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The Sunday Brief, May 12 2013: Wireline’s Future Through the Lens of Cablevision, CenturyLink’s Earnings

happy-mothers-day-from-bollywoodHappy Mother’s Day from Rochester, NY, where the entire Patterson clan has gathered to celebrate graduation and motherhood.  It’s still a “calling event” day in the US, although there will be plenty of Facebook communications and the like (text messaging – not recommended, unless accompanied by a call or visit.  It’s hard to see the “Mom speech” including “But you never text me anymore”).

The earnings parade continued this week, with Charter Communications continuing their string of successes (stock is up over 44% in 2013), Cablevision struggling with the effects of slow subscriber growth and increasing programming costs, and Frontier, CenturyLink and Windstream bringing up the rear as they continue to transform.

One important thing to keep in mind when discussing cable and wired companies is the gradual nature of subscriber change.  Unlike our discussion of 4G LTE penetration and the corresponding growth of data revenues at Verizon or AT&T (20%+ annual growth on a $20 billion base), growth for the wired side of telecom is slower (if not negative).  Here’s the comparison for Cablevision, the most highly penetrated cable company in the US:

cablevision q1 earnings

Note the very small changes, even on a year-by-year basis:  52K voice customer growth (0.5% penetration increase), 53K High-Speed Data customer growth (0.4% penetration increase), and 64K video subscriber loss (2.0% penetration decrease).  Three years ago, during a recession, these same cable systems (excluding Bresnan) generated more than 2x these levels of growth (2010 Q1 annual growth levels = 125K High-Speed Data and 165K Voice customers).  As FiOS and U-Verse strengthen, Cablevision’s prospects decelerate.

This slower growth is driven by Cablevision’s already sky-high penetration levels – nearly 56% of homes passed take their High Speed Data product compared to 37% at Comcast and 39% at Time Warner Cable.  Voice is equally impressive, with 46% of serviceable homes/ businesses taking Optimum Voice vs. 19% and 18% at Comcast and Time Warner Cable.  While slight, it is interesting to note that Cablevision continues to grow voice penetration while residential voice declined at Time Warner Cable.  Can the buying habits on Long Island be that different from New York City (~33% of Time Warner Cable’s homes passed)?   Or is the bundle not as powerful in more urban areas?  We’ll look at this phenomenon in a future Sunday Brief.

Assuming there’s not much room to grow market share at these levels, how does a company like Cablevision increase profits and cash flow?  If there is enough product differentiation (e.g., sports programming packages, High Speed Internet performance), there’s the opportunity to raise prices.  Cablevision began to do just that with their High Speed Data product (Optimum Online) this year, a $5 monthly increase that represented their first “price up” in a decade.  They also applied a small sports surcharge to their subscriber base.

While top line opportunities will be challenging, there are always ways to take out truck rolls ($70-90 per event) and customer service calls ($4-9 per call depending on its complexity and duration) at Cablevision or any other wired infrastructure company.  It is not surprising to see Cablevision’s CEO, Jim Dolan, focusing his time on improving operating efficiency.

Cablevision represents the “end state” that many cable companies will face once they begin to peak (and, as we showed in the earlier statistics, penetration rates have a way to go in High Speed Internet before Cablevision’s problems become Charter’s or Comcast’s).  As more companies reach these levels, expect consolidation to increase.  Outside of Adelphia, there have not been a lot of changes to the cable industry structure over the past decade. Familial ownership structure (Cablevision = Dolan; Brighthouse = Miron; Cox = Cox; Bresnan = Bresnan) eliminates many of the messy shareholder squabbles over “fair market value.”  It’ll be an interesting dynamic to watch over the next few years, especially if some version of Senator McCain’s television regulations are implemented (for more on the regulations, see this write-up).

