As competition heats up for the cable TV industry, Time Warner (TWX) is responding the way it always has -- by spending money to develop new services.
In a meeting with analysts Wednesday, Time Warner executives acknowledged that one reason cable operating margins dropped in the fourth quarter was the accelerating investment in telephone service to be offered over cable TV systems.
Driving that speed-up, said CEO Dick Parsons, was Time Warner Cable's desire to defend its subscriber base from poaching by satellite TV services, and to win back some of the customers it had lost to direct broadcast satellite.
In fact, the company acknowledged Wednesday that basic cable service -- that is, a straightforward lineup of video channels without add-ons like interactive TV, high-speed data and telephony -- is a no-growth business.
"Satellite is a real competitor, and the competition is getting tougher," Parsons said.
Wednesday's comments from Parsons and other Time Warner executives illustrate a fundamental challenge faced by Time Warner and other cable operators, especially following the deal by Rupert Murdoch's
to take a controlling stake in
, which operates the DirecTV DBS service.
Following billion-dollar cable TV upgrades over the past few years, operators -- including Time Warner -- have promised investors that capital expenditures are declining, and that they'll increasingly be generators of free cash flow, or cash flow after capex and interest expense have been subtracted out.
Yet, as Time Warner's disclosure about the accelerating investment in telephony rollout indicates, investors are forced to wonder how costly it will be for cable operators to invest in new services as they fight DBS for market share.
The market share won through advanced services and the costs of that market share are especially important since -- as Time Warner executives acknowledged on the call -- plain-vanilla basic cable service is a low-growth or no-growth business. And since Time Warner is the nation's second-largest operator of cable TV systems (only
is larger), any challenges faced by Time Warner are no doubt faced by other publicly traded operators.
Though it may be difficult to quantify the costs of the antisatellite investment, certainly the effect is real, as illustrated by the company's response Wednesday to an analyst's question about why operating leverage declined at its cable systems. (Adjusted operating cash flow margin slipped from 40.2% in the fourth quarter of 2002 to 39.8% in the fourth quarter of 2003, while revenue grew from $1.8 billion to $2 billion.)
After factoring out various items that may have affected operating margins, CFO Wayne Pace said that one issue affecting fourth-quarter cable margins was the company's decision to accelerate the planned rollout of its new telephony service, also known as voice-over-Internet protocol, or VoIP. The company, which started offering VoIP in its Portland, Maine, system last spring, has said it hopes to introduce the service throughout its systems by the end of 2004.
Later in the call, Parsons said that one reason for the sped-up introduction of VoIP was the company's desire to fight off satellite competition. Making a point often hammered home by
, a cable operator that has been offering telephone service to subscribers for several years, Parsons said he was hopeful that adding voice to video and data services would increase the loyalty of Time Warner Cable subscribers.
Adding telephony will boost subscriptions to high-speed data, conjectured Parsons. The voice-video-data "triple play bundle," as he put it, is going to give the cable modem business "another kick."
VoIP could even be used to lure satellite subscribers back to cable, he said.
Despite those possible winbacks, Time Warner doesn't have high hopes for expanding the penetration of basic services. Growth will likely come from advanced services, not growth in basic customers, said Pace.
In fact, over the past year, Time Warner Cable has extended its systems to pass 293,000 additional homes that could subscribe to cable -- but it has netted only 5,000 additional customers.
So, though things are looking up in many ways for Time Warner's cable operations and other businesses, an old question lingers: How much will it cost?