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Cable's Bright Picture Fades To Gray


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CABLE'S BRIGHT PICTURE FADES TO GRAY

Jerry Seinfeld is going to tell jokes. Larry King will host a talk show with such celebrity guests as Ted Turner. And John Mellencamp will rock 'n' roll. But visitors to the 1994 national cable convention are likely to identify most with another scheduled event: Little Richard performing at a blues bar.

Cable-TV executives are in such a funk as they prepare for their annual meeting on May 22 that not even the New Orleans locale or record turnout may lift their spirits. One can understand why: Since last year's meeting in San Francisco, the federal government has slashed cable rates by 17%, several lucrative deals between cable and telephone companies have foundered, and some of cable's best-known networks have lost viewers.

NASTY POTHOLES. Last June, cable executives spoke grandly of their central role in building the Information Superhighway. Now, they're more worried about faltering credit ratings and their inability to launch new networks because of scarce channel capacity and even scarcer funds. "I'm more concerned about the financial state of the industry than I've been in the last 10 years," says Steven Rattner, a general partner at Lazard Fr res & Co. who brokers cable deals.

It's hard to weep for an industry that still rolls up profit margins of 40%. And cable has weathered previous storms, such as the credit crunch of 1990. But given its track record of unbridled growth and the recent euphoria over digital technology, cable has unquestionably hit a wall--perhaps the biggest in its three-decade history. John C. Malone, Gerald M. Levin, and other captains of cable yearn to be the vanguard of an information revolution. By slashing an estimated $3 billion from the industry's $20 billion in total revenues, though, the Federal Communications Commission has thrown cold water on their dreams of building vast interactive networks.

STAR WARS. The telephone companies, meanwhile, are forging ahead with plans to offer a panoply of video services. After two years of nosing around the programming business, Bell Atlantic Corp., Southwestern Bell Corp., and other Baby Bells seem emboldened to get into the video business--with or without cable. "We absolutely feel more confident," says James G. Cullen, president of Bell Atlantic, which called off a $21.4 billion merger with Tele-Communications Inc. after the February rate cut.

Bell Atlantic is spending $11 billion on video-ready networks over the next five years and already is testing video services in the suburbs of Washington. U S West Inc., which has a $2.5 billion investment in Time Warner Inc., is spending $750 million over the next two years to upgrade its networks. It plans its own interactive test late this summer in Omaha.

If that's not bad enough, new and old competitors are assailing cable in its own backyard. Hubbard Broadcasting Inc. and General Motors Corp.'s Hughes Communications are ramping up direct-broadcast satellite operations, which will offer such networks as HBO and MTV at competitive prices. And the broadcast networks--which cable executives used to dismiss as pterodactyls--have staged a comeback. Powered by hit shows and a riveting Winter Olympics, the Big Three's share of the prime-time audience rose from 60% to 61% in the 1993-94 season. Basic cable, by contrast, was flat at 22% (chart). Some networks, including CNN and ESPN, even lost viewers.

Cable operators blame the poor ratings on several factors, including new FCC rules that forced them to change the position of cable services on the TV dial. But they worry that cable has begun to stagnate because of a lack of new programming services. "We're so stalemated that we haven't been able to add any new basic services," says Charles F. Dolan, chairman of Cablevision Systems Corp., the fifth-largest cable operator.

Indeed, Turner Broadcasting System Inc. and USA Network are the only programmers that have launched major basic services since Con-gress reregulated cable in 1992. And their new offerings--the Cartoon Network and Sci-Fi Channel, respectively--have struggled to gain distribution from operators who fear lower rates will make them unprofitable. As a result, Turner and other big programmers are casting about for new avenues of growth (page 132).

CRYING WOLF? If Turner is feeling the pinch, Cablevision and other operators are caught in a vise. Dolan is spending $120 million this year to upgrade his systems on Long Island, N.Y., and elsewhere with fiber-optic wire. But the company already is highly leveraged, and, after the FCC rate-slash, Moody's Investors Service downgraded Cablevision's debt. To mollify Wall Street, Dolan announced the first layoffs of his career, 160 employees out of 3,000, to save $20 million.

TCI and Time Warner have gone further than Cablevision, by cutting their capital spending programs (table). TCI says it has suspended, though not canceled, $500 million of its $1 billion spending plans pending clarification of the FCC rules. And Time Warner Cable says its $100 million cutback (out of $800 million) won't affect its deployment of fiber-optic wire or its ambitious test in Orlando. Instead, Time Warner won't purchase as many trucks or wire remote areas.