If Cablevision is the poster child in “The Quest For Growth” in the cable industry, CenturyLink is their peer in the traditional telco industry.  We wrote extensively on CenturyLink’s bold move in February (dividend cut; aggressive stock buyback; company-wide reorganization), and it’s interesting that they have made up about half of their one-day 23% stock loss this quarter.

centurylink 12 MayCenturyLink, like many traditional telephone providers, faces several threats:  a) Wireless substitution, particularly in the residential segment, is quickly devolving to home security alarm support; b) Cable providers are capturing a significant share of net residential High Speed Internet decisions; c) Cable’s business efforts, particularly in the very small business (< 250 employee) arena are beginning to take hold; and d) traditional carrier infrastructure business, a long-time stronghold of incumbent telephony providers, is being increasingly challenged by competitors such as Zayo, FiberLight, DukeNet, Level3, and the cable providers.  There is no “safe” segment left for CenturyLink that actually makes a decent return.  Core profitability is under attack.  How should CenturyLink fight back?

First, CenturyLink has to decide to fight back with a higher percentage of their footprint at higher speeds.  In their earnings presentation, CenturyLink disclosed their progress using the following chart: The Elusive CenturyLink picture

They have made good but not great progress in hitting a 10Mbps threshold and are measuring their success against cable’s current standard (DOCSIS 3.0).  This comes as cable’s new standard, DOCSIS 3.1, begins to launch in 2014 with 10Gbps top speeds.  That’s what Cox, Brighthouse, and Comcast will be offering within 36 months in Las Vegas, Phoenix, Denver, Seattle, Minneapolis, Orlando, and Salt Lake City.

Understanding the adoption curve and uses of data (ahead of the DOCSIS 3.1 tsunami) is one of the reasons why CenturyLink elected to retain their license for West Omaha and roll out a 1 Gbps trial to 48,000 homes in that locale.  It’s a bold yet relatively inexpensive move given Qwest’s previous video trials in that region.

All is not dire for CenturyLink, however.  They made a good acquisition with Savvis, a managed hosting and collocation (Gartner) “Magic Quadrant” leader.  Hosting revenues continue to grow at a slow clip, especially when their acquisition of the Ciber IT is included ($15 million of the $24 million in year-over-year growth).  Unlike the rest of CenturyLink’s units, however, Savvis has been a consistent growth engine with strong brand loyalty.  CenturyLink needs to prove that they can efficiently sell the SavvisDirect (small and medium business) offering to the existing CenturyLink base.  In turn, they need to prove that they can withstand the pricing downdraft that is occurring in computing and storage.

CenturyLink also has a tremendous opportunity to globally diversify through the Savvis asset.  As they stated on their call, they will add 90,000 square feet of sellable space in 2013.  They have a Tier 1 backbone through Qwest, and the opportunity to continue to improve their partnerships with a multitude of service and applications providers.  They must act quickly, however, and cannot afford to have slow sales quarters like they experienced in 3Q 2012.

Lastly, CenturyLink needs to build a world-class enterprise experience with their current assets and future partnerships.  This is starting to occur as they are being included on more RFI/RFPs, but there is a point where they need to “break out” and take a calculated risk.  These partnerships fill product gaps (e.g., a hearty Desktop as a Service or DaaS offering for Ethernet customers), as well as geography gaps (e.g., DaaS in Mexico City).  They have a robust data center presence around the globe, and those data centers connect to many local service providers in the cities they serve.  What’s missing is the customer value proposition and a competitive distribution strategy.

CenturyLink and Cablevision’s situations are similar in one important regard:  Doing nothing is not an option.  Even with their respective histories, they are only a few years away from significant hardship.  Both have strong management teams, yet agile is not a word commonly used to describe either company.  This is the plight of wireline today – essential, yet replaceable; committed, yet measured; profitable, yet barely meeting long-term expectations.  Management’s ability to navigate and execute through changing times will clearly separate winners from losers.

Next week, we’ll publish part two of the “No Contract Analysis” we started before first quarter earnings.  Click here for a link to Part 1.  For more detailed analysis and daily updates, bookmark www.mysundaybrief.com on your website.

Thanks again for the many Sunday Brief referrals.  If you have friends who would like to be added to this email blog, please have them drop a quick note to sundaybrief@gmail.com and we’ll add them to the following week’s issue.  Have a terrific week!

