Time Warner Cable Heading for the Doors?

When a major player in the content business starts thinking that maybe it doesn't need to control distribution to the extent it once did, watch out. It is an indication that the strategic value of distribution networks could be changing. That might be just what is happening at Time Warner, which has generated significant profits from its cable system ownership. The latest thinking is but the latest iteration of a constant theme in the video entertainment business: the relative strategic value of distribution and content assets. Though the mantra of late has been that "content is king," distribution always plays an important role. Sometimes it is the key role. Satellite radio wouldn't be much without the creation of new distribution networks. But movie studios are barred by law from owning theater chains.

Once upon a time a company had to build an operate its own network to deliver voice services. And cable TV wouldn't exist without the cable network. And the same might have been said for the terrestrial TV and radio businesses as well. But there are other media models that show how content businesses can flourish without any ownership of distribution networks. Newspapers and magazines provide a prime example. Grocery stores, kiosks and the postal service provide distribution.

Senior executives at Time Warner are considering whether the media company should substantially reduce its cable holdings over time, says Wall Street Journal reporter Matthew Karnitschnig.

Cable has been a core part of the company and its precursors for decades and is now the biggest contributor to profits. But the long-term future of cable, as the Internet emerges as a viable venue for watching TV, is murky, says Kartnitschnig. Some within Time Warner wonder whether the company wouldn't be better off if it were to get out of cable and double down on the Web, where it already owns AOL.

Getting rid of a big chunk of its cable holdings would transform the nature of Time Warner, making it more reliant on its role as a provider of filmed entertainment and print and Web content. For years, Time Warner has believed in wedding its movies and television programs to powerful distribution networks, primarily its cable operation, as a way to ensure that their content wouldn't be blocked by rivals. But with the Internet increasingly serving as a home for TV and film offerings, content companies may feel they no longer need to control old-style distribution networks such as cable or satellite TV.

The issue will be put before the board at a meeting next month, part of an annual strategic review, say people familiar with the situation. Time Warner management will present several alternatives for future ownership of Time Warner Cable.

The fact that Time Warner is even willing to think about a major reduction of its cable holdings is a sign of how much attitudes toward the cable industry are shifting. Despite cable's recent streak on Wall Street and its success in attracting customers to its bundled offering of Internet, telephone and television service, this is a business some analysts believe will become increasingly commoditized, squeezing profit margins.

News Corp. already has sold its stake in DirecTV Group Inc. to Liberty Media Corp., which continues to believe in the value of distribution networks.

The obvious issue for telecommunications companies active in the access market is precisely this issue of the strategic value of video entertainment, and the effort and expense that requires. One might argue that telcos are getting into a mature business just as key players are getting out. On the other hand, one might also argue that telcos will share immediately in a signficant chunk of the walled garden video business, but would have to create a new role in the as yet unproven Web video market, where control of distribution, by definition, isn't a key strategic imperative.

What Else Would Vonage Say?

Vonage says it has no "workaround" in hand to sidestep Verizon's patented Internet phone technology. That would simply stand to reason. It obviously would take time to circumvent a broad patent covering interconnection of public and IP networks.

This is precisely what one would argue if angling for a permanent stay of an order that would shut one's company down, while an appeal winds its way through the courts.

More to the point, though, Vonage says isn't sure that such a plan is even "feasible," given the expansiveness of Verizon's patents, which set out methods for passing calls between the Web and conventional phone networks. Friday the 13th, indeed.

A federal court recently ruled that Vonage had infringed on Verizon's patented technology. As punishment, Vonage was barred from using the disputed technology to support new customers. Vonage has gotten a temporary stay, but has petitioned for a permanent stay until the appeals process is finished.

Vonage told investors and customers not to worry because a "workaround" was in development. That does not necessarily contradict the fact that "Vonage currently has no workarounds that moot the need for a stay."

"While Vonage has studied methods for designing around the patents, removal of the allegedly infringing technology, if even feasible, could take many months to fully study and implement," Vonage has said in a document filed with a federal court, USA Today reporter Leslie Cauley says.

We wouldn't think the filing necessarily reveals much, other than the strongest-possible argument to a judge that a permanent stay is urgently needed.

IPTV: Tough Going in Western Europe

It's a good thing U.S. consumers like television quite a lot. Because IPTV results so far from Western Europe are sobering. While 11 Western European incumbent telcos have launched IPTV services, Forrester Research’s says consumer interest remains low, and revenue potential remains modest. Forrester predicts 25 percent of European xDSL/fiber broadband subscribers will have IPTV within 10 years. In the U.K. market Forrester expects 13 percent penetration in a decade. In France, Forrester expects 33 percent penetration in year 10.

Lars Godell, Forrester Research principal analyst says “Europeans are generally unwilling to pay much for TV content, and a discount scheme is needed to entice them to buy triple play."

In a mature TV market, this means incumbents will need to price IPTV below competing cable and satellite TV services. Assuming the typical provider gets a third of the market, annual IPTV revenue will work out to about €11.24 in net annual IPTV revenues. Remember that 50 percent or more of the actual gross retail value has to be given directly to the content owners and packagers.

At the end of June 2006, Belgacom, FT, and Telefónica had only achieved 1.7 percent, 1.2 percent and 1.8 percent IPTV household penetration, respectively. Telefónica has been the most successful in tapping into its retail broadband subscriber base, with 8.3 percent IPTV penetration among broadband customers.

DT wants to get to one million IPTV subscribers, representing 2.5 percent of German households, by the end of 2007.

Forrester estimates that IPTV investments will generate a cumulative €3,742 in losses for an average broadband subscriber over a 10-year period.

