For deep-pocket telcos, superhighway is looking a lot like cable

The dealmaking frenzy coming to a head in the wake of the proposed Bell Atlantic/TeleCommunications, Inc. merger is charting a chaotic course for development of the national information superhighway — a course that bears little resemblance to the agenda long touted by leading thinkers on the subject.

Until now, the focus in discussions on advanced telecommunications has been government support for accelerated development of broadband telephone networks. However, the prevailing market and regulatory conditions have now made the lowly cable television network the new medium of choice among the people with pockets deep enough to put the information highway in place.

WHATEVER THE HESITATION, CONSIDER IT OBLITERATED

Bell Atlantic’s bid to acquire (or, as the participants prefer to say, “merge”) with TCI has obliterated whatever remaining hesitation there might have been among the major telephone companies about which network offers the best shot at staking claim to the future. Virtually all the major telcos now want in on the act, leaving open the question of whether the resources will be available — let alone used — to sustain a competitive expansion of the nation’s local exchange networks.

Ameritech. “We feel an incredible amount of pressure to conclude a deal (in cable),” said Mike Brand, spokesman for Ameritech. Sources said Ameritech was pursuing discussions with Comcast and Cablevision Systems, though neither would comment on specific contacts.

BellSouth. “We think Bell Atlantic’s agreement with TCI is a very powerful move,” said John Clendenin, chairman and CEO of BellSouth, to a Washington audience attending the Networked Economy conference in late October. “We have high admiration for the vision.”

BellSouth recently said it was taking a 22.5 percent stake in Prime Management Co., which owns cable systems serving more than 500,000 customers, including 200,000 in Las Vegas. But Clendenin made it clear he doesn’t see this as the end of BellSouth’s forays into the mega-deal arena. “Everybody is talking to everybody, and we’re going to make sure we find our own partners,” he said.

US West. US West, already partnered with Time Warner, isn’t at the end of its pursuit of cable holdings either, said Steve Lang, a company spokesman. Sources said US West was courting Cablevision Systems, the nation’s fifth largest MSO (multiple system operator), which operates in several attractive regions of consolidated franchise holdings, including Long Island, Westchester County, Southern Connecticut and parts of New York City.

Insiders at Cablevision said that, along with its dealings with CEO and majority owner Charles Dolan, US West was also trying to persuade Time Warner to sell all of its cable holdings to the RBOC outright. At the same time, they said, other RBOCs are knocking at Dolan’s door as well.

Southwestern Bell. One RBOC that can be counted on to expand its cable holdings is Southwestern Bell, which is awaiting local franchise authority approval as the last hurdle in its acquisition of cable properties outside Washington, DC. The company has set up a cable subsidiary with a mandate to expand, now made more urgent by Bell Atlantic’s move.

“This week’s events underscore this is really an arena with a lot of opportunity,” said SWB spokesman Mike Black at the time of the Bell Atlantic deal announcement. “We’re very encouraged.”

Pacific Bell. On the West Coast, a variety of parties not known to be in communication with each other suggested Pacific Bell was on the verge of a major announcement involving a cable company. Jones Intercable, the nation’s seventh largest cable MSO with practically no operations in Pacific Bell territory and a history of business dealings with Pacific Bell in the UK, was the most frequently mentioned acquisition target.

(In the upside down world of current regulatory restrictions, it is in a telco’s interest to find a partner with few holdings in its territory, owing to the prohibition against telco ownership of in-territory cable properties.)

THE EXPLOSIVE FORCES BEHIND THE DEALMAKING

Nothing more graphically illustrates the force behind the explosion of dealmaking now underway on the cable-telco front than the dichotomy between the pace of in-territory expansion at Bell Atlantic, the most aggressive RBOC, and the expansion schedule it has mapped for its proposed out-of-territory TCI holdings.

A disparity in pace. Ray Smith, chairman and CEO of Bell Atlantic, said that by the end of 1995 the company will complete the transformation of several major TCI systems, representing hundreds of thousands of subscribers, to “full service network” (FSN) status.

By the same juncture, Smith acknowledged, only some 100,000 customers will be connected to FSNs in Bell Atlantic telephone territory.

Not invented yet. In part, the disparity in the pace of expansion in-territory and out of territory is a function of government regulation, where the telephone company bears a burden of proof that new revenues, rather than higher traditional service rates, will cover the costs of transition to broadband capability. This has been a chicken-and-egg issue of first magnitude, given the difficulty of proving that there’s a market for telco video services that either haven’t been invented yet or that would directly duplicate services already provided by cable operators.

