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Time Warner Cable's High-Speed Internet 97 Percent Profit Margin is a Big, Bright Red Flag; Critics Rebuked. | Bruce Kushnick
1. Time Warner Cable's High-Speed Internet 97 Percent Profit
Margin is a Big, Bright Red Flag; Critics Rebuked. | Bruce
Kushnick
In the previous article, I laid out excerpts of Time Warner Cable's SEC-filed 2013 Annual Report
which detailed TWC's profit margin (revenues minus expenses) for High-speed Internet.
And we wrote about it because it is a big, bright red flag, especially considering that Time Warner
Cable and Comcast have proposed a merger. In fact, we filed a Petition for Investigation Complaint
with the FCC (and NY Public Service Commission) to halt the proposed merger, and to start
investigating a number of issues, including Time Warner Cable's High-speed Internet profits.
Using just Time Warner Cable supplied information, we find that the company reported over $5.822
billion in revenues for High-speed Internet, but had direct expenses, according to their own annual
report, of $175 million -- thus the "gross" profit margin is 97% -- (i.e., $5.822 billion minus $175
million, equals $5,647; divided by $5.82 billion). Applying it to the revenues per customer we see
that the customer pays $43.92 to TWC, on average, and it cost Time Warner Cable $1.32 to offer.
This is a flat reading of the data presented by Time Warner Cable. And in the previous article, we
also mentioned that there are other common expenses, but these are not itemized or divided by lines
of business.
There Are Some Who Think that This Is Not a Valid Analysis.
Here are a few comments from Huff Po and Reddit
"This is so wildly inaccurate. He has no idea what a profit margin actually is. He is confusing gross
income (what he refers to as "profit") with operating income. Gross income does not include things
like capital expenditures ($3.1 billion), interest ($1.6 billion), amortization ($126 million), or
depreciation ($3.2 billion)."
"I like how you didn't include any of the operating costs. The salaries of the employees, the upkeep
on their equipment, etc etc etc."
2. "This article goes to great lengths to "follow the numbers", but demonstrates no comprehension of
basic book keeping principles like Fixed v. Variable costs, Gross v. Net Profits, etc. Or at least I hope
it's a lack of comprehension. Or else it's willfully misleading.."
I'll come back to these comments in a moment.
But I note that others have also found that the cable companies have obscene profit margins on their
Internet service. Two years ago, MIT Technology Review wrote: (February 4, 2013)
"In parts of the country, slower-speed copper, fast-download cable, and a few fiber networks are
already built out. The cable distribution giants like Time Warner Cable and Comcast are already
making a 97 percent margin on their "almost comically profitable" Internet services, according to
Craig Moffet, an analyst at the Wall Street firm Bernstein Research. As Blair Levin points out, "If you
are making that kind of margin, it's hard to improve it." And most Americans have no choice but to
deal with their local cable company."
The Reason We Wrote the Article: Investigations before Any Merger
It isn't simply what appears to be obscene profits on one of the primary lines of business that
triggered our interest. We included the information in a Petition for Investigation Complaint with the
FCC (and NY Public Service Commission) against Time Warner Cable and Comcast, to halt the
proposed merger http://en.wikipedia.org/wiki/VoIP_phone until some basic issues were investigated.
These profit numbers need to be examined in terms of the charges customers pay, as well as the lack
of competition for primary services -- cable TV, and High-speed Internet broadband. As we
documented:
There have been 22 years of continuous rate increases on a regular Time Warner Cable (Brooklyn,
NY) cable TV service.
The Time Warner Triple Play is filled with "made up" fees, pass-through taxes, and charges for items
that are not included in the advertised price of service.
We also called for an investigation of the "Social Contract" and its ties to the High-speed Internet
profits.
In 1995, the FCC created the "Social Contract" -- an Order to grant the cable companies financial
assistance for upgrades of the cable plant for new services, as well as fixing quality-of-service issues.
Time Warner charged basic cable subscribers up to5 a month extra on cable bills. The Social
Contract was supposed to expire in the year 2001. After 2001, there was no oversight or
investigations and the companies never lowered their rates to remove this extra federally-added
charge on customers' bills.
Wiring the Schools: In the Social Contract, the companies also committed to bring High-speed
Internet to schools in their franchise areas. Schools were also supposed to be given free cable
modem service, a free cable modem, and would even get the inside wiring at cost. We found no
formal reports or evidence that the companies had wired the schools for High-speed Internet.
To read about the other issues: Petition for Investigation Complaint
3. Examining Lines of Business
The big disconnect for many of the commentors is that they believe that we need to examine the
companies' company-wide, total capital expenditures, depreciation and all other financials to
understand the High-speed Internet profits.
Unfortunately, using the total revenues, profits and expenses to determine the profitability of one of
the lines of business, is like getting a copy of the US national budget and expecting it to reveal the
financial secrets of the school lunch program -- or any detailed area the government funds.
Separate products and services have their own profitability and moreover, because of massive cross-
subsidies (which we documented on the phone company side) the High-speed Internet service may
only be paying 'incremental revenues', or not even paying for items like capital expenditures.
And I did write the book (s) on it, literally In 1993, New Networks Institute and Probe Research
published the largest examination of the Bell phone companies' (now ATT, Verizon and Centurylink)
financials and business practices for their first decade (1984-1994). It included a report "Bell
Earnings, Expenditures and Profits", among other research reports.
For the updated details see: "The Book of Broken Promises: $400 Billion Broadband Scandal Free
the Net"
Examining Separate Lines of Business Is the Norm: Incremental Revenues and Expenses
This might annoy some of you but...
