Winning in the Fast-Access Wars, Part 2

Yesterday I described some of the traps in the cable-vs.-ADSL fast-Internet-access battle and tried to sort out the advantages and disadvantages of each technology. Today, we'll look at how you can make money in this contest.

It's essential first to understand the hidden agendas at work here. They explain why winning this war is so important to the combatants -- and to investors.

Beyond the substantial revenue from providing fast Net access, cable providers want to draw you into their digital net so they can also start selling you alternative local-loop voice telephone service, along with your cable Internet access and cable-TV service. Cable access to the Web is the camel's nose under the tent for cable operators.

Their "one wire/one provider" approach is a promising idea, but you'll have to decide whether you trust your cable provider enough to be your sole supplier of something as essential as telephone service. You can live without Judge Judy and Yahoo! (YHOO), but when you need to dial 911, you need a dial tone. Will the cable providers around the country prove capable over the next couple of years of delivering the kind of reliability we associate with today's ubiquitous dial tone? Will we believe them? Fast cable access is a wonderful opportunity for cable operators to build that bond and trust and to begin to erase, for many cable customers, bad cable-guy memories.

The growth of cellular service will help overcome customers' worries about the reliability of telephone service via cable. The correlation between homes in which one or more residents carry a cell phone and homes likely to consider converting to cable telephony for their basic phone service is probably very high. If you know you can always use your cell phone, is the absolute reliability of your wired service quite so critical?

On their side, the telcos' hidden agenda is similar. They not only want the fast-access revenue, but they also want to head off cable's incursion onto what they see as their turf, to keep local-loop competitors out of the game and to soon be in a position to sell you discounted long-distance service as well, by hooking up with partners such as Qwest (QWST) (which I am long).

So How Do You Make Money?

Starting at the technology end of the food chain, probably the best place to invest to play the fast-access market is Aware (AWRE), which I am long. It smells like a big winner on the ADSL side. AWRE has pioneered G.lite technology and is now licensing it to the RBOCs. I first mentioned AWRE as a potential winner here on Jan. 8, when it closed at 26.50; Thursday it closed at 37.31, a 41% gain in about a week. During the same period, the Nasdaq composite was down slightly.

Cable-modem and ADSL modem businesses may prove profitable, but it's hard to find a play.

On the cable-modem side, chip maker Broadcom (BRCM) looks like the best technology play. In addition to a strong base in chips for cable modems, BRCM also has irons in the fire in ADSL and VDSL, cable-TV set-top boxes, Ethernet controllers and chips for MPEG encoding for satellite video transmissions -- all hot markets over the next few years. I also noted BRCM here on Jan. 8, when it was trading at 120.75; Thursday it closed at 135.94 -- a nice if less spectacular 12%-plus gain -- after a wild ride over the previous couple of weeks, when it touched 190. Like AWRE, Broadcom looks like it has a good year coming up. (If only they had put a dot in the middle of their name, they'd be headed for a fantastic year!)

In the middle, the cable-modem and ADSL modem businesses may prove profitable, but it's hard to find a play. Motorola (MOT) sold a little more than 300,000 cable modems last year, but their cable-modem business is a drop in the bucket for a $29 billion (in sales) outfit. Maybe it will be important in a year or two, but not now. 3Com (COMS) cable modems are being sold through CompUSA (CPU) in Spokane, Wash., by TCI (TCOMA) for its system there -- but again, the business is not material for 3Com, a $16 billion company. Cisco and others will be in the cable-modem business soon, but their cable-related revenues are even smaller.

ADSL modems are an even smaller and more diffuse business right now, but will grow this year as the ADSL business explodes. Fujitsu, Orckit (ORCTF) and a few others are in, but no one's selling many boxes yet.

Move up to the next level, the service providers, and it's still hard to figure how to play the fast-access market. The leaders in cable access are TCI, soon to be part of AT&T (T), in tandem with partner @HOME (ATHM); Time Warner's (TWX) RoadRunner service; and MediaOne Group (UMG). All are pursuing much broader markets than just cable access.

