CHAPTER 19
Prescience is a double-edged sword. If you’re a little early, you might hit the jackpot with Altair BASIC or Starwave. But if you’re too far ahead of technology or the market, you can wind up with something like Metricom.
With the advent of digital cellular technology in the early 1990s, it occurred to me that the Wired World “pipe” for the global network of the future might not be wired, after all. The appeal of wireless technology, named untethered access, was obvious. Because most people move from home to work to shops and restaurants in their daily lives, I thought the Internet should travel with them. Who wouldn’t want to surf the Web when riding in a car, or check e-mail in the shoe department at Nordstrom’s?
In 1993, I bought my first shares in Metricom, a broadband mobile data provider with national aspirations. At the time, it was the one reliable wireless avenue to the Web. A Metricom customer could Velcro a modem to a laptop and get consistent digital service throughout a wide area network, or WAN, from the corner coffee shop to the airport gate. It was a grand idea, and soon I’d built a controlling interest. But Metricom’s business model was strategically flawed. The company tried to get too big too fast, in too many markets at once. As installation lagged behind manufacturing, piles of very expensive equipment filled our warehouses and drained our working capital. Given that Web browsing was still a novelty (our national subscription base peaked at around 51,000), a fast-tracked rollout was an act of hubris.
As Metricom’s losses mounted, financing dried up. Telecom investors were among the first to hit bottom in the dot-com bust, and they had little left to invest. Meanwhile, mobile phone companies began to pour billions into their digital 2G wireless networks, with cell-based systems and cheaper chipsets.
Metricom filed for bankruptcy in July 2001. Just one year later, the BlackBerry smartphone would confirm my intuition that people were eager for mobile data. Five years after that, the iPhone would help establish a mass market for it. But consumers weren’t quite ready for our product, and inept management was the coup de grâce. Metricom demonstrated the many pitfalls that lie between an idea’s genesis and its execution.
ON AUGUST 9, 1995, Netscape doubled the opening share price for its initial public offering to $28 then watched the price soar to $75 by the end of the day. As the Internet continued to gain traction, I could see that it would soon swamp walled gardens like AOL. There could no longer be any doubt about the essential platform for the Wired World: It was going to be the Internet. By 1996, 36 million people were using the Web regularly, more than double the total from one year before.
For me, just one question remained. What pipe was best suited for bringing data streams into the home, to accommodate both the Web sites of the day and the more demanding content of the future? In 1995, twisted-pair phone lines ran analog networks at 28,800 bits per second (bps). DSL, which piggybacked on the copper lines, was rated at 128,000 bps. Satellite broadcast operators offered a broadband signal at a more competitive 12 million bps, but they were hamstrung by going predominantly one way, from operator to consumer, which made Internet service impractical.
That left cable TV, the poor-relation delivery system best known for mediocre video quality, terrible service, and a lethargic monopoly mentality. Even so, it held the most promise for the long term—you could tell by the capacity of its pipes. Coaxial cable carried 10 million bits per second; optical fiber cable, the distribution backbone, 2.4 billion. A hybrid fiber-coaxial system, which some operators had begun to deploy, was hands down the fattest pipe around.
My excitement over cable had less to do with television service and more with the other things that could flow through it, from home shopping to streaming video. It seemed like the best bet for two-way, high-speed, affordable data, the most logical platform for Starwave and Ticketmaster and a thousand other applications. While not as ubiquitous as the telephone, cable was already in people’s homes. By the end of the nineties, 65 million households would be subscribers. Just as the personal computer revolution had flowered with software applications like word processing and spreadsheets, cable was primed to become the interactive foundation of the Wired World.
Early on, I invested in companies that would prosper as high-speed data networks expanded, like Go2Net, a broadband Internet portal, and ZDTV (later TechTV), a network that covered the latest developments in technology. For greater impact, though, I thought I needed a pipe of my own. Cable was a big gamble. I’d have a smaller footprint than established powers like Time Warner and Comcast, and the price of admission was exorbitant. But I wanted to put my Wired World vision to a real-world test. And I felt sure that I could add value with innovative technologies and interactive content, key ingredients for the computing of the future.
