inherently capital-heavy, and that spending will never roll back to minuscule levels. Even as major build activity peters out, demands from both ends of the network will drive spending for in-home electronics, like digital set-tops, cable modems and telephony units.
That points to a large shift in how capital dollars are spent. From this year out, the ratio of plant materials to inhome electronics starts to tip toward the CPE gear. As upgrades wind down, spending on plant materials–opto-electronics, amplifiers, line extenders, strand, pole-line hardware, passives, etc.–slims, while spending on items needed for advanced services, such as cable modems, digital set-tops and telephony gear, swells.
In addition, watch for growth in spending for servers, software and integration. Virtually every new IP (Internet Protocol) service targeted for cable deployment relies heavily on software, which is still a relatively new animal for cable providers to mind.
The spending shift is part of a logical progression, especially given that all of the top seven MSOs are nearing the finish line for 750 MHz, two-way plant capable of doing high-speed Internet access, telephony and digital video.Cable upgrades in aggregate
Architecturally, most North American cable providers are running bundles of 48 fibers from headends or primary hub sites to secondary hub sites. From there, six fibers extend to each of the neighborhood nodes. The neighborhood nodes, in turn, feed coaxial networks equipped with 750 MHz or 860 MHz, two-way amplifiers. Each node typically passes 500 homes; most MSOs cite an average of 380 homes passed.
The six-fiber bundles are important for upstream bandwidth management. Because the spectral area allocated for home-to-headend (upstream) signals is inherently slim–just 35 MHz located between 5 MHz and 40 MHz, and some of that is simply unusable because of noise–operators are keeping a close eye on penetration rates and bandwidth usage for two-way services, like high-speed Internet access and telephony. If speeds suffer, the extra fibers can be used to subdivide the node, potentially to as few as 125 homes passed. Cost estimates on node splitting vary, but run in the range of a half-day's time, at $5,000 to $10,000.
Anecdotal evidence from Cablevision Systems Corp. shows that at penetration rates as high as 40 percent for high-speed Internet service, the need to split a node still hasn't developed. Customers apparently aren't complaining: Cablevision's "Optimum Online" service is ranked fastest by DSLreports.com.
On an aggregate basis, our analysis shows that cable providers will end '01 with an estimated 79 percent of their collective plant upgraded, up from around 71 percent at year-end 2000.MSO-by-MSO trends
AT&T Broadband. As of early March, AT&T hadn't yet finalized its capital spending plans for the year, making it the wildcard MSO. It professed to have 70 percent of its networks upgraded to 750 MHz, two-way status as of the end of 2000. Since then, it shed 512,000 subscribers to Charter and 840,000 subscribers to MediaCom, picking up 62,000 new subscribers in Florida from Charter in a clustering effort. Net, it trimmed its sails by nearly 1.3 million customers.
Although the MSO isn't discussing its specific buildout plans yet, it will say that 15.4 million of its subscriber base were marketable for high-speed Internet services in 2000, and 6.2 million were equipped to receive phone services. It's possible that the MSO will spend capital at a similar rate to 2000–$4.2 billion–which would propel the aggregate U.S. spending rate for the top seven MSOs to $16.2 billion.
If that happens, and regardless of the final amount allocated by AT&T for capital, it's likely that the dollars will be spent in a way that's vastly different than in years past. Instead of investing heavily on plant materials, AT&T could tip as much of 70 percent of its capital budget toward in-home electronics just to keep pace with hooking up new digital video, high-speed Internet and phone subscribers.
AT&T, which outpaced its MSO brethren across all three service fronts in 2000, is nonetheless shouldering a huge amount of ugly from mainstream media outlets. There's a pack instinct going on–vultures circling what they describe as a bleeding, rotting carcass–before anyone has proven the MSO to be dead.
It's easy to trace the reasons. AT&T Broadband threw a curve ball to its mainline hardware providers last Thanksgiving, sending memos stating it had as much gear as it needed for the time being. Blindsided suppliers spent the holiday doing damage control with investors, who went public with the information.
In February, AT&T sent a similar memo to makers of phone and cable modem gear. And, its widely publicized layoffs in the same month affected a proportionally large number of employees involved in plant construction.
Now, the speculation about the future of AT&T Broadband includes a sell-off scenario, where the MSO continues to shed subscribers in search of better operating cash flow. Yet, AT&T can't hold off on upgrades forever. At some point, whether it's later in '01 or next year, whether they're owned by AT&T or someone else, those systems will get a facelift.
AOL Time Warner. It was seven years ago that Time Warner Cable started its rebuild/upgrade projects, and this year, the end is in sight. Projects for 2001 mostly include shining up plant from recently acquired systems. Even so, the cable television portion of AOL Time Warner's capital expenditures will be about $2.2 billion this year, slightly more than it spent in 2000.
That money, proportionately, goes toward digital set-tops and cable modems, although the MSO does still plan to do about 6,400 line extension miles, and 31,000 upgrade miles (compared to 6,300 line extension miles and 53,000 upgrade miles in 2000).
