Jim McDonald

You can't really blame Jim McDonald if he smiles when he ponders his winnings. After all, he laid some pretty hefty bets to reap that pile of success.

Perhaps because it was pushed or perhaps because it was prescient — or both — McDonald's company, Scientific-Atlanta, took a longer, more precarious route to playing in the digital cable TV market. While archrival General Instrument (now a part of Motorola) profitably rolled out millions of digital boxes for prime customer Tele-Communications Inc. (now AT&T Broadband), S-A hunkered down, following a more complicated, longer-term route with Time Warner Cable (now AOL Time Warner).

The plan was simple in design: Make interactivity an integral component of digital cable. What complicated matters was the dearth of interactive applications that would drive these products into consumer homes.

The service provider and the vendor held course — only now the market is changing. More channels don't necessarily equate to more customers, but more features might. S-A has a whole series of digital set-tops that can offer everything from the most basic interactive services such as channel guides to full Web browsing and beyond.

Things continue to look up in the money area, too. S-A has posted 10 consecutive record quarters and is flourishing in a weak economy. It is, according to UBS Warburg, a “digital supertanker.”

“Our customers, in general, are doing quite well,” says McDonald. “If you look at Time Warner Cable, Cox, Comcast, Rogers, they're all doing quite well. As a result of them doing quite well, we've done quite well.”

S-A is not, and has never been, joined at the hip with AT&T, which is suffering its own mini-slump, although the vendor did take a hit when AT&T sliced back its transmission business.

The big threat to S-A came when its major customer — Time Warner — merged with America Online. Some speculated that the new combined company would move its business into the arms of some more glamorous, consumer-name set-top box makers.

It won't happen, McDonald insists.

“The Time Warner Cable people have been very forward-thinking people about this all along, whether it's thinking of video-on-demand or Internet-additional applications,” he says.

McDonald sees the whole cable industry staying aggressive and perhaps even picking up the pace to jump into gaps being left by weakened — and disappearing — competition in the telecom space. But the industry will stick to cable basics, he says.

“We look at our customers, where their priorities are and where they make money, and I don't think there's any question their most profitable service is video, their second most profitable service is data, and voice would be a distant third,” says McDonald.

S-A has always had its bases covered with video. While other companies broke into niche areas of building transmission or customer premises equipment, or spread themselves too thin over a mass of products, S-A concentrated on an end-to-end system. That let the company build a market for video first but prepare for whatever else may come down the wire.

“Most of our customers — with a couple exceptions — have put their focus on video first and data second. The majority are waiting for telephony,” McDonald says. “They don't want to go to market with a me-too service.”

That means waiting for feature advancements — probably in the IP space — that will make cable stand out against the entrenched telco suppliers that are gaining strength as their CLEC competitors bite the dust.

“Sure, cable systems can carry voice signals just like they can carry data signals,” McDonald says. “They believe if you enter the market with a me-too service, it's OK, but it isn't anything great.”

What is great is digital video. AOL Time Warner reports its digital subscriptions were up 213% over last year and will continue to grow. “The bottom line is people are buying the new services and the concept of building it out, rolling it out, is paying off,” says Dave Woodle, chairman and CEO of S-A competitor C-COR.net.

Woodle has a lot less reason to cheer than S-A, he admits.

“At Time Warner, their network is rebuilt at about 95%. We did a high percent of that from the RF side,” he says. “They are enabled now to provide two-way communications and roll this out forward. Our insight into it as a vendor is less than those who provide modems and set-tops to them.”

He is probably referring to S-A.

“The answer for us is the more services we carry on these networks, the better for us and our customers,” says McDonald.

Besides, he adds, there's the possibility that AOL and AOL-TV “could be a very positive thing in terms of increased revenue and increased cash flow for all the operators. Anybody who has 29 million people hooked to his service has to have some value.”

S-A has several other things going for it, McDonald says: It uses its own silicon, which cuts costs and speeds development time. It also licenses its box technology to other manufacturers to make certain there is plenty of product available.

Finally, S-A is deeply entrenched in the all-important operating system facet of interactive set-tops, taking increasing control of PowerTV, which, according to UBS Warburg, is a great move.

“The one factor that we believe more than any other makes S-A deserve a premium valuation is software,” UBS Warburg said in a report following S-A's most recent earnings. “Specifically, we are talking about PowerTV and its potential to be the host operating system for the AOL application on the TV in particular.”

Just more good news for McDonald, who sees the good times are here to stay despite what the economy may do.

“Our employees aren't scared — we've done well,” he says. “We've hired people. We have almost 12,000 employees.” And the customer base — cable TV — has proven to be very resilient to previous economic recessions. “Historically, that's the way it is,” McDonald says.

The only smidgen of worry might be that people are paying an awful lot more for cable than they have in the past — and a lot of that cost might be going to the new digital services or high-speed data. “It's new territory,” McDonald admits. “Some people will worry because of increased revenues associated with things like digital services.”

McDonald, still smiling behind that big bundle of chips, isn't one of them. “In general, we still feel pretty good about it.”