Cable vs. Telco: The Battle Heats Up

S&P Ratings examines the competitive landscape as players from both camps scramble to sign up customers for voice, video, and broadband offerings

by Richard Siderman From Standard & Poor's RatingsDirect

The trends in U.S. wireline telecommunications of the past two years have continued over the past several months, with phone companies still losing residential-access lines while adding more digital-subscriber-line (DSL) customers. Meanwhile, competition between cable and phone companies for video customers has heated up. Overall growth remains good in the wireless sector, but not all carriers are benefiting equally. The cable industry seems to have peaked in terms of the number of video subscribers, though growth from advanced services is still solid.

Significant longer-term uncertainty pervades the telecom sector because the clear lines of demarcation between industry subsectors are all but gone. And the establishment of wireless as a substitute for a traditional wireline has redefined the balance between the two technologies.

Standard & Poor's Ratings Services believes that the key determinants of credit quality in both telecom and cable are a company's ability to differentiate its products and services and its financial policy. The first factor takes into account product substitution, intense competition, and mature major product lines.

Cable Is Likely to Grab More Telephony Share

Wireline companies have continued to lose access lines in the low- to high-single-digit percentage range. Some of these lines are being lost to wireless substitution because a good portion of younger consumers are shunning traditional phone service even as they form households. Cable providers are increasingly taking away a significant number of these access lines. Given that most major cable operators introduced their VoIP services only in the past couple of years, cable telephony is still in an early stage, and the potential market share remains unknown. According to the National Cable Industry Assn., there are already more than 12 million cable telephony customers—out of about 180 million phones in the U.S.—and the number is growing.

While the history of cable telephony is short, it's likely incumbent telephone providers will cede some minimal telephone penetration to cable companies. This low-hanging fruit consists of customers who just plain dislike their local telephone company as well as people who want to take advantage of cable telephony's attractive introductory prices. However, those introductory prices are often just that, and they may rise significantly after a year.

The combination of dissatisfied phone company customers and bargain shoppers means that most cable operators can likely attain telephony penetrations of 10% or more of their video customers with a reasonable marketing effort. After that basic level is achieved, the cable company needs to make a more compelling case. In particular, this means explaining its telephone service to customers (addressing such issues as whether they can keep their old number and what happens to their phone service during a power outage), effectively bundling it with video and broadband services, and giving the consumer an economic incentive to change phone providers with an assurance that installation will be minimally inconvenient.

Success in cable telephony is certainly possible, judging from the experience of Cox Communications (S&P credit rating BBB-), the telephone pioneer among major cable operators. Cox had more than 2 million customers at yearend 2006. Similarly, metropolitan New York City operator Cablevision Systems (CVC) (BB) provides telephone service to about a third of its video customers, gaining these customers almost exclusively at the expense of Verizon Communications (VZ) (A).