With their noisy announcements, both companies are engaged in some antiregulatory posturing. Still, the cumulative effect of such cutbacks will slow cable's construction of the Information Superhighway. Cable analyst Paul Kagan Associates figures that a $3 billion decline in revenue could cause the industry to delay wiring some 11 million homes--or 15% of homes passed by cable--for advanced video services. Cable executives argue that the FCC is dealing a blow to America's information infrastructure. "The Information Superhighway is all but dead," declares Marc B. Nathanson, chairman of the 12th-largest operator, Falcon Cable Systems Co.

In truth, the highway will continue to be built. It's just that the cable companies may end up playing a supporting role. "The cable industry is in danger of being steamrollered by the phone companies," says John Waller, who brokers cable deals. Competition has already replaced cooperation in the wake of the failed Bell Atlantic-TCI deal and a scuttled alliance between Southwestern Bell and Cox Enterprises. Bell Atlantic is still open to cable investments, but it is focusing on less costly joint ventures.

Just as the Baby Bells have an advantage over cable, big cable companies now have an edge over smaller operators. Michael Garstin, a cable banker at Daniels & Associates, points out that TCI and Time Warner draw enough of their earnings from unregulated businesses, such as TCI's Liberty Media Corp., to withstand a rate cut. By contrast, mom-and-pop cable systems will suffer the full brunt of a 17% hit. As a result, he says, many will end up selling out to larger rivals.

WORKING THE HILL. Cable executives aren't taking all this lying down. They have launched a full-court press to influence future regulation by urging the FCC to give operators incentives to add new services. And they support a bill in the U.S. Senate that would allow cable companies to offer phone service in their regions two years before the Baby Bells can offer video. After years of poisoned relations with Washington, cable executives are hopeful: "There have been indications from the FCC that the rate cuts are behind us; now let's move forward," says Brian L. Roberts, president of Comcast Corp.

Meantime, Comcast and other operators are scrambling for growth in other areas. They're expanding aggressively overseas, where telecommunications markets are less regulated. At home, they're focusing on adding such unregulated services as premium and pay-per-view channels, and transactional businesses, such as home shopping. This is an unexpected bonanza for premium services such as HBO. Home Box Office Inc. Chairman Michael J. Fuchs says he considered starting a mini-pay channel--roughly $5 vs. $9 to $12 a month--to sell to hungry operators. Instead, Fuchs is dividing HBO into separate premium channels. Other pay services also have good prospects: The Golf Channel has raised $60 million from six cable operators.

With the growth of such pay services, basic networks will be hard-pressed just to hold on to their audience. Some are responding by starting spin-off channels. The Arts & Entertainment Network, for example, plans to launch a second service, the History Channel, this fall. Because of the rate cuts, says A&e President Nickolas Davatzes, the new network will take one-third longer to turn a profit.

Notwithstanding the Cassandras in the cable industry, some experts believe that the FCC rulings will actually have some unintended benefits. In seeking new sources of unregulated revenue, says Rattner, cable companies could develop the next generation of programming concepts--raw material for the Information Superhighway.

In addition, cable executives point out that their programming, technology, and systems are still plenty attractive to other players who want a lane on the data highway. Privately, they predict a round of deals between cable and long-distance phone companies such as MCI Corp. and Sprint Corp. Certainly, the Baby Bells aren't about to claim victory: "This is a resilient group of entrepreneurs," says Cullen, "who've managed to find their way around and through a lot of obstacles."

Still, think back just six months, when the cable industry's elite seemed to own the world. Comcast's Roberts was in the thick of a $10 billion battle for Paramount Communications Inc. Cablevision's Dolan was entertaining multibillion-dollar offers for his company. And TCI's Malone had engineered one of the largest deals in U.S. corporate history. It will take more than Cajun cooking to bring back those highs.

A BIG COMEDOWN

Cutbacks by leading cable operators

TELE-COMMUNICATIONS

(10.2 million subscribers) Suspended $500 million of capital spending. Says regulations could cost it $300 million, or 16%, of 1993 cash flow.

TIME WARNER CABLE

(7.1 million subscribers) Cut $100 million from $800 million capital budget. Analysts estimate 1994 cash flow will drop $90 million, or 9%.

CABLEVISION SYSTEMS

(2.3 million subscribers) Laying off 160 staffers, out of 6,000, and revising employee benefits to save $20 million annually.

SOURCE: COMPANY REPORTS, BROWN BROTHERS HARRIMAN, OPPENHEIMER & CO.Mark Landler in New York, with Ronald Grover in Los Angeles and Kathy Rebello in San Francisco


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