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The WOW factor

MARK HAVERKATE MUST FEEL A BIT LIKE THE CAT THAT swallowed the canary these days. From his perch in Castle Rock, Colo., he had been quietly building WideOpenWest, a small cable TV operation that initially served Lakewood, a western suburb of Denver, with plans to expand into four other cities. In late May, that plan was given a serious makeover with the announcement that the company had acquired Ameritech's New Media division.

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With the stroke of a pen, WOW has been set on a course to become the nation's largest cable overbuilder and the most likely candidate to challenge incumbent cable operators' dominance of the residential video and high-speed data markets. That the company would be in a position to acquire more than 100 cable systems that currently serve about 310,000 customers wasn't a surprise. WOW is privately funded by Oak Hill Capital Partners and ABRY Broadcast Partners and went to both for additional capital needed to make the purchase. As part of the deal, the company also agreed to bring in MKMB Corp., which is taking a stake in WOW and will provide the company with marketing and other operational services throughout the Midwest.

What seemed to catch industry observers off guard was that anyone would want to expand a business model that many analysts have declared dead. Indeed, most overbuilders have either scaled back or simply shut down their operations over the last year (see box on page 30). In fact, Ameritech itself had been trying unsuccessfully to unload its cable operations since early 2000, a fact that may have played into the decision to acquire the properties.

“From an economic standpoint, if you can buy those assets at a good price, it looks no different than the economics of any cable system in the country,” says Haverkate, president and CEO of WOW. “If we can put digital services on the video side and high-speed data, then we have the same high-growth, high-value business.”

SBC paves the way

‘I would rather have this cable network than any of the incumbents.’
— Mark Haverkate

If Haverkate is the cat that swallowed the canary, SBC Communications played the part of the careless guard perfectly by openly shopping around its cable operations and all but publicly announcing that it would sell it for a song.

Far from playing its cards close to the vest as is typical in negotiations, SBC gave potential suitors a virtual open-faced hand by repeatedly denigrating the condition of its cable systems in a very public way.

In reports published in local papers across the Midwest, SBC officials often described the cable as old and out of date. Moreover, the company had little desire to continue a business that didn't fit into its long-term plans, particularly as it relates to high-speed data.

“We really saw DSL as the most practical means to reach the majority of customers in a timely fashion,” says an SBC spokesman. “We're not in the cable business, and cable really didn't fit the corporation's long-term business plan.”

Despite a general perception that the ANM plant is old and requires millions to upgrade, it isn't exactly clearance-rack material. Ameritech never intended to run cable modem or telephony services over the network, but it did build a network with between 400 and 500 homes per fiber node, which provides a good fiber density even by current standards.

“They certainly built it above any standard that I've seen in the cable industry,” Haverkate says. “I would rather have this cable network than any of the incumbents.”

To some extent, SBC was forced by external factors to downplay the condition of its plant. As part of the merger agreement with Ameritech, SBC officials often cited their desire to compete in the cable market as a reason for regulators to approve the marriage. Upon closing the deal, however, SBC quickly moved to put the cable operations under review, and classifying the plant as outdated gave it a good enough excuse to not raise any regulatory questions.

At the same time, such positioning likely cost the company in the final sale price. What that final price is hasn't been revealed, and as a closely held company, WOW isn't getting into specifics. But it's clear Haverkate got a deal. According to estimates of analysts and one competitor, the sale was somewhere in the range of $300 million, which works out to about $968 per subscriber. In contrast, in February, Mediacom Communications acquired systems in Georgia, Illinois, Iowa and Missouri with 840,000 subscribers for about $2.215 billion (or about $2637 per subscriber).

“It's a phenomenal price [for WOW],” says Keith Kennebeck, an analyst with the Strategis Group. “Granted, it's a one-way plant that hasn't been upgraded, but it's still a deal.”

Not your father's overbuilder

In April, Kennebeck released a report doubting the viability of the overbuilder strategy, and while he hasn't changed opinion on the overall model, WOW warrants slightly different consideration. “[The Ameritech acquisition] does change the business model,” he says. “They have an installed base of subscribers. They are in a lucrative position to use the cash flows to build. It's something that gives them a good foot in the door.”

However, it's imperative for the company to offer more than just video, he adds.

“If they just buy these systems and leave them like they are, it's not going to be a winning proposition. What you really want to do is get the high-speed data service, make the video more appealing and offer some interactive video services. They also want to be able to do voice.”

All of which amounts to a very crowded agenda for WOW, says Haverkate. Prioritizing the tasks, Haverkate says making a smooth transition from ANM to WOW is his top priority, followed by adding a digital tier, which should be completed by the fall. After that the company will begin upgrades that include adding reverse amplifiers to provide cable modem service and eventually telephony.

“The order of things would be making sure the transition goes well. The second would be to make these other services available,” he says.

