Comcast Cuts Raise Fears on Price Front

The big cable operator defends its broadband strategy, but investors wonder about margins.
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Investors can't stop worrying about high-speed Internet pricing among cable companies.

Over the past year, most major cable operators have repeatedly said they feel no pressure to cut prices on cable modem service in order to compete with telcos' offers for high-speed Internet connections via DSL.

But as

Comcast

(CMCSA) - Get Report

-- the nation's largest operator of cable systems -- has seen in recent days, investors are quick to see signs that pricing of broadband Internet service will crumble among cable operators.

Though industry executives and analysts say such lower prices might make sense a few years out, as the high-speed Internet market matures, any indication that high-speed data subscription prices are falling more quickly than expected would call into question a major part of the cash flows that investors expect cable operators to reap from advanced services.

And unfortunately for cable operators, investors are quick to see such indications of pricing weakness, no matter how much the cable operators insist they aren't there.

The latest example: reports that Comcast was offering a one-year discount on high-speed Internet service in selected markets for $19.95 a month, less than half of the company's standard monthly basic rate of $42.95. Reported Nov. 7 on the broadbandreports.com Web site, news of the promotion was picked up last week by

CNet

,

USA Today

and

Reuters

.

Though the emailed offer was limited, says Comcast, to current customers for DSL service in three states where Comcast offers high-speed Internet service, some observers saw the offer as a sign that cable operators are effectively dropping prices for cable modem service -- or, at least, as a reminder that pricing is a front-and-center issue. "We believe Comcast's promotion clearly heightens price competition as the company specifically targets the current DSL subscriber base," wrote Merrill Lynch analyst Jessica Reif Cohen in a note Monday.

Comcast's shares traded at $31.14 Tuesday, down 56 cents. The stock is down 8% since the beginning of the month.

Terms of Endearment

A particularly striking element of the promotional offer was the one-year term. Late last month, when

Comcast reported its third-quarter financial results, the company said that a decline in monthly revenue per broadband customer from the second quarter was due to promotions that involved up to six months of discounted service. News of one-year discounts so soon after Comcast's discussion of six-month discounts could be interpreted as rapidly deteriorating pricing.

Such discounting -- targeting customers of

SBC

(SBC)

and

Verizon

(VZ) - Get Report

-- would also be noteworthy, given Comcast's disdain of offering cheaper, less-featured service as a competitive tool -- though the company has at the same time said it makes aggressive promotional discounts to match aggressive discounting on DSL by telcos.

On Comcast's third-quarter call, Comcast Cable President Steve Burke said, "I think when you go downmarket and you compete on the basis of a lower price, and the product that you're offering is a product that in many instances has lower speed and lower service -- I think you're at a competitive disadvantage vs. someone like ourselves who says we have a faster product, we have a more reliable product," according to the CCBN and FDCH e-Media transcript of the call.

So if Comcast isn't interested in offering lower-priced, lower-featured service, at what point do discounts on full-priced, full-featured service become price erosion?

Not here, says Comcast, which compares the offer to previous promotions the company has instituted to poach video customers who have subscribed to satellite service instead of cable.

"This highly targeted email offer is a test campaign aimed directly at DSL customers," said Dave Watson, Comcast's executive vice president of marketing, in a statement. "It is similar to other winback-type programs we've conducted in the past. This particular campaign is a limited offer, and we anticipate it to be a one-time event as other offers of shorter duration such as six months have proven successful."

Up to Speed

To its credit, Comcast showed no sign of slowdown as it added cable modem customers in the third quarter. In fact, the company added more cable modem customers than it had in either the third quarter of 2002 or the second quarter of 2003, beating analysts' estimates.

Though price competition could be an issue next year, David Joyce, an analyst with Guzman & Co., says the one-year offer isn't a sign that price is an issue now. Limited, localized promotions like this one "tend to get ballooned out of proportion," Joyce says. "There are all sorts of trial balloons always being floated," Joyce says. "It's nothing that should impact

Comcast's operating cash flow to any great degree at this point."

Guzman, whose firm has done recent banking for Comcast, has an outperform rating on the stock and a $40 price target.

Meanwhile, another industry has another interpretation of Comcast's promotion, which targets discounted DSL service with less than 10% penetration of Comcast's market. By limiting the discount to this degree, says Dave Burstein, editor of the industry newsletter

DSL Prime

, Comcast is signaling to telcos, "If you drop prices, we will" -- an encouragement, says Burstein, not to be dropping prices.

Burstein says he doesn't know if such a strategy will work. "The telcos are desperate not to lose voice subscribers," he says, "which will happen with greater cable modem penetration."