German cable picture clears up with new deals

Surprise KDG-Orion deal seen as major step for market

FRANKFURT, Germany -- An $870 million deal inked Thursday by Germany's No. 1 cable company, Kabel Deutschland (KDG), and No. 3 cabler Orion Cable could mark a breakthrough in the consolidation of the world's second-largest cable television market.

The multifaceted deal will see KDG purchase 1.2 million of Orion's German cable subscribers for €585 million ($821 million) while Orion will pay Kabel Deutschland €38 million ($53 million) for KDG's 18% stake in regional cable group Primacom AG.

In addition, KDG has agreed to withdraw its takeover bid for Primacom, leaving Orion, which, following today's deal, controls 42.3% of Primacom, as the sole bidder.

The surprise deal comes after months of fierce fighting over Primacom. Both companies saw the group as key to turning the German cable TV market from a money pit into a cash cow.

Now, in one elegant maneuver, both companies could come out winners and Germany is a major step forward on the path from being a jungle of small cable players into a consolidated, and profitable, cable nation.

With 18 million cable households, Germany is a potentially huge market. But since monopolist Deutsche Telekom sold off its cable assets in the late 1990s, companies moving into the sector have seen nothing but red ink. Early investors such as Garry Klesch or Callahan Associates piled up losses or went bankrupt with their German cable holdings.

Slowly, things are starting to change. KDG, the market leader with 9 million cable homes in Germany, boosted sales by 19%, to €290 million ($403 million), in the first quarter of 2007-08 and slashed losses by 67%, to just €4.3 million ($6 million).

KDG chief executive Adrian von Hammerstein attributes the turnaround to the explosion of KDG's triple play business -- customers taking Internet and phone services along with the company's TV offerings via cable.

Therein, however, lies the problem. Despite consolidation, hundreds of small cable providers still control the key "last mile" to customer homes. Without these last-mile providers, the big cable companies are stuck.

Since the last-mile networks tend to be old and analog, they can't be used for triple play.

Of the 9 million households it currently serves, KDG controls the last-mile networks to only one-third.

"KDG and other players need to increase the number of last-mile networks. Without them, there is no chance of making its triple play strategy work," an international investment banker familiar with the German cable market said.

Which is why Primacom is such a prize. The bulk of its 1.5 million subscribers are last-mile, triple play ready.

With Thursday's deal, KDG goes from 9 million to 10.2 million subscribers and Orion, assuming it succeeds in buying Primacom, will increase its subscriber base from 4.7 million to 5 million.

But both companies will rank about even when it comes to those lucrative last-mile customers, with KDG handling just over 4 million and Orion close to 5 million.

There is just one thing in the way of a full-scale consolidation, with its accompanying profit surge: Germany's small-time operators, those last-mile companies, some of which serve just 5,000 homes.

Many small-time operators are now merging in a bid to resist the big players.

"Consolidation with the small cablers is slow and not necessarily in favor of the big companies," said Heinz Peter Labonte, a small cable network operator and president of FRK, a union that represents last-mile operators. "I used to serve 5,000 households. Today, it's 17,000 and I know companies that have had similar growth over the last years," Labonte said.

But, most analysts agree, Germany's small-time cablers are just delaying the inevitable: a takeover by one of the major companies. With no access to big capital, the small operators can't afford to upgrade their networks to carry triple play services.

How long this ongoing cable market consolidation will continue is still anyone's guess. Tightening worldwide credit markets could hamper the giants as they move to gobble up the remaining independent networks.

But as the KDG-Orion deal makes clear, Germany's cable industry is starting to look like a real business.
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