Moreover, expansion in cable doesn’t lead immediately to creating open platforms, which means there are transitional states of service expansion that can be extremely lucrative to a relatively unregulated gatekeeper who has a stake in the programming. In contrast, telcos expanding in territory can only offer video services under the FCC’s video dialtone rules, which require open access to everyone and bar telco ownership of the programming.

It’s cheaper to switch cable. Adding to cable’s appeal is the fact that it’s much cheaper to bring a cable network to FSN status (i.e., two-way switched service) than it is to increase the bandwidth of a telephone network. This condition is further aided by the FCC-driven trend toward imposition of rules at the state level that require telephone network operators to offer switch connections and other facilities to competitors. For those who would build cable FSNs, this obviates installation of some of the more expensive facilities associated with getting into the phone business.

“TCI is developing full broadband networks within the traditional capital structure,” said John Malone, president and CEO of TeleCommunications, Inc., in an appearance at last month’s Networked Economy conference. That traditional spending rate translates to about $50 per customer in cable versus about $200 in the telephone industry, or an aggregate of $3 billion annually in cable against $20 billion in the local exchange business.

Visions on par. The cost difference is not a function of discrepancies in capabilities. Malone made clear, as have many others in the cable and telephone industries (see Vol. 3, No. 5, p. 6), that cable’s version of the FSN is on a par with that of the telcos.

“Bi-directional video telephony is the superset of all applications,” Malone said. “This is the application we’re designing our networks to accommodate. If you can do video phone service, you can do anything else.”

SURGING STOCKS INDICATE UPSIDE, ONE WAY OR ANOTHER

A surge in stock prices for cable and telephone companies alike reflected Wall Street enthusiasm for the telco potential in cable. Two weeks after the announcement, telephone stocks had settled back to predeal levels, but most cable stock prices, already on the high end of a long runup, continued to ride above predeal levels.

Massive cash infusions. “It has to be obvious that the (out-of-territory) telephone companies will provide a massive cash infusion to cable for offering voice as well as video services,” said Jessica Reif, an analyst for Oppenheimer and Co. “With the regulatory barriers against telcos along with the traditional barriers to success for cable overbuilders, cable will be competing in the telephone business much sooner than telcos will be going after cable’s business.”

While this view might seem a little glib in light of the formidable barriers to local exchange competition in most states, the fact is that cable companies like TCI are looking at high-margin, enhanced telecommunications services that could be implemented in many areas under existing rules. These include so-called bypass long distance access services, data communications and specialized dedicated links on the business side and a variety of new services for consumers.

Bypass access. For example, existing laws typically would allow cable companies to extend bypass access to long distance switches to all customers at significant discounts to local telephone company access fees. For example, existing laws typically would allow cable companies to offer customers low-cost access to long distance service via cable links, bypassing the local exchange network. Time Warner is experimenting with this type of service at its Queens, NY, facilities.

Cable companies are also beginning to offer Ethernet and other data links over cable on a franchise-wide basis, permitting LAN-like connectivity for small business applications. Perhaps most importantly, MSOs are poised to exploit the federal government’s override of local common carrier rules regarding implementation of personal communications services (PCS), the new microcellular wireless service recently authorized by the FCC.

Preparing for PCS. Cable companies have been preparing their networks to serve as primary backbone conduits for the implementation of PCS. In the cable-based model, strand-mounted low-power transmitters, known as “microcell extenders,” are linked by cable to a central base station. These transmitters communicate with pocket phones within very small signal propagation areas (known as “picocells”), measuring about 1,000 feet in diameter.

Within the cluster of picocells served over a dedicated RF channel from the base station, representing an area a mile or more in diameter, the user stays on the same frequency so that frequency reassignment is only necessary in movement from one cluster to the next. This reduces the volume of signal handoffs at the switch to a much more manageable rate than is possible in an all-wireless PCS system, where frequencies are reassigned with movement between microcells measuring only a half mile or less in diameter. In fact, developers believe the cable-based approach is the key to permitting high-speed mobility for PCS in direct competition with cellular.

The FCC has estimated a cable-based PCS system would cost half as much to install as an all-wireless system and considerably less than a hybrid telephone wire/wireless system, owing to the impact of the high-capacity cable links on per-use and switching costs. Cablevision Systems Corp., which recently demonstrated full-speed vehicular mobility and a data communications capability over its cable-mounted PCS test network in Lynnbrook, NY, says adding full PCS functionality to its network will cost about $50 per household.

Fred Dawson