As I hunted for a point of entry, a sequence of developments turned the industry upside down. The Telecommunications Act of 1996 opened cable-franchised areas to television service by satellite and phone companies. To stave off competition, cable operators responded with massive outlays to upgrade from analog to digital. They had a long and expensive way to go—by the end of 1997, only one in ten cable customers had access to digital TV. These pressures set off a furious wave of consolidations. Stronger companies swallowed weaker ones and swapped systems to concentrate their customer bases. The timing seemed perfect for someone with new ideas and lots of capital. But as Fortune observed in 2000, after I’d joined the cable fray: “As with any new technology wherein lots of players chase a limited pool of would-be subscribers, someone’s bound to go down. Hard.”
IN APRIL 1998, I paid $2.8 billion for Marcus Cable, a Texas-based operator with more than a million customers. That transaction, I told the press, culminated a long-standing dream: “Over twenty years ago, even before I helped to co found Microsoft, I saw a connected future. I called that future the Wired World. By investing into Marcus Cable, I will finally have some wires for my Wired World.”
My pivotal buying opportunity came three months later with Charter Communications, based in St. Louis. The tenth-largest MSO (multisystems operator) in the country, Charter had 1.2 million subscribers. It was the number-three cable provider in the balkanized Los Angeles market, which I saw as a potential anchor. Factoring in $1.9 billion of debt, Charter would cost me $4.5 billion, or fourteen times its projected operating cash flow. The Los Angeles Times called it “a rich price even by the standards of the merger-crazed cable industry.”
Responding to that perception in a July 1998 e-mail, Bill Savoy optimistically advised:
It is also important to note that Charter has the best performing cable properties in the industry, as measured by both growth and by cash flow per subscriber. So a 14x multiple is not outrageous, we paid almost 12x [actually 11.1x] for Marcus and AT&T paid 16x for TCI.
What Savoy failed to note was that I was buying at the top of the telecom boom in a notoriously cyclical industry. In three months, I’d spent more than $7 billion.
Scale and density are make-or-break factors in the cable business. I set a goal of 5 million customers—music to the ears of Jerry Kent, Charter’s CEO, who loved making deals as much as Savoy. Over the next nineteen months, after merging Marcus with Charter, we acquired a dozen more cable businesses in a $23 billion spree. In 1999, to subsidize our rapid expansion and help upgrade our systems, Charter raised $3.7 billion in one of the largest IPOs in U.S. history.
It was a dizzying ride. None of us sufficiently scrutinized how well Charter’s new pieces fit together operationally or, more important, whether the company could survive its mounds of debt if its growth curve were to flatten. Cable is a capital-intensive industry that borrows heavily to extend and upgrade infrastructure. During the boom of the late nineties, when bankers lent freely to operators, conservatively managed companies like Comcast and Cox were leveraging at around four times their operating cash flow (earnings before interest, taxes, depreciation, and amortization, or EBITDA). But within months of the Charter acquisition, our debt multiple stood at more than nine times EBITDA. We were wildly over-leveraged. (I can still hear Bill Savoy saying, “Jerry thinks nine times is what we should go with.”) Our heavy debt service created negative cash flow, making us vulnerable to interest rate hikes, bumps in the economy, or corporate missteps. If all went well, our leverage would boost our stock price, but if something went wrong. …
That was my blind spot, and my first big mistake with Charter. My second: In deals to buy other systems with Charter stock, I guaranteed that the former owners could sell their shares back to me at a prenegotiated price. If cable values fell and the stock slumped, that price would be grossly inflated. The sellers were protecting their downside at my expense.
My third error was underestimating the importance of critical masses of customers. While other MSOs had been building out systems in major cities for years, Charter’s acquisitions were mainly weighted in far-flung rural networks with relative handfuls of subscribers. Though we had substantial segments in St. Louis and in Fort Worth, Texas, along with a good share of Los Angeles, we never gained control of a top market. Our strategy to become the dominant operator in L.A. foundered when we were outbid for Adelphia and Century Communications.