Comcast. Clustering is and has been the name of the game for Comcast, which spent the last few years swapping and acquiring systems so as to plump up its Mid-Atlantic presence. As of the end of 2000, more than 40 percent of its 8.2 million basic cable customer base was seated along the Eastern seaboard–1.9 million customers in Philadelphia, 1.1 million in Washington, and 595,000 in Baltimore.
The focus has been upgrading the 600,000 passings it bought from Lenfest, the 300,000 from Jones Intercable, and 400,000 more that came from Prime Cable, executives say; by the end of the year, 95 percent of its passings will be two-way plant with bandwidth capacity at 550 MHz or higher. To conclude the upgrades, Comcast will spend $1.45 billion this year, slightly more than it doled out last year.
Charter Communications. With $3.5 billion earmarked for 2001 capital expenditures, Charter could come out on top in spending this year (depending on AT&T's strategy). The MSO remains focused on upgrading acquired systems that resulted in it being clustered around St. Louis, portions of Alabama, and Reno, Nev., among other locales.
Architecturally, Charter is averaging 380 homes per node, and is among the MSOs driving at least six fibers to each node–so as to have breathing room, via node splitting, for service penetration increases.
Charter is also bullish on the more advanced of cable's service mix, slotting 10 markets for VOD, as well as a late '01 introduction of combo set-top/cable modem boxes that accommodate IP streaming video. Its work in IP telephony will continue this year, as a suite of tests in Wisconsin perhaps pave the way for a 2002 phone service launch.
Cox Communications. On a proportional basis, Cox will spend 48 percent of its estimated $2 billion capital budget for the year on distribution, and 37 percent on in-home electronics. The remainder, interestingly, goes to fuel its new business services division. By the end of the year, 88 percent of its total plant will be activated for 550 MHz, two-way capacity; 70 percent will reach up to 750 MHz.
Cablevision Systems. New York is the name of the game for Cablevision, where it offers services to around 3 million customers. The focal point for this year will be its massive Sony set-top project, which is earmarked to begin in the fall.
The MSO adjusted its Sony set-top rollout schedule not because of equipment problems, executives say, but because it didn't want to overload already overloaded customer service reps with yet another new thing. A victim of its own success, Cablevision enjoyed an immense spike in weekly run rates for cable modem installations when it turned up the retail distribution path, through its The Wiz properties.
Notably, Cablevision is also stepping back on its original intent to do a 100 percent analog-to-digital box switchout, at least to start. Instead, executives say, it will start by upselling the new box and its service suite, as well as installing it in any homes that require along-the-way attention. IP telephony, still a strong priority for Cablevision, will start rolling at about the same time; watch for a PCS wireless offer to fold into the package, too.Suppliers struggle for rebound
A $12 billion aggregate cable budget from the MSOs mentioned above should come as sunny news for cable's big hardware suppliers–Antec Corp., C-COR.net, CommScope Inc., Harmonic Inc., Motorola and Scientific-Atlanta Inc.–which lost an aggregate $122.5 billion in equity value since their respective stock highs last year. Take that number with seasoning, however: Including Motorola in the calculation means including all of its non-cable business units, which skews matters. Without Motorola, cable's big vendors lost $24.2 billion since their 2000 highs (see Table 3).
AT&T's spending correction didn't help matters for hardware manufacturers, and particularly those that make plant materials. Capital markets were already sliding into decline late last November when AT&T informed key suppliers that it had as much gear as it needed.
Antec Corp. slid to an intra-day low of $6.87 on Nov. 24, an 88 percent plummet from a high of $57.50 nine months earlier. From March 9, 2000 to the AT&T-induced D-day, the company lost $1.9 billion in market capitalization. Since then, the company's stock is starting to climb out of the torture chamber, but slowly, to $9.18 on March 8.
Also hit hard was Harmonic, which makes opto-electronics used in cable broadband upgrades. From its March 8, 2000 heyday price of $150.87 to its January 3, 2001 low of $5.25, the company lost 94 percent of its equity value. Its rebound is coming, but slowly. One year to the date from its 52-week high (March 8), Harmonic had regained only slightly from its nadir, to $6.68.
The good news is, cable hardware suppliers are resilient. Not much surprises them anymore. Sudden spending shutoffs aren't anything new–AT&T Broadband, when it was Tele-Communications Inc., did the same thing repeatedly in the 1990s. Its own executives used to ruefully acknowledge a tendency to run out of rebuild money in the third quarter, which prompted the old TCI to shut down the build cycle for winter.
Nor have suppliers done much but feast–heartily–for the past half decade. The proof of this is in the networks themselves. For most MSOs, the use of hybrid fiber/coax (HFC) plant is a foregone conclusion, and in the future, HFC won't be the story so much as the software, servers and electronics connected to its end points.Flat sailing is good sailing
In all, cable's upgrade schedule looks solid for the next few years. It won't be the hare, but it won't be the tortoise, either.
And although cable providers like to assure Wall Street that they'll eventually be finished with their construction projects–and their capital expenditure line will drop accordingly–most know that it's never that easy. As penetrations for new services rise, so will the focus on increasing upstream bandwidth by splitting nodes or other means. As new services emerge that rely heavily on software, so will a need to spend on servers, licenses and integration.
It's all in a day's work, and for cable upgrades, the work is never done.
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