Cable Industry Preparing for a Brighter ’97

The cable industry could finally earn some respect in 1997 and emerge from the shadows of a dismal 1996 as new services finally begin rolling out.

Despite consumer outrage over the industry’s never-ending rate hikes and service record, many analysts are looking to a successful launch of digital set-top boxes and high-speed cable modems. Cable stocks could even rebound from their all-time lows this year. And new federal rules and a court ruling on channels could mean big changes for the industry.

“If 1996 was the year of darkness, 1997 will be a year of sunlight for cable,” said Mario Gabelli, whose Gabelli family of mutual funds owns cable stocks.

John Tinker, an analyst at Montgomery Securities, said the introductions will shift the debate in cable from “Can they do it?” to “To what extent can they do it?”

Newly available digital boxes promise improved picture and sound quality and more channels--including pay-per-view movies, nearly on demand, and even limited interactive capabilities. In addition to siphoning revenues from rental stores, such as Blockbuster, cable companies hope the digital boxes will keep customers from turning to digital satellite rivals, such as DirecTV, which have more than 4 million subscribers after only two years.

Cable operators will offer the boxes in selective test markets before a broader roll-out toward the end of next year. Most experts expect them to charge an additional $10 or so per month for a comparable package of digital channels.

The boxes signal that relief is coming for cable programmers struggling to launch new channels and those that have been knocked off systems because of a shortage of capacity. But most experts say the capacity crunch will take five years to alter.

John Malone, chairman and chief executive of cable giant Tele-Communications Inc., recently predicted that it would take three to five years to get 25% of the nearly 70 million U.S. cable households to subscribe to digital. In the meantime, antagonism between programmers and operators could grow: Malone said this month that cable networks should not count on being carried into any of his 18 million households.

With more channel choices than space to carry them, cable operators are for the first time dictating the subscriber fees they pay programmers. TCI has threatened to knock off channels that charge fees in favor of new ones that are offering a bounty to be carried. And Time Warner has hinted that it may follow suit, with other operators expected to join in before digital boxes take widespread hold.

Experts predict that these economics could force weaker services out of business and favor families of networks that can bring their leverage--a CNN, MTV or ESPN--to bear on operators.

If digital boxes can help cable fend off satellite rivals and open up channel capacity, cable modems would allow them to minimize damage from potential cannibalization of TV viewers by the Internet. Cable modems connect users to the Internet at speeds a thousand times faster than phone lines.

“The question is whether operators will roll out quickly or in dribs and drabs,” said John Aronsohn, an analyst at the Yankee Group, a market research firm in Boston. “No one is saying, because they don’t want it to be held against them if they don’t deliver.”

The cable industry lost credibility on Wall Street after failing to deliver on promised new services that were supposed to help pay down debt incurred from increased capital spending and acquisitions.

But even the industry’s harshest critics expect a surprise next year. “I think the cable modems will work well,” Tinker said. “And that would be a shock, given cable’s record.”

The industry could also get a reprieve in its battle with digital satellite suppliers. Subscriber growth began to taper off at the end of 1996 despite price wars that brought upfront costs for a year of satellite service to between $500 and $600--closer in line with cable.

Analysts said Christmas sales of satellite dishes would be a strong indicator of consumer demand.

“Sales probably won’t be as strong as expected because the price is still too high for most people,” Aronsohn said. “That means you have to give away the equipment to drive further sales, following the cellular phone model. That would spell trouble for News Corp.”

Indeed, Rupert Murdoch’s News Corp. is scheduled to launch its ASkyB satellite service by the end of next year--a late entry into a market so competitive that existing rivals are losing at least $200 per subscriber even before giving away the equipment. The battle could speed consolidation in the satellite segment.

Phone companies had been expected to pose a greater competitive threat to cable companies than satellite, but their presence will continue to be minimal next year, with a possible exception in Los Angeles. Pacific Telesis promises to deliver video to customers in Los Angeles and Orange counties beginning this spring. Several major cable operators, particularly Cox Communications in Orange County and Century Cable in Los Angeles, are aggressively expanding their systems with digital and new services--and competition may finally lead to some discounting.

In 1997, broadcasters will also begin conversion to digital, initiating a process that analysts say will take 20 to 30 years to complete. Television stations will have to transmit both analog and digital signals until a majority of households buy new TV sets equipped to receive digital.

A more immediate concern for broadcasters is whether the Supreme Court will uphold a law requiring cable systems to carry broadcast stations. Most analysts predict the rules will be eased or knocked down entirely, leading cable operators to drop less popular independent stations in favor of cable channels requested by their subscribers. Network stations would probably not be affected, since they account for about 60% of cable viewing.

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Independent stations are already having a tough time competing against ever mightier station groups for sought-after programming. Eliminating these so-called must-carry rules would make their lives even more difficult.

The decision, expected before June, could also affect UHF station operators, such as Barry Diller’s Silver King Communications, which had hoped to rely on mandatory cable pickup to fill in coverage in markets where signals are weak.

If the law is struck down, Diller could sell his stations--and would probably make a fat return if the Federal Communications Commission passes “duopoly” rules next summer allowing multiple ownership of TV stations in a single market. Ownership rules were already eased in February, driving consolidation that will continue next year.

While Westinghouse and CBS combined to reach more than 30% of TV households in the U.S. and News Corp. bought the New World Communications station group to reach the government’s new limit of 35%, ABC and NBC are still far below the ceiling.

Approval of duopolies would allow VHF station owners to improve their operating efficiencies by owning UHF stations in the same markets. Station group owners that already manage UHF stations under special agreements would probably buy them to avoid paying leasing fees.

More consistent interpretation of ownership rules by the Justice Department could lift the chill on radio mergers next year. After the department required modifications to several radio transactions last summer, radio stocks took a dive. But its latest actions heartened the industry. In December, it approved acquisitions that will give just three owners 30% each of the Orlando, Fla., market, indicating that only those transactions that result in shares of 40% or more of a market are targets.

“Radio stocks will rebound in the first quarter, after some year-end profit taking,” said William Steding, managing director of the Dallas radio brokerage Star Media.

Still, some analysts worry about the high prices being paid for radio stations whose revenues as an industry are growing at only an annual rate of 8%. While Steding predicts that radio will take advertising revenues from newspapers because of the new clout of these large local station groups, some doubt that the impact will be enough to justify the rich prices.

Indeed, next year will be a watershed one in determining whether the mega-mergers struck over the last two years make financial sense.