What’s more, our largest acquisitions were second- and third-rate assets. Most of Falcon’s systems were in remote areas of Southern California and offered only thirty-five channels, barely a third of the industry’s norm. It would take a huge capital investment for Charter to catch up, and a lot more to upgrade the company’s infrastructure. Even after doing so, our returns would pale next to those of more urbanized operators.
In October 1999, hungering for a presence in New York and other major cities, I invested $1.6 billion in RCN, a high-end, fiber-optic “overbuilder” that tried to poach customers from entrenched cable franchises. The problem was that RCN couldn’t get enough customers to justify the expense of building out its network. Plagued by steady losses and crushing debt, the company eventually filed under Chapter 11 in 2004. It emerged from bankruptcy with new management a few months later, but my investment was essentially wiped out.
As I pursued my cable vision into the new century, all the ingredients were in place for me to be in over my head: an over-leveraged company, stiff competition from satellite providers, a wheeler-dealer CEO, and my own lack of experience with the industry’s financial variables. Then, in 2000, the tech bubble burst. Charter’s plan for a secondary public offering, a much-needed capital infusion, had to be canceled. With Wall Street eyeing cable balance sheets skeptically, the company’s valuation crumbled.
We were hanging by a string.
* * *
IN A CABLE WORLD interview published in November 2000, Jerry Kent was asked, “What’s it like to be the anchor of Paul Allen’s Wired World?”
Kent replied, “When an individual entrusts a management team with a $7 billion investment … it means we have an awesome responsibility to execute and perform.”
But while he said the right things in public, Kent behaved erratically behind closed doors. In the fall of 2001 (just after 9/11), in a decision that seemed impulsive and bizarre at the time, he announced his resignation.
One year later, Charter’s subscription base peaked at 7 million customers. But as the tech slump became a crash, cable operators were hit hard. Adelphia collapsed into bankruptcy, leading Wall Street to downgrade its outlook on the whole industry. The value associated with each subscriber shrank by a third or more. Highly leveraged companies like Charter were valued at less than ten times operational cash flow, considerably under what I’d paid. The company’s share price, as high as $25 a year earlier, tumbled by 80 percent.
That summer, I learned that Charter management was under federal investigation for accounting fraud, which led to the indictment of four top executives. With our reputation in tatters, the company’s share price fluctuated wildly, sometimes dipping below a dollar. Charter’s debt climbed to $17 billion. Jerry Kent’s sudden resignation began to make sense to me. One could speculate that he saw serious problems heading Charter’s way.
When I told David Geffen what was going on and described the guidance I’d been getting, he said, “You have been so poorly served.” Then he wheeled into advice mode: “Here’s your best chance to fix this. You’ve got to go to New York and find the best attorneys, the best restructuring guys—the people who really know their way around.” I hired the New York law firm Skadden, Arps to guide Vulcan through our legal issues, and Miller Buckfire for strategic advice. Separately, Charter brought in Lazard Frères, a top advisory investment bank. In this dire situation, we finally had the right people on our side.
An outside financial analysis was both sobering and hopeful. Of Charter’s $20 billion value, 85 percent was debt, a load that continued to gulp our cash flow and then some. But with most of our capital upgrade complete, the analyst concluded, the debt leverage should recede to more acceptable multiples by 2010. Some of my old optimism returned. Once we stabilized the financial operation, I felt confident that we could speed the innovations to lift the business.
But there was a catch, the analyst noted: “The challenge facing cable today is to learn how to effectively market its basic and advanced services in an increasingly competitive marketplace.” As things turned out, the competition was even more intense than anticipated. And we failed to rise to the challenge.
