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Small operators make big changes as cord-cutting, programming costs rise

When it comes to cable video, the biggest companies are gettingbigger while the smaller companies are getting smaller.

The divide is apparent in recent subscriber numbers: WhereasComcast Corp. and bothgrew their total number basic video subscribers in the first quarter, most of thesmaller operators saw year-over-year declines.

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Cable One Inc.,one of the 10 largestcable operators in the country serving nearly 700,000 customers in 19 states, isgaining attention for its position at the forefront of a strategy shift to higher-marginbroadband and business services over residential video. Cable One sees itself asthe "demarcation point" between two sides of the cable industry: a handfulof large operators versus the many small and midsized operators whose customersnumber in the thousands rather than millions.

"Virtually everybody bigger than us publicly is very weddedto actually growing video," Cable One CEO Tom Might said during a May 23 investorconference. "Virtually everybody smaller than us, [with] one or two exceptions… have been coming along with us on the more HSD and business-centric side,"he added.

A number of industry observers said they noticed this trend atthis year's INTX: The Internet & Television Expo in Boston. American Cable AssociationPresident and CEO Matthew Polka said in talking with operators, he got the sensethat the paradigm and business around video has shifted.

"From the operator perspective, it's not about video, it'snot about telephone; it's all about broadband," Polka said in an interview.

ACA is comprised of roughly 800 small and midsized independentproviders serving nearly 7 million consumers in all 50 states. "As we see theselarger companies within our membership do more to change the paradigm, I have nodoubt that these smaller companies will follow too," he added.

Many industry observers are mining Cable One's financial resultsto see how their strategy has paid off. Cable One became an independent publiclytraded company in July 2015 after completing its spinoff from GrahamHoldings Co. The change provided additional transparency regarding thecompany's performance.

During Cable One's first-quarter earnings , Might pointed to the company'sincreased free cash flow, which rose to $57.9 million in the first quarter, up from$43.0 million in the year-ago period.

"Residential linear video and phone produce very modestoperating cash flow today and no free cash flow to speak of. Add cord-cutting trendsto that and we think we can do better elsewhere," he said.

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Yet while free cash flow is up, video subscriber numbers aredown. The company ended the first quarter with 336,524 residential video customers,a decline of more than 17% from 406,522 customers in the year-ago period.Residential high-speed data customers numbered 467,077, up from 456,896 a year earlier.

"For a company that has spun a broadband-not-video story,Cable One's broadband subscriber results have been mediocre at best," CraigMoffett of MoffettNathanson Research wrote in a recent research report, noting thatbroadband subscribers are growing at just a 2.4% annual rate at the company. "That'sless than half the growth rate of peers, and it comes from a much lower base."

Moffett said that Cable One's first-quarter data ARPU and freecash flow growth was mostly the result of a $5 across-the-board rate increase institutedin October 2015.

"Maybe the main takeaway from Cable One's first-quarterresults is this… Cable is a helluva business," the analyst wrote. "Afterall, where else could you lose subscribers hand over fist but beat numbers by raisingARPU double digits?"

Marc Tayer, president of MediaTech Insights and author of thebook Televisionaries, noted that thereare some smaller companies that have chosen to stay focused on video while pursuingtheir own alternative strategy. "The skinny bundles are a big trend that'ssort of goes against cord cutting," he said in an interview.

This is the approach taken by Cincinnati Bell Inc., which launched its MyTV skinny bundle packages in March. Customerswho sign up for the MyTV offering get the Starter Package, a $29.99-per-month bundlethat features more than 50 channels, and then must choose at least one Genre Package,which cost between $6 per month and $25 per month.

Cincinnati Bell CFO Leigh Fox said in a May earnings call thatfirst-month sales of the MyTV packages tripled the company's initial forecast, whichhe described as "very, very positive results."

Whether a smaller operator opts to move away from video or pushskinny bundles, the ACA's Polka said the two strategies both come as reactions torising programming costs.

"I do think that the paradigm on video has changed. Andfrankly, there is no one to blame for that but the big programming bundlers themselves,"he said. "What I think the broadcasters and even the big content providersreally fail to see — and maybe it's because they are addicted to the bundle of programmingor they're addicted to retransmission consent — is that cable operators really noware ISPs who also provide some cable services."

SNL Kagan analyst Tony Lenoir noted that even for the three largest cable operators, videomargins "fell off a cliff" in the first quarter. In an interview, SNLKagan analyst Ian Olgeirson said the situation has been even worse for smaller operators.

"Smaller operators are having more difficulty maintainingmargins because their programming costs tend to be higher without the bulk discountsof their larger peers," Olgeirson said. "This reduces the motivation —and ability — to compete on price for video."