SATELLITE, CABLE & BROADCASTING David B. Kestenbaum 212-218-3851 dkestenbaum@morganjoseph.com James Leahy 212-218-3784 jleahy@morganjoseph.com Company Update December 13, 2006 Key Metrics LBTYA - NASDAQ $28.63 Pricing Date 12/12/2006 Price Target $30.00 52-Week Range $28.77-$18.21 Shares Outstanding (mm) 196.7 Market Capitalization ($mm) $5,631.5 3-Mo Average Daily Volume 1,303,604 Institutional Ownership NM Debt/Total Capital 61.5% ROE NM Book Value/Share $16.41 Price/Book 1.7x Dividend Yield NM LTM EBITDA Margin NM EPS($) FY: December Prior Curr. Prior Curr. 2005A 2006E 2006E 2007E 2007E 1Q-Mar 0.08 -- 0.09A -- -- 2Q-Jun (0.34) -- (0.40)A -- -- 3Q-Sep (0.32) -- (0.40)A -- -- 4Q-Dec 0.36 -- (0.14)E -- -- FY (0.20) -- (0.94)E -- (0.13)E P/E NM NM NM Revenue($mm) Prior Curr. Prior Curr. 2005A 2006E 2006E 2007E 2007E 1Q-Mar 1,235.3 -- 1,625.9A -- -- 2Q-Jun 1,276.3 -- 1,586.1A -- -- 3Q-Sep 1,295.8 -- 1,622.4A -- -- 4Q-Dec 1,443.1 -- 1,670.0E -- -- FY 5,151.3 -- 6,367.4E -- 7,118.3E Liberty Global Inc. Rating: Buy A Trip Around The Liberty World: Japan Investment Highlights: We present our final stop on our tour of the Liberty Global world. We have, from time to time over the past year, presented a view of each of Liberty Global's major markets, including Holland, Switzerland, Austria, Chile, Poland, and Hungary. On each stop, we have explored the competitive environment and assessed the company's market positioning. Our final stop takes us to Japan, home to Liberty Global's J:COM (4817-94,600 - JASDAQ) operation. Business remains healthy; Liberty Global evaluating alternatives for J:COM. The company's J:COM operation continues to deliver solid financial results and healthy subscriber metrics, driven by demand for bundled packages of advanced services. That said, the company is currently looking at three options that could create additional value for J:COM: 1) sell; 2) enter into a European asset swap; or 3) spin out the segment to provide a pure-play for investors interested in Japan. While low Japanese interest rates of 1%-2% present an opportunity for J:COM to leverage up its assets and pay dividends, Sumitomo Corporation (SSUMY.PK - $14.85 - OTC), the company's partner in J:COM, is not willing to do so, given EPS concerns associated with increased interest expense. In our view, a European asset swap would be ideal. However, given the difficulty in execution, we believe a spin-out is the most viable option, as a J:COM pure-play would create more clarity for investors. 1 Year Price History for LBTYA 2006 Q1 Q2 Q3 30 27 24 21 18 15 Created by BlueMatrix Company Description: Liberty Global Inc. (www.lgi.com) is a worldwide provider of broadband distribution services and video programming, including analog and digital video television, Internet access, and telephony. It also offers direct-to-home satellite service in certain markets as well as multi-channel distribution systems. As of September 30, 2006, the company's networks reach approximately 25.6mm homes, including 12.3mm video subscribers, 3.4mm broadband Internet subscribers, and 2.5mm telephone subscribers. The Disclosure section may be found on pages 18-19 of this report. The Valuation section may be found on page 18 of this report.
Market Overview While Japan represents one of the most technologically advanced nations, multichannel television penetration remains quite low. Today, a vast majority of Japanese viewers get their programming from NHK or the five major terrestrial broadcasters and not from the major cable or satellite television providers. Beyond television, Japan has a highly competitive telecommunications market, with a dominant incumbent, two other large and dominant telecom providers, a dominant satellite television provider, and a wide variety of smaller broadband and telephony service providers. The competitive nature of the Japanese market is due in large part to a regulatory structure that has pushed for universal (and ultra high speed) broadband. We note that the competitive environment for broadband has made Japan a home for inexpensive broadband services (on a price per Mbps basis, Japan is easily the cheapest in the world). In addition, the dense population and large number of multi-dwelling units has enabled the incumbent providers and other fiber-based providers to deliver the world's fastest set of broadband services, with downlink speeds of up to 100.0Mbps. Japan has also seen a large deployment of fiber-based services in recent quarters, as many providers and even the large incumbents, have begun to replace their copper infrastructure with fiber, creating huge downstream pipes throughout the country. Despite this highly competitive market, Liberty Global's Japanese operation, J:COM, is by far the largest cable television service provider in Japan and one of the country's largest broadband service providers, thriving thanks to its virtual lock on the triple-play in Japan. Table 1: Broadband Pricing and Penetration Rates $4.00 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 Japan Korea US Germany UK France 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Pricing Penetration Source: NTT 2 MORGAN JOSEPH & CO. INC.
Table 2: Japan Telecommunications Market Forecast (subscribers in millions) F2003 F2004 F2005 F2006E F2007E F2008E F2009E F2010E Broadband ADSL 7.0 11.2 13.7 14.4 14.9 14.4 13.2 12.4 FTTH 0.4 1.5 2.9 5.6 9.0 12.5 14.0 15.5 CATV 2.0 2.5 3.0 3.3 3.8 4.2 4.8 5.5 Total Broadband 9.4 15.2 19.5 23.3 27.7 31.1 32.0 33.4 Telephony Copper POTS 50.7 51.0 50.6 49.0 45.0 42.0 40.0 37.0 ISDN 10.1 9.1 9.5 7.9 6.9 6.4 5.9 5.4 Total Analog Lines 61.2 61.0 62.0 62.9 61.4 61.3 60.9 60.1 VoIP 2.0 4.3 7.5 9.5 14.4 17.6 18.5 19.2 ADSL 2.0 3.6 4.5 4.9 4.9 4.6 4.4 4.1 Other 0.0 0.7 3.0 4.6 9.5 12.3 13.5 14.4 Total Digital Lines 4.0 8.6 15.0 19.0 28.8 34.5 36.4 37.7 Total Telephony 65.2 69.6 77.0 81.9 90.2 95.8 97.3 97.8 Television BS Broadcasting 11.5 12.0 12.5 13.1 13.4 13.7 14.0 14.2 CS Broadcasting 3.0 3.2 3.3 3.5 3.7 3.9 4.1 4.2 CATV 15.2 16.5 17.7 18.7 19.8 20.7 21.5 22.0 Total Television 29.7 31.7 33.5 35.3 36.9 38.3 39.6 40.4 Source: MIC, Company reports, and Morgan Joseph & Co. Inc. estimates Basic Japan Economics Japan boasts one of the world's most highly developed economies, ranking behind the US as the second most technologically powerful nation and ranking behind the US and China as the third largest economy on a purchasing power parity basis. Beyond its powerful economic status, the country also boasts a very high standard of living. Given that Japan is a relatively small country by land size and its island status, the country has a very small agricultural sector but a very large fishing base. On the industrial and service side, Japan is very technologically advanced and is a worldwide leader in electronics and other high technology goods. Despite all this, the country saw its economic growth slow dramatically through the 1990s (average growth during the decade was 1.7%) and into 2000-2003 due