The broadband Internet business rebounded for cable operators in the third quarter.

The surge in third-quarter signups -- which echoes seasonality in other aspects of the cable business -- signals continued strength for cablers in their fight with telcos for high-speed Internet access subscribers.

But the aggressive marketing that helped drive the rebound spotlights the challenges cable operators will face in recruiting more dial-up Internet access subscribers for broadband service, while maintaining current levels of profitability.

"There's still a lot of land here, because there's still a lot of dial-up subscribers," says Bruce Leichtman, a Durham, N.H.-based researcher who focuses on the adoption of broadband, cable and satellite TV. "The question is, how do you get new users to convert without pricing it so low you cannibalize users at your existing price?"

Turning Point

For now, the third-quarter subscriber numbers clearly give cable operators a reason to celebrate. The eight large cable operators tracked by

TheStreet.com

-- including heavyweights such as

Comcast

(CMCSA) - Get Report

, the nation's largest, and

Adelphia Communications

, operating under bankruptcy protection -- added 1.23 million residential subscribers in the third quarter, up from 1.19 million in the third quarter of 2003 and much improved from the 793,000 users they added in the second quarter of this year.

Temporarily, at least, the numbers also represent a halt in the market share slide that cable operators have been suffering in their competition against the DSL service that regional Bells offer for fast connections to the Internet. Against the four Baby Bells, those top eight operators reaped 56.6% of new signups. That's down from the year-ago figure of 62.8% but up from cable's 49.1% share in the second quarter. (The telco figures come from CMA Group analysis, published in Pike & Fischer's

Broadband Daily

newsletter.)

Cable Turns the Tables
Telcos see a setback after high-speed ISP customer gains

Quarterly net additions of high-speed Internet subscribers, as reported at eight top cable operators and four top telcos.
Source: CMA Group via Broadband Daily, Cable operator SEC filings and press releases

Part of the rebound from the second quarter is the oft-discussed seasonality in the cable business, with low second-quarter numbers attributed to college students disconnecting service at the end of the school year. "Traditionally -- and the tradition is now two years old -- the second quarter is a down quarter," Leichtman says.

But the upswing was also the product of what looks like aggressive promotions from major cable operators, according to UBS cable/satellite analyst Aryeh Bourkoff.

Noting weak sequential trends for average data subscriber revenue, as well as softer earnings before interest, taxes, depreciation and amortization, Bourkoff wrote in a recent report, "Cable operators sacrificed some profitability to post stronger levels of unit growth."

Much of that unit growth came from Comcast, which added 549,000 subscribers in its latest quarter, up from 473,000 added one year earlier.

Equilibrium

Looking forward, Leichtman, among others, expects that cable operators and DSL providers will have a roughly 50/50 split of net new additions. But it's only been since the second half of last year, says Leichtman, that DSL has been a serious competitor to cable.

"If you look back before the third quarter of 2003, it was really the varsity playing against the JV," he says. "Cable built up a 20-point lead at halftime. They've still got a 20-point lead. It's not like DSL is catching up. It's that they started playing the game after halftime."

Leichtman says cable operators will have to contend with the risk of increased churn, as they seek growth from lower-paying subscribers. And they'll also have to contend with investors' hopes for continued unit growth. "I think what the companies are going to have to do next year is kind of calm down Wall Street's expectations for net adds," he says.

Bourkoff, meanwhile, says cable operators next year will have to manage the tension between free cash flow and market share growth.

Building market share, Bourkoff says, can be done a number of ways -- spending more to market the service, introducing a new, lower-priced tier of service, or spending additional capital to aggressively subsidize equipment, for example.

Telcos continue to cut prices for DSL.

SBC

(SBC)

and

BellSouth

(BLS)

, for example, announced lower subscription fees in recent weeks. "While cable, I think, was successful in gaining share in the third quarter," says Bourkoff, "it has to continue to be aggressive to sustain that momentum."

Bourkoff also foresees that cable operators will have to make greater-than-expected capital expenditures to compete on the video front.

"The combination of potential tiering and marketing spending in data, as well as increased capital requirements for video," says Bourkoff, "will change the balance of free cash flow and market share growth in 2005. ... It's going to cost more to drive share."

"The cable industry can grow market share or free cash flow, but they're somewhat mutually exclusive in the near term during this investment cycle," says Bourkoff. Still, he adds, sacrificing margins in the high-speed data business and spending more on video capex is "a healthy investment for the cable industry to make."