‘We're not focused on the local phone business. We're not putting in local switches. We're putting all our focus on the data and video.’
— Mark Haverkate

If that doesn't fill up the schedule enough, WOW also must complete a network buildout on Chicago's South Side, an area designated as Area 5 by local cable authorities. “It's about two-thirds built,” Haverkate says. “They've got lots of customers there. It's under construction and that construction will continue.”

The company has no plans to expand into other areas of the Chicago or any other market that is not currently under franchise. However, it is getting some help in the Chicago market through MKMB, which acquired an undisclosed stake in the firm as part of the Ameritech purchase. MKMB, a Chicago-based, minority-owned firm, previously did some marketing work for Ameritech's cable unit and has been a wireless reseller for Ameritech Cellular, which is now owned by Verizon.

In its role with WOW, Haverkate says MKMB will provide similar services but also make sure WOW complies with local regulations.

With that much on the plate, WOW has already begun negotiating new terms for franchises in markets such as Fort Worth, Texas, and St. Peters, Mo. The company had planned to begin construction in both markets, but it's holding off until financial market conditions improve.

“We're not pulling out, and they're not kicking us out,” says Haverkate. “We're leaving all of the work in a suspended stage.”

While not every city is going to be happy to renegotiate terms, Haverkate says the fact that a competitor is ready to build should provide some leverage for the municipalities over incumbent cable operators. “Generally speaking, we're discussing those issues with each of those municipalities,” he says.

A unique situation

Despite the opportunity facing WOW, most cable overbuilders in the industry are still paring back. Seren Innovations, which had planned an ambitious expansion in the Midwest and West Coast, has since put the brakes on to concentrate its efforts on two systems — one in St. Cloud, Minn., which has about 10,000 customers, and another that was just launched in Walnut Creek, Calif.

“After looking at the economics of it and the current situation, we decided that pulling back was the best move,” said a spokesman, noting that factors such as the power crunch in California were having an effect on expansion.

Some overbuilders, including SNET, are simply giving up. After being acquired by SBC, SNET almost immediately asked the Connecticut Department of Public Utility Control to change the terms in its unique statewide franchise by letting it out of the requirement to build systems across the state.

In late 2000, after quietly shopping the system around to other providers, including ISPs that might use it for high-speed data service, SNET returned to the DPUC requesting a shutdown of the network. In its filing, SNET said its cable operations had been unprofitable from the beginning and would remain so for the foreseeable future. SNET shut down its cable operations as of June 30.

While SNET represents an extreme case, it follows a familiar pattern, says Kennebeck of the Strategis Group. “What makes a lot of overbuilders falter is the buildout takes so long, and you never end up paying off your system,” he says.

The one exception to the rule could be the original cable overbuilder: RCN.

In part because of huge outside investments — including an early $1.65 billion infusion from Paul Allen's Vulcan Ventures — RCN has been able to work through much of the early stage difficulties plaguing other overbuilders.

In addition, the company's joint venture with Washington D.C.-based utility Pepco and its 1999 acquisition of 21st Century has given RCN enough cash flow to survive.

More important, RCN is predicting that it will be cash flow-positive this year.

“If they succeed, that will be a spectacular moment in the overbuild industry because it means the business model works,” says Kennebeck.

“The concern with the overbuild model is that it costs too much to build, and the penetration rates will never be high enough to pay off. One hundred fifty thousand subscriber systems need above 30% penetration and other favorable factors like low cost of capital,” Kennebeck adds.

WOW starts fairly close to that point. Ameritech, with little marketing, has hit about 25% penetration, Haverkate says. The goal is to drive further into those existing markets without the burden of having to feed a corporate parent focused on voice services.

“In our case, we're not focused on the local phone business. We're not putting in local switches,” he says. “I really think that's the good spot to be in. We're putting all our focus on the data and video side.”

Overbuilders fade away
Ameritech Sold properties to WideOpenWest
SNET After seeking a buyer throughout 2000, officially closed operations June 30. Had 29,282 subscribers at last report
BellSouth Continues to operate in several markets throughout the Southeast, though it has halted expansion plans
Bell Atlantic One of the earliest in the overbuilding game, gave up the ghost quickly, shuttering its Toms River, N.J., operation
GTE Sold off Hawaii system to Craig Broadcast Systems; still searching for buyers for Ventura County, Calif., and Tampa Bay area systems
Knology Company is operating systems in eight cities across the Southeast
Pacific Bell Explored possible wireless overbuilds in Los Angeles area, but sold licenses after SBC acquisition
RCN The most successful of the overbuilders so far with about 240,000 video subscribers on net and loads of outside cash
SBC Non-starter. Played around with some trials in Richardson, Texas, but shut them down early
Seren Innovations Pulled back from original ambitious expansion plans to concentrate on St. Cloud, Minn., and Walnut Creek, Calif. Has had good success with video services, with about 10,000 customers in St. Cloud
21st Century Sold Chicago properties to RCN

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© 2014 Penton Media Inc.

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