Redrawing the Map

MSOs and their competitors have spent the last decade merging themselves silly. But anyone who thinks the fun is coming to an end should probably think again. Competitive pressures and increased bundling of products by cable, telcos and even DBS operators are creating a need for all sides to achieve better scale economics. "There’s going to be continued consolidation within the cable industry," says Scott Stawski, an analyst at Knightsbridge Solutions. "All those companies—in one way or another—are going to the same household." Of course, major MSOs like Comcast and Time Warner Cable already enjoy massive economies of scale. Getting much bigger could be dangerous. "The overarching risk of merger activity is the possibility of distraction from core operations," points out Aryeh Bourkoff, a media analyst at UBS Warburg. Still, deals seem inevitable as cable, telco and DBS operators search for ways to improve their respective positions. The two DBS players could merge to combine capacity. AT&T’s recent move for BellSouth suggests that a reconstituted Ma Bell is in the cards. And many midsize and small MSOs could band together for better leverage with programmers and suppliers. Consolidation could also cross industry lines: A telco could purchase a DBS operator, or a cable operator might acquire a pure-play wireless provider such as Sprint. Below are consolidation scenarios, as laid out by telecom analysts and industry observers. A BIGGER TIME WARNER CABLE? Within the cable landscape most merger activity is likely to involve smaller deals that shore up particular markets. Sanford C. Bernstein and Co. senior analyst Craig Moffett says Comcast may have enough girth, although Time Warner Cable could still target private players like Bright House Networks and Cox Communications. That could come after its acquisition of Adelphia systems and subsequent spin-off from the Time Warner parent. Says Bourkoff: "Time Warner Cable needs to decide if it’s going to get bigger or not. After the Adelphia acquisition, Time Warner Cable will have its own currency." Its future may also depend on its stock performance after the spin-off, says Thomas Eagan, senior media analyst at Oppenheimer & Co. But he says that a new Time Warner Cable entity—buoyed by recent Wall Street optimism for cable stocks—could make a play for Bright House. Meanwhile, Eagan says Cox and Charter could swap or sell systems. Properties that aren’t adjacent to big MSO clusters—such as Cox’s systems in Texas and Louisiana—could end up with a smaller private player like Suddenlink Communications (formerly Cebridge Connections). "I think there’s more to go," Eagan says of consolidation. Suddenlink has acquired several systems over the last few years, most recently from Cox and Charter. A $150 million investment by private equity firm Quadrangle Group will give it access to even more capital for expansion. CABLE-WIRELESS MERGERS? Matt Davis, director of consumer multiplay services at Framingham, Mass.-based research firm IDC, says large MSOs could also look outside the traditional cable industry to solidify the wireless service component, targeting stand-alone wireless entities like Sprint (already partnered with four major MSOs) and/or T-Mobile. "First, there are partnerships," he says. "But potentially there’s a consolidation at some point." TELCO-DBS OR CABLE-DBS MERGERS? As AT&T works toward closing the acquisition of BellSouth, it could also digest Verizon and/or Qwest, creating one monolithic telco facing off against one DBS operator and a few massive MSOs. Then again, "an AT&T-Verizon deal might be pushing it too far in Washington," says Bourkoff. More likely, says Davis, is that AT&T would set its sights on EchoStar to solidify its video offering in homes within its territory where it has yet to commit to deploying IPTV, as well as to create a national video footprint. (In fact, Knightsbridge predicts that DBS distributors will eventually be folded into cable or telco conglomerates.) AT&T already has a close billing and customer-service relationship with EchoStar. "Strategically, it makes sense," says Davis. In addition, AT&T’s status outside the DBS industry could appease antitrust regulators, who in 2003 blocked the attempted merger of then Hughes-owned DirecTV and EchoStar over concerns that it would hurt competition in rural markets. DBS MERGER? A merger between the satellite companies remains an open question, even with the telcos rolling out video services. "Nothing proposed by the RBOCs in the time since would change that calculus [of competition] one iota," a Sanford Bernstein report on DBS merger speculation says. Then again, Kenneth Ferree, a partner in the Washington office of Sheppard, Mullin, Richter & Hampton and former chief of the FCC Media Bureau, argues that "the world has changed somewhat" since 2003, when he was at the commission. Not only do DBS operators shoulder increasing capacity constraints from the digital transition and HDTV, but they face a potential onslaught of telco video services over the next few years. "These aren’t your usual new entrants," Ferree says. "These aren’t little scrubs." Antitrust authorities may view DBS consolidation as a way to strengthen a third video competitor and avoid the risk of a cable-telco duopoly future. "Do you have to wait until you’re at death’s door before you fix things?" says Ferree. "There’s a pretty good chance that the antitrust authorities would let [a DirecTV-EchoStar merger] go." A DirecTV-EchoStar merger would cut satellite, local backhaul and uplink costs in half, pare marketing and retail support costs and yield other benefits, the April Sanford Bernstein report says. "It makes a lot of sense," says Bourkoff. "There are a lot of synergies. But there are also hurdles to overcome, including control issues." (Imagine News Corp. founder Rupert Murdoch and EchoStar founder Charlie Ergen in a conference room together.) QUESTIONS ON OWNERSHIP CAPS Of course, MSOs and telcos face their own hurdles. Cable operators, covered under Title VI of the Communications Act, already operate under long-standing ownership caps that restrict them to not more than 30% of cable homes passed nationwide. Ferree says telcos could become subject to the same caps as they enter video markets—even though they won’t approach such penetration levels for years, if ever. "If they’re required to get franchises, I don’t know why that part of Title VI wouldn’t apply to them," Ferree says. On the other hand, the cable ownership rules are largely in disarray following federal court decisions blasting the FCC’s reasoning. The agency started a proceeding to rewrite the rules in 2001, but that effort has stalled. MORE CONSOLIDATION AND MORE CONTENT PLATFORMS The next round of consolidation could give operators and their competitors more leverage with technology and programming suppliers. On the other hand, the Internet and mobile services are fast becoming part of the distribution landscape. "The media industry is growing," notes David Richardson, liaison to the content industry and director of business development for NDS, a conditional access and interactive TV vendor. "There are more opportunities to distribute content." That dynamic could act as a check on cable’s—and DBS’ and the telcos’—growing size and power as programmers find other outlets, such as new-style distributors iTunes and Google. Daniel West, VP of marketing at Nellymoser, which manages mobile content for Comedy Central and others, says that consolidating MSOs can’t look to their size or influence to maintain distribution power. "I’d be very careful about being aware of what the upstarts are doing," he says.