23 November 1999
i-Cable Communications (i-Cable) belongs to the same group (Wharf) which owns 100% of New T&T, one of the four Fixed Telecommunications Network Services (FTNS) licensed by the Hong Kong government. The others are Hutchison, New World and of course the former monopoly Hong Kong Telephone, wholly-owned by Cable & Wireless HKT. In this article, we'll look at the strange decision to keep converging businesses separate, and take a look at the prospects for i-Cable's business, regulatory environment, competition and technical challenges.
One network, two companies
In the era of convergence, voice, data and video signals are all becoming basically the same thing - bits of data, electronic "1"s and "0"s that flow down fibre-optic cables. In 1992, Wharf Communications, the immediate parent of i-Cable, agreed with the MTRC that it could build a fibre-optic loop around the MTR system which forms the backbone of their communications systems. Video signals pass along this backbone as digital data before breaking out at various "nodes" and eventually being converted into VHF analogue channels for the "last mile" to your home. Likewise, New T&T digital voice and data traffic follows a similar route, and also shares ducts in the streets with the cable TV system.
The agreement with the MTRC was supplemented by a 1998 agreement with the MTRC for network capacity expansion. Basically, cable TV channels and New T&T traffic are all carried around the MTR system in digital form, often sharing the same fibre sitting in the same ducts.
Until now, this network has been shared by New T&T and i-Cable. Formally speaking, i-Cable was leasing "certain of these network assets" to New T&T, and in turn, some of this leased capacity was not being utilised and was leased back to i-Cable. Bear in mind that both companies were wholly-owned by Wharf so it did not really matter what happened between them - it all disappears on consolidation.
New T&T is not being included in the i-Cable flotation, so for the purposes of the flotation, the shared assets have been divided up between the two businesses. On 30-Sep-99, i-Cable transferred the "portion of the leased assets that had been directly used by New T&T" to that company and retained the portion that were previously leased back and used by Cable TV. Now that expression might make you think that these assets are separately identifiable. Not so. The prospectus, if you dig deep enough, tells you just how arbitrary this is:
"The Transferred Assets include a portion of certain assets, such as cable ducts, which are shared by [i-Cable] and New T&T. The identification of those assets attributable to the Group and New T&T's businesses has been estimated by management... based on current and planned usage by each party. These ratios have varied from time to time... and are subject to a high degree of judgment and estimation."
In other words, it is like trying to separate the amount of runway used by different airlines at the airport. The phrase "such as cable ducts" might sound innocuous, but it in fact goes deeper than that. They are sharing some of the same cable, and it has been necessary to set up a complicated "Duct and Cable Sharing Agreement" which will persist as a connected transaction between i-Cable and Wharf. This highlights the fact that the businesses are convergent in their infrastructure. Under the agreement, i-Cable will be responsible for all the maintenance work and will make a charge to New T&T based on its deemed share of the network.
Why no telephony?
The current Cable TV system has been operational in Hong Kong since 1993. Years earlier, cable companies in the UK were finding that one of the key applications of the cable network was cable telephony. Even in the days of analogue signals on the cable lines, that made sense. The bandwidth down a coaxial TV wire is far greater than that down a telephone wire simply because the wire is thicker and more shielded from outside interference. So UK customers were watching cable TV and making phone calls on spare channels at the same time.
But until now, Cable TV has failed to attempt to exploit this additional revenue stream. Part of this was due to the slow roll-out of the "hard-wired" HFC (Hybrid Fibre Co-axial) part of the cable system to physically connect the end-user with the station. Until this year, the majority of i-Cable customers have been served by MMDS (Multi-point Microwave Distribution System) which is one-way and so cannot carry phone calls. It beams signals from hilltops to rooftops. It would have been more appropriate to call it "Microwave TV" at the time, but that might have put people off their microwaved TV dinners. The proportion of customers served by HFC has only just reached 50%, and that is due to two factors. Firstly, the government has told them to give back the MMDS frequencies they were using and increase the extent of the HFC network, and second, you can't do 2-way cable modems by microwave broadcast.
If i-Cable had moved into telephony earlier, then by now it would be a major competitor in residential lines to C&WHKT, since it controls the only other lines into most flats besides the phone line (we'll ignore, for now, the possibility of transmitting data over the electricity wires - that's beyond the scope of this piece). i-Cable could have made the business case for telephony much earlier, and we believe the regulators would have allowed New T&T to offer that service across the cable lines in the interest of competition. The FTNS licenses were operational in 1996. Instead, over 90% of household FTNS service (your basic HK$90 per month of line rental) is still provided by C&WHKT, principally because they control the wires into your house.
All this is changing, and i-Cable has now applied for an FTNS license. This will not only allow voice and fax calls but also the potentially lucrative cable modem traffic to use the network.
So why are New T&T and i-Cable being separated?
All of this begs the question, why was New T&T excluded from the flotation of i-Cable? It would have made a lot of sense to bundle them together and avoid all this notional division of cable (splitting hairs, or at least fibres). Perhaps Wharf has plans to sell equity in New T&T by way of a separate joint venture. When i-Cable gets its own FTNS license, it will be in competition with New T&T. The prospectus attempts to play this down by saying:
"Accordingly, New T&T may become a potential competitor of [i-Cable] in the market for the provision of voice services. [i-Cable's] focus will be residential subscribers who will be connected by its HFC network. In contrast, New T&T's focus is mainly on the commercial segment."