Below the Surface, Why Wireless Carriers are Worrying

lead photo 19 MayGreetings from Austin, Charlotte, and Dallas.  En route to Charlotte, I had the opportunity to meet Matt Wallaert, a behavioral scientist for the Bing! division of Microsoft.  Earlier in the week, Matt had been to the premiere of Star Trek Into Darkness in Los Angeles and had the Klingon word for success (see here) shaved into the back of his head.  (Bing! also launched the Klingon language translator this week).  I have to admit, I was a bit hesitant to strike up a conversation at first, but we had a terrific chat (most of it I will post on www.mysundaybrief.com this week).  Matt also has a terrific start-up background (Thrive, which was acquired by Lending Tree, as well as Churnless).  He was headed to the NASCAR race Saturday night in Charlotte.  Hopefully he found a good ball cap (or a razor).

Star Trek festivities aside, it was a pretty eventful week in telecom.  Google had their I/O conference this week in San Francisco (see here and here and here for the highlights – I still do not fully understand the value proposition of Google Music but this article does a good job of explaining the differences between six different music offerings).

Blackberry also had their Blackberry Live user conference this week in Orlando and used it as an opportunity to launch a low-end smartphone (3.1” screen) called the Q5.  A good summary of the phone from Engadget is here.  For a full take on the conference, Blackberry has a good blog on the topic here.

In the world of patent infringements, we had an earthquake of sorts when Alcatel-Lucent’s appeal of their patent infringement loss to Newegg was unanimously denied by a three judge panel.  This article from Ars Technica summarizes the case – definitely worth studying, as it was a terrific outcome for Overstock and Newegg.

Speculation is running rampant that the Clearwire shareholders are going to vote down the current offer from Sprint.  The vote is scheduled for Tuesday – look for the last minute offer modification (if there is one) early on Monday.  Meanwhile, Sprint closed its acquisition of US Cellular licenses and will soon use the spectrum to bolster their coverage in Chicago and St. Louis (Chicago has always been a spectrum-starved market for Sprint so chances are they have already started to put that spectrum to work).

Many more events happened in advance of the CTIA Conference in Las Vegas this week.  This year’s extravaganza features a power panel led by Mary Dillon, CEO of US Cellular.  On Wednesday, the focus turns to Latino marketing with Jennifer Lopez taking the stage.

CTIA is always a good show, but this year there is an undertone of concern and nervousness.  Each new smartphone announcement lacks the impact of previous years.   Consumer appreciation of camera quality can only improve so much.  Meanwhile, many phones, like the Blackberry Q5 and Nokia Lumia 520, are entering the market at very low price points (Nokia is rumored to have the 520 available for $150; it’s likely that Blackberry will be in the same range).  With more cases around more phones (thanks, Apple, for AntennaGate), there is an emerging market for trade-in/ reconditioned devices at $200-250 less than their newer counterparts.  The consumer has many choices, and subsidies are growing stale.

Meanwhile, three events have impacted the balance of post-paid power thus far in 2013:  1) Wal-Mart’s introduction of the iPhone5 (3G only) through TracFone/ Verizon.  We have spent some time on the million net add effect on Verizon’s Q1 and 2013 results as it has significantly impacted the landscape;  2) Verizon’s re-introduction of a $35 retail pre-paid feature phone offering in April 2013 and their recent announcement that they were increasing data speeds for their $60 and $70 smartphone monthly plans (2GB of 3G data, up from 500 MB, and 4GB, up from 2GB); and 3) T-Mobile’s introduction of their Simple Choice/ Less Money Down plans, especially the $99.99 (now $149.99) iPhone5 plan.

Pricing for each of these events points in one direction – down.  While there has been significant growth in smartphone adoption and shared data plans for families and small businesses, the unmistakable trends are lower cost devices, more replacement/ refurbished devices, and fewer contracts.   The postpaid subscriber is in the crosshairs.

Research firm NPD backs up this theme with their study released last Wednesday.  Here’s the first quarter year-over-year change in pre-paid smartphone additions as a percentage of the total: 19 May


That is a substantial change in mix with comparable (non) events in each quarter (no iPhone or Galaxy S III launches to skew the data).  Interestingly enough, it is a full 10 percentage points (1000 b.p.) higher than 4Q 2012, which was a big quarter for the iPhone5.