The combination of T and TCOMA looks especially potent. Not only do you have strong existing AT&T and TCI long-distance, wireless and cable businesses, but this combo should be a fierce competitor in the near-term future, given T's long-line and wireless businesses. Note too that with a straddle across both wireless and cable businesses, the combined company will be able to work both sides of the street on selling local-loop voice service. This may not be a buy on cable-access-revenue prospects alone, but over time it can be a powerhouse in the broadened "fat-pipe-into-the-home market.

For Time Warner, cable access is now only a very small part of their business -- though overall, RoadRunner's management of its cable-access business is exemplary. TWX apparently cares about this business, and if it can accelerate its rollout, it stands to own a big chunk of the cable-access market by midyear.

(A spinout of RoadRunner to TWX shareholders is a tantalizing possibility. If the market values @HOME's 175,000 subscribers at $11B (Thursday's close), what value might it assign to RoadRunner's only-slightly-smaller customer base? With TWX's market cap floating around $74B, and the stock still hovering around only 60 after a mid-December split at a split-adjusted 54, Gerry Levin has got to be thinking about returns to his stockholders. Propelling RoadRunner into a pure-play fast-Net-access entry in a .com world would make a lot of sense for TWX holders.)

MediaOne announced in December that it's merging its MediaOne Express cable-access service with TWX's RoadRunner, so there's not much play there.

All these cable-access providers share one big advantage: Their internal capital costs to start offering per cable-access-home are only about $500 vs. the telcos' estimated $3,000 cost per ADSL-ready house. And the "take" rate for cable-access providers has been very high, exceeding in some cases 10% of cable customers offered Web access.

Lower costs and a high conversion rate of the existing customer base sound like a potent combination.

The ADSL Players

On the ADSL side, the MegaBit service from USWest (USW), FastAccess service from BellSouth (BLS) and GTE's (GTE) Bronze/Silver/Gold/Platinum tiered services dominate ... and expect similar branded services from all the RBOCs very soon. But the existing and near-term ADSL business revenues from all ADSL suppliers are still tiny -- remember that only abut 25,000 ADSL customers are connected today -- and buying any provider based on high hopes for its ADSL business is premature.

One note about home vs. office service: Local cable providers have generally avoided selling cable access to businesses. They argue that few offices have cable connections and that installing wiring inside an office building can be hideously expensive (which shouldn't be a problem for them, since that can be contracted out as a customer cost at installation). Also, they admit privately, both the security issues with cable access to the Net and the potential decline in typical delivered bit rates in an office building -- where they may have many simultaneous users sharing fixed bandwidth -- argue against using cable access at work.

It may be too soon to start buying cable-access or ADSL providers -- but as an investor, it's not premature to start watching them.

By contrast, ADSL, even with its outrageous pricing, looks in many cases like a good bet for businesses, especially small businesses. And its three-to-four-mile service limitation also lends itself to campuswide service for clustered offices, colleges and universities and other related nearby entities. BellSouth has been quietly testing G.lite ADSL at the University of Florida at Gainesville and at the University of Miami, with success.

It may be too soon to start buying cable-access or ADSL providers. But as an investor, it's not premature to start watching corporate announcements about expansion of both cable and ADSL Net-access services. Those announcements, especially in the burgeoning cable-access business, are likely to drive stock prices up far faster than the actual number of fast-access connections grow.

And consider those cable-access and ADSL technology companies, such as Aware and Broadcom now.

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For your own PC, my advice is simple: Grab whichever is available first in your area. If you have a choice, go for cable. And if you can only get ADSL, consider paying for a higher-tier service. Most PC users say any improvement in their Web access time is welcome, but moving to 256Kbps isn't nearly as satisfying as jumping to 512Kbps or higher.

To make your life a little easier, note that both Compaq (CPQ) and Dell (DELL) are now selling -- or are about to sell -- preconfigured G.lite ADSL-ready and cable-access-ready PCs set up to work with the particulars of the service available in your area. You don't need a new PC to use either cable or ADSL service, but if you're moving up anyway, why not make your life a little easier?)

Tell me, was reading these long wheezes yesterday and today worthwhile? Does it help you understand cable-vs.-ADSL better? I hope so. If not, let me know.

Look for a TSC chat on this topic in the near future.

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