JERRY KENT’S SUCCESSOR, Carl Vogel, worked hard to renegotiate our loan maturities and keep us afloat. The problem was that Charter was equally vulnerable on the operational front. A cable business must continually sweat all the details of customer service, from pricing tiers to just how many technician visits (or “truck rolls”) it takes to get someone’s service issues resolved. From where I sat, Carl wasn’t up to that part of the job.
For years I’d been urging the cable industry to trump our satellite and telecom competition with faster deployment of digital video recorder set-top boxes and video on demand. I knew that consumers would want these features. I had them for years in my home-brewed multimedia system, and my visitors—several industry leaders among them—responded with enthusiasm. But as Cox and Cablevision began to roll out DVRs more aggressively (along with high-speed phone service, “triple-play” TV/phone/Internet packages, and, later, high-definition TV), Charter lacked the funding and focus to keep pace.
Smelling weakness, satellite providers targeted our areas with promotions and extra advertising. We lost subscribers by the bucketful, half a million during Vogel’s four years at the helm. By 2003, Charter’s debt load reached $20 billion. Much of it traded at less than half of face value, a dark forecast of the company’s solvency. As the stock price plummeted, the people who’d sold us their cable systems redeemed their shares. I was forced to pay out another $2 billion in cash.
That fall it came time to drink “some castor oil,” as I later told BusinessWeek. I fired Bill Savoy and pared my investments to forty companies, with an eye to diversification and maximizing return—basic principles that I’d almost lost sight of in my headlong pursuit of the Wired World. (One of those shed was Asymetrix, my first solo business. After a subsequent merger, it is now called Sum-Total Systems and continues to be a leader in e-learning software.) The irony is that I was forced into retreat just as events affirmed my vision. Broadband data penetration rose from 0.3 percent of American households in 1998 to 7 percent in 2000 to 61 percent in 2005. The digital platform I’d imagined was fast becoming a reality.
In August 2005, Charter finally got the CEO it needed in Neil Smit, a former Navy Seal and an outstanding executive from Time Warner. Over the next three years, we fought our way back to stability by extending maturities on our debt load, keeping our creditors at bay and our bondholders paid.
Neil ran Charter’s day-to-day operations with both expertise and a needed grind-away mentality. As he trimmed bureaucracy and got digital telephony running across our systems, fewer customers deserted us to satellite. Charter’s cash flow was growing 10 percent annually, and would soon catch up to our interest payments. It looked like the company might have a future, after all.
But our progress could last only as long as the credit markets gave us space to breathe. On September 15, 2008, Lehman Brothers fell into bankruptcy. The credit markets seized up, and commercial lending ground to a halt. Our refinancing options disappeared overnight. Charter’s debt load had swollen to $21 billion, with nearly $2 billion coming due in 2009, and the company lacked the cash flow to cover it.
In February 2009, after a decade of losses, we finally ran out of runway. Under the reorganization plan proposed by Lazard, Charter stockholders’ equity—including my 52 percent share—would be virtually wiped out, a bitter pill. But with the company casting off $8 billion of debt, junior bondholders would invest $1.6 billion in new capital. Charter would reemerge stronger than before.
The wild card was how the company would pay off $12 billion of senior secured debt held by JPMorgan and other big banks. If the obligations were reinstated at their original, low-percentage interest rates, the restructuring could move forward. But if they were reissued at steeper current rates, the bump in annual debt service—hundreds of millions of dollars—would sink the whole plan. Without liquidity, the junior bondholders would lose all incentive to convert their bonds into equity. The company might lurch into “free-fall” bankruptcy, with uncertain implications for all concerned, including sixteen thousand employees.
To avoid a free fall and get the loans favorably reinstated, Charter had to show that the same interests would remain in control before and after the reorganization. The junior bondholders needed my cooperation (and my retention of a 35 percent voting stake) for the agreement to work. I wanted to help ensure a smooth transition. But it also seemed reasonable that I get some consideration for my role in the plan, which would save the company billions in interest payments. We arrived at a compromise, and Charter filed under Chapter 11 in March.