NPD goes on to say:

“In a quarter without a major product launch from either of the two market leaders, consumers refocused their attention away from the postpaid wars and toward finding the best value for their dollar,” said Stephen Baker, vice president of industry analysis at NPD. “Sales of prepaid smartphones doubled from the previous year, continuing a string of more than 12 quarters of triple-digit sales increases.”

We all know how a triple digit percentage increase on a small number can still result in an still small number (especially compared to post-paid) but 12 consecutive quarters of year-over-year sales increases cannot be ignored.

This is what keeps Sprint, Verizon, and AT&T up at night – customer refocus away from postpaid and on to no-contract.  They are asking “Can I get a good enough phone with good enough data to satisfy my needs from one of the top carriers?”  It’s a continual tug of war between the allure of smarter devices and bargains for the formerly smartest devices.

AT&T and Verizon Wireless have joined Sprint and T-Mobile in answering this question.  The matrix below compares their plans:

smartphone plan comparison matrix

There are a lot of nuances between plans, but let’s look at the first two columns – Verizon Wireless and AT&T.  Both of the major carriers have competitive rate plans with sub-$100 devices (the Galaxy Amp is an Android 4.1.2 (Jelly Bean) device for $99; the Samsung Illusion is an Android 2.3 (Gingerbread) device for $99).  Both allow customers to bring their own device (with restrictions and potential one-time costs).  Both offer CDMA-Rev A and HSPA speeds (neither offers LTE) with generous data buckets for a mobile-dependent segment.  Neither plan offers the option of extending into a family plan.

This “first line” world is going to become intensely competitive over the next two years, particularly in areas where up to four networks are competing for the customer.  By the end of the year, some network plans (Sprint, T-Mobile) will include 4G LTE speeds and devices.  Also, by the end of 2013, a wave of GSM and CDMA iPhone 4S devices will hit the refurbished market (85% of these have been encased in silicone or heavy duty plastic since they were first used).  They will be more “like new” than any other refurbished Apple device.  T-Mobile is already adding 100,000 refurbished (AT&T) iPhones to its network each month.

When the average monthly cost of an unlimited plan (including the smartphone purchase) falls below a day’s wage (at minimum wage = $58), the “family” nature of postpaid plans begins to unravel.  This could happen at a $40 unlimited plan (with LTE as the predominant network, a 2GB plan is possible) and a $100 device.

T-Mobile is getting very close to this level with their 2-line cost of $100 and $0 down/ $14 per month new smartphone plans ($50 + $14 = $64/ line).  In fact, for three or more devices on a family plan, the costs are below $58/ line.  There are a lot of caveats to these plans (e.g., the $14 gets paid over 24 months which equates to a $336 commitment per device; T-Mobile’s network is not as large as AT&T’s; roaming and other charges are not included), but the point is clear:  For the ~ 200 million post-paid devices covered by four networks, the competition is about to get intense.

Where does customer loyalty reside?  Is it with Apple/ Samsung, or Verizon?  Does 4 Mbps/ second satisfy the needs of most smartphone consumers?  How big an impact will refurbished models have on the pricing and availability of new devices?  How does the availability of 100,000 Cable Wi-Fi Hot Spot devices affect the 2GB usage cap?  Does any of this matter when the user of the device is a teen or child?

The wireless industry was not asking these questions two years ago – phones were too expensive and showed signs of wear/tear, and we were thinking about the effect of the merged AT&T/ T-Mobile on the industry.  Two years from now, customers, not their contracts, will dictate their network provider choice.   That trend is causing many senior executives to pause and reassess their postpaid strategies, creating an extra wrinkle of worry on many management brows.

Next week, we’ll take a break for the Memorial Day holiday.  Following that, we’ll do our twice annual issue on which devices are being stocked for the summer season.  In the meantime, please support the fantastic entrepreneurs at TIP solutions by downloading their new application – CALL SNAP.

Thanks again for the many Sunday Brief referrals.  If you have friends who would like to be added to this email blog, please have them drop a quick note to sundaybrief@gmail.com and we’ll add them to the following week’s issue.  Have a terrific week!