In the late 1980's-1990's, the phone companies started to add services known as "calling features",
like "Call Waiting" or "Caller ID" (you can see the number of the person who is calling). While
commonplace today, and free/included with most bundles of service or even wireless services, in the
1990's these were new services.
Calling features had a deep secret -- very high profit margins. And the phone companies claimed at
this time that these services should be allowed to be charged at 'market prices', even though the
company had a monopoly on phone service at this time.
Many states, in fact, deregulated these services allowing the companies to charge what they wanted
and to keep any extra money, with the understanding that these extra profits would be used to
maintain and upgrade the state utility networks.
In 1999, the Florida Public Service Commission did an analysis of profits above costs on "Calling
Features", from 'Call Waiting to Caller ID', In 1999, Call Waiting cost $4.00 for residential customers
per month, but had a profit over the cost to offer the service of 48,680% -- it cost less than a penny
to offer.
4. ("Report of the Florida Public Service Commission on the Relationships among the Costs and
Charges Associated with Providing Basic Local Service, Intrastate Access and Other Service by the
Local Exchange Companies in Compliance with Chapter 98-277, Section(2)1 Laws of Florida,"
February 19, 1999)
Reading across, 3-Way Calling cost $3.75 a month, cost $.62 cents for the phone company to offer it
and had a profit of 501% above cost, while Call Forwarding cost the customer $1.00 dollar but cost a
fraction of a penny to offer; 47519% above cost. (And these profits were based on 1999 BellSouth
(now ATT) pricing.)
How could the services be so profitable? Incremental costs. These services were added to the
network as part of the normal upgrades and maintenance as the new network switches were
designed for these services, so the 'incremental' cost to offer these services was nominal.
Now, had they remained 'regulated', these services would have cost a fraction of what was charged -
- i.e., Call Waiting would be closer to $.10-$.40 a month (or less) not $4.00.
Verizon: Who Paid for the Construction of the Fiber Optic Networks to Deliver the FiOS Service?
The reason why you simply can't use the 'total' financial information, even TWC's construction and
depreciation, and apply it to the revenues and expenses of High-speed Internet is because the high
speed service might not be paying for construction or taking depreciation as an expense.
In examining Verizon's financial accounting over the last five years, we uncovered that Verizon's
entire fiber to the premises (FTTP) networks are being constructed as "Title II", common carriage to
get the state-based utility rights-of-way as well as charge phone customers for 'massive deployment
of fiber optics' -- I.e., Verizon New York's local phone customers paid for the construction of some, if
not most of the costs of upgrading the networks.
5. (I note that Verizon has claimed that "Title II harms investments" and this issue is at the center of
the Net Neutrality fights. We found Verizon failed to disclose these facts about Title II to the FCC,
courts or public and we filed a Petition for Investigation against Verizon with the FCC over this.)
Based on the financials from Verizon New York (and filings with the NY Public Service Commission,
etc.) the FiOS cable TV line of business did not pay for construction of the fiber networks, nor did
the 'Internet-broadband-ISP' part of the business. It was paid for by the Title II voice/telephone part
of the business. Moreover, the revenues from the FiOS cable service and ISP services appear to go
into different financial corporate buckets, not back to fund the networks' upkeep.
I note that in July 2014, a petition was filed by Connect NY Coalition calling for an investigation of
Verizon New York's financials and the rate-making process using data from our reports.
Thus, if we examine Verizon's total capital expenditures and the depreciation, etc., for just Verizon
New York, we would not be able to answer what the FIOS TV or FiOS Internet expenses are.
But it gets worse when you attempt to examine the parent company, Verizon Communications' Inc.'s
wireline holdings as that information combines multiple affiliate companies in multiple states and
the numbers are not broken out by the same 'lines of business' as Time Warner Cable, so it is
impossible to 'reengineer' what happened in the financials from the corporate annual or quarterly
reports.
Thus, it would seem that with Time Warner Cable, the broadband and Internet 'service' essentially
pays only incremental costs. The network infrastructure was already in place, the customer service
staff is already in place for cable TV, and it would appear that the cable TV side of the business
picked up most of the expenses.
That's one of the only ways that this High-speed Internet profit margin could show up.
But, in the case of TWC, while their own financials show the revenues and expenses for High-speed
Internet -- TWC never discloses how the rest of the expenses they list relate to High-speed Internet.
Time Warner Cable has over 100 subsidiaries and so, examining the total depreciation or t1 service
charlotte nc capital expenditures doesn't get us the answer of what is going on specifically with the
High-speed Internet service.
6. The 97% is a red flag that during a merger should be on the table to examine.
And I'll be the first to admit that there are fundamental questions that need answers before any
merger is approved. We'd like to know:
What are the exact profit margins of the broadband-Internet, phone and cable TV services when the
common costs are added?
Did the Social Contract's additional $5.00 help create the profit margins of the High-speed Internet
service?
Did basic cable TV subscribers fund non-regulated building of the broadband and Internet service?
How can the companies discuss bandwidth caps if their profit margins are so high?
Price to competitors? On the business side, if these margins are true, does Time Warner Cable's
High-speed Internet service have a sweetheart deal and does it get major financial advantages?
Are the Time Warner Cable's lines of business paying what competitors would pay for use of the
networks and 'access fees'?
I assume others have questions that the FCC, States and Congress should ask Time Warner Cable
and Comcast before any merger is agreed to.