Er, just a minute - aren't we forgetting about IDD 007, New T&T's flagship IDD service? That has always been pitched very much to residential customers and generates far more revenue per customer than simple line rental to households would make. At the end of 1998, New T&T had registered over 383,000 IDD customers.
It also seems likely that i-Cable, in serving its new telephony customers, will end up pooling its bulk IDD needs with New T&T rather than buying the capacity separately. That's another reason to have kept them together. From 1-Jan-2000, C&WHKT loses its monopoly over external facilities (i.e. the undersea cable and satellite links into HK) and companies will be free to make their own arrangements.
It was even envisaged in earlier statements that New T&T and i-Cable (then known as Wharf Cable) would jointly work on cable modems and cable telephony. Witness this statement from the 1997 annual report dated 8-Apr-98:
"Wharf Cable is also investigating the potential of cable modem and cable telephony technologies. The former offers high speed access to the internet and is being successfully rolled out in other markets. The latter is a joint project with New T&T to exploit the untapped potential of the fibre optic network, which will add significant value to Wharf's investment."
Clearly Wharf must have some reason for leaving New T&T out of the float, and probably a financial reason that overcame the practical logic of keeping the two communications businesses together.
The regulatory outlook for i-Cable is cloudy. Unlike the USA, where the battle continues, OFTA (the regulator) has already decided that i-Cable should open its HFC network to competing telecoms and pay-TV service providers. The terms of interconnection have to be negotiated but can ultimately be determined by OFTA.
OFTA will probably be keen to avoid a repeat of the situation in which they find C&W HKT's system (used for broadband internet and video-on-demand). In that case, although the network is open to outside traffic, the interconnection charge was set higher than the price which is charged to retail customers by C&W HKT, making it impossible for other ISPs to compete over that network.
Secondly, most people in Hong Kong live in blocks of flats which share a co-axial cable system running up the inside of the building. Cable TV signals are received either by the HFC network or via a microwave dish on the roof. To this are added broadcast terrestrial TV (from ATV and TVB) and often satellite from Star TV. In fact, i-Cable owns a company called Rediffusion Satellite Services, which handles about half of all rooftop dishes. They had a field day after Typhoon York knocked a lot of them out in October.
The government now requires that the in-building co-axial system be opened up to competing pay-TV and telecoms providers. For example, the new wireless FTNS licensees (when the are announced) will be allowed to share the same coaxial route to the living room from the roof. They will use it to give you phone lines and broadband internet.
So, faced with the end of its pay TV monopoly and a competitive broadband market which it has yet to enter, the prospects for i-Cable are not too bright.
Digital Cable - around the corner
Something which is not discussed in the prospectus is the coming era (and cost) of digital cable TV. Although the cable signals currently traverse fibre optics in digital form, they are transmitted up the spine of your building as analogue VHF signals. That copper co-axial cable can only handle a certain number of channels. Think of it as a highway with 31 lanes currently allocated to cable TV. That places a practical limit on the number of channels (30 plus one for signals) that i-Cable can give you without upgrading its system.
The next step is an expensive upgrade to "digital cable" in which multiple channels (typically 6-10) can be squeezed into the space previously occupied by one channel through a technique known as "digital compression". That same technique allows you to fit 74 minutes of video onto a VCD. To do this, the equipment at the fibre node and all the set-top boxes will have to be upgraded and the old ones scrapped. The process is already underway in the USA, where they also have digital satellite. Doing this will step up the number of cable channels from 30 to perhaps 200. It allows the station to offer "near video on demand" where the same movie shows on 10 channels at 10-minute intervals, or alternatively each tennis court at Wimbledon could have its own dedicated channel. In a Grand Prix, you could choose which car to sit in from the driver's point of view.
This may sound futuristic but i-Cable will have to make that investment to keep up with competition from other pay-TV providers. And a further threat is that broadband internet, when it reaches speeds of 2Mbps or more, can be used to transmit VCD-quality video, so anyone who provides you broadband internet access will ultimately be able to serve you video on demand. That VOD potential capability will be almost impossible to regulate out, and it means that the distinction between cable pay-TV and TV across the internet will rapidly fade.
A good deal for Wharf
With all these challenges ahead, Wharf has capitalised on the internet fever and the rich valuations on Nasdaq by floating off enough of i-Cable to repay a large chunk of its construction cost to date. They will also have to cut their holding further to meet an undertaking to increase the public float from 19% to 25% within 2 years. That means either selling shares or issuing new ones.
Profits will be a long time coming and competition will be tough. i-Cable has relatively little in the way of reusable copyright material - it is just one of many coming "fat pipes" for data. That's a commodity business which will have low margins. As consumers and publishers, we look forward to the vast internet bandwidth that i-Cable and its new competitors should be able to provide us. As investors, we'd rather be owning copyright content than the commoditised means of transmitting it.
And that name...
Kind of clunky, isn't it? We did a "who-is" check on i-Cable.com, and found that the registered owner of that domain is still a Dutch outfit called "Internet Cable Company" although i-Cable seems to be using it. The administrative contact for the site is listed as Billy Tam, who is part of the team of people which has already left i-Cable to form a new startup called DotComPacific.com. It would have been nice to float something which was actually the registrant of its domain.
© Webb-site.com, 1999