JPMorgan led the court challenge. On November 17, the U.S. Bankruptcy Court for the Southern District of New York ruled in our favor and affirmed the reorganization plan. A month later, Charter came out of bankruptcy. I resigned as board chairman, and later Neil Smit moved on to become Comcast’s president of cable operations. We left behind a company with positive cash flow and a strong foundation, but the lessons I learned were among the most expensive ever. My net loss in the cable business was $8 billion.
WITH THE CLARITY of hindsight, I could say that I took the wrong people’s advice in plunging into Charter. I needed savvier, more experienced executives to assess my risks and to run the company, and I didn’t have them until it was too late. But the fact remains that the investment was mine, and I made serious miscalculations. Most of all, I failed to understand the downside of over-leveraging. My dreams of a Wired World empire finally sank under the weight of Charter’s mountain of debt.
In placing the biggest bets of my life on cable, I focused on its potential to change the world, not the downside scenarios. After embracing SkyPix early on, I underestimated the challenge from satellite systems, with their reputation for superior service. I did the same with the phone companies’ video and data offerings. And I failed to discern that the cable pipe couldn’t galvanize change by itself, or at least not as quickly as I’d thought. Operators have reaped handsome profits from selling high-speed data, but they’ve yet to capture much added value with new products and services over the top of the data stream. Even today, the fat pipe remains by and large a “dumb” pipe.
At the same time, recent trends suggest that I was more right than wrong in my prediction of a broadband future. As TV channels’ subscription fees squeeze profit margins, high-speed data is more vital than ever to cable’s growth. People have a voracious appetite for faster information flow, and fiber-optic technology has made cable far and away the top provider of digital data into their homes. The fat pipe has helped bring Amazon, Google, Facebook, and YouTube into near-universal acceptance. It has changed the way we live.
As the industry embraced DVR boxes and other services I’d been early in urging, operators found that customers were willing to pay for them. Now they can plow the extra revenue into the next round of innovation, in a virtual cycle.
The Consumer Electronics Show in Las Vegas each year contains a cavalcade of ideas that once percolated within Interval Research and my vision for the Wired World, from wearable HD camcorders and holographic displays to fully functioning multimedia set-top boxes and TVs, Web browsers included. In some cases, I was just too early. In others, our execution failed for a slew of reasons.
But even if I’d had more luck in my timing, the cable industry was wrong for me. In consumer electronics, product cycles run as short as six months; in computer software, about every two years. But in cable, it takes five years or more to introduce something new across the customer footprint. Cable is like a mule train. It’s moving as fast as it can but still takes forever to get anywhere. Case in point: When my company, Digeo, developed an Emmy-winning set-top box, it could not gain traction with Comcast and Time Warner, which were wedded to inferior boxes from their subservient legacy suppliers. Only recently have they begun to mandate Digeo-caliber boxes for future deployment.
Or consider that cable has yet to fully incorporate mobile phone service, a platform that now supersedes landlines, in a triple or quadruple play.
Consumers who came of age in the digital era are agnostic about delivery systems. A bit is a bit, regardless of how it reaches them. Though many of us have broken our picks in the pursuit of interactive television (including the ill-fated WebTV), there’s no question that television and computer platforms are now converging. People might not choose to read long e-mails on their fifty-five-inch screens, but they’ll use a tablet as a TV remote while scanning their Facebook page. Or they’ll use Xbox to manage their photos and music.
An Internet port will soon be standard on higher-end television sets. If the cable industry doesn’t move aggressively to integrate Internet functionality with its TV offerings, providers like Apple TV and Google TV will fill the void with “over-the-top” services. If you can stream Amazon.com or Netflix films and videos to your television, with their tens of thousands of on-demand titles, how appealing is pay-per-view? More threatening still, broadband channels are moving to distribute “linear” network content as well: CBS, TNT, Comedy Central. Multichannel television could be gradually supplanted by streaming video, with only sports and political events left as obligatory real-time viewing.
The technology already exists. The consumers are up for grabs. The digital future will belong to those who seize it.