That is not to say telcos should nix the construction of fiber deep access networks or entering the video entertainment market. It is simply to point out that such efforts are fundamentally strategic matters, not revenue generators per se.

4G Has to be Taken Into Consideration....

One thing about the access business. It isn't as though the cable and telco contestants can rivet their attention on each other, and ignore everybody else. 4G wireless, for example, sometimes is defined as an access featuring 1 Gbps for stationary users and 100 Mbps to mobile users. The cable industry's DOCSIS 3.0 specification, for example, will bond channels to provide downstream speeds up to 120 Mbps and upstream bandwidth in the neighborhood of 80 Mpbs, at least in the lab. In the real world, physical impairments of various types and the need to share that bandwidth across a base of users will, in practice, reduce the actual bandwidth any single user might be able to pay for. We would note that at least one U.S. telco, SureWest Communications, offers a 50 Mbps symmetrical bandwidth service today for any customer that will purchase SureWest's most-expensive bundle, including every video service, wireless, fixed line voice and Internet access.

"Why Vonage?" Jon Arnold Wants to Know...

Bloggers Jon Arnold and Daniel Berninger want to know why Verizon went after Vonage on the patent front. Why not some other company? The answer is that the dominant telcos want some competition, but not effective competition. The reason is simple enough. It is quite beneficial to show regulators that there is effective competition in their markets. But what happens is that there's a threshold. Below a certain level of success, we leave you alone. Cross the line, and we have to deal with you.

That's why some competitive local exchange carriers actually were encouraged to take share away from certain large tier one incumbent telcos. Helped, actually. All to demonstrate that there is effective competition in the market. Not every CLEC got that sort of material help. And not every CLEC found itself so favored once the legislative and regulatory battles requiring proof of effective competition drew to an end.

Vonage gets attacked because it frankly doesn't help to attack SunRocket or Packet8. Vonage is the one company that crossed the threshold, as all the leading cable companies have done. And that is my take on "why Vonage?".

Vonage Starts Cutting

Vonage says its quarterly results for the period ended March 31, 2007 will show $195 million revenue, 332,000 gross customer adds and 166,000 net adds. That would bring Vonage in flat with net adds for the fourth quarter of 2006, when it added 166,000 net customers.

Marketing cost for each gross customer addition, though, backed down to $275, towards the more historic range of $239 in the second quarter of 2006, $306 in the fourth quarter 2006, $254 in the third quarter and $239 in the second quarter last year.

Quarterly revenue of $195 million was stronger than the $180 million Vonage reported for the fourth quarter 2006. Monthly ARPU was $28.17.

But Vonage also expects to boost operating results by cutting $110 million in marketing expense, possibly a quarter of what it originally though it would spend this year. Vonage now expects to spend $310 million for 2007 marketing, instead of $400 million to $425 million.

A 10 percent force reduction also will slash SG&A costs of about $20 million in 2007. Planned cuts in other SG&A expenses are expected to generate an additional $10 million in savings.

Collectively, the moves will get Vonage very close to positive operating income, though not profitability.

Carriers Innovate Because They Have To

I wasn't the only one at the Voice Peering Forum recently who was struck by the sudden lead some European telcos have taken in their transformation efforts. BT actually is growing customer counts and revenue in its tough mass markets segment, for example. To be sure, some of the progress is born of necessity. As Carlos Dasilva, France Telecom Americas region marketing director notes, "we had to move aggressively because the regulators are killing our business." And though she didn't specifically make the same point, BT has had to strike out on some very innovative paths precisely because it was forced to do so. But a significant turn in the direction of flexibility (an internal requirement, perhaps) and openness (more important for third party application providers) is going to pay dividends for end users, who "aren’t waiting" for regulators to set rules and service providers to start giving them what they want, Anna Boukovskaia, BT head of market development, said.

Which isn't to say regulatory action is inconsequential. Quite to the contrary, regulatory ground rules always always always create the preconditions for all revenue generating activities in the public and private network spaces. Deutsche Telekom and Telstra, for example, find regulatory demands so onerous they simply have refused to build new optical networks, because they aren't sure they will earn a return on the investments. Credit aggressive wholesale requirements for the concern.

Paradoxically, hammering by regulators is largely responsible for the innovation now being shown by the likes of BT and France Telecom (Orange). But the changes come at a serious price. France Telecom is laying off 20,000 people. If you know France, you know how unusual that is, and how powerful the need for change therefore is. Keep in mind there are multiple forces at work here.

Regulators, technology and capital markets normally work in tandem to create markets. They also can work in tandem to change them. What less often occurs is that end users change the markets. But that is precisely what is happening now.

To be sure, the legacy markets were going to change, in any case, because of regulatory shifts, technology advances and capital availability. What is highly unusual is the impact actual consumer preferences now are having. Text messaging was an accidental success. Nobody really claims to have "always believed" that short message service would be such a big revenue driver. Carriers and service providers did not create this market: end users did. So Boukovskaia flatly says "we don't know what the next killer app is going to be."

Notable is BT’s commitment to take all voice and data services at the edge and deal with everything as IP and Ethernet. Every voice line is converted to VoIP right where the copper pair is terminated. All 30 million of them. DSL services are provided from the same linecard. There’s no separate DSLAM, POTS termination, SONET/SDH Add Drop Mux.

Fractional TDM based Frame Relay and IP services are packetized and bundled right at the POP. If it isn’t TDM leased line (E1 or bigger), it gets packetized and sent through the core using MPLS.

A dramatically simplified network results.

Going forward, TDM as an enterprise access technology is over in the United Kingdom, at least as far as BT is concerned. BT embeds the VoIP functionality as close to the customer as possible. This has the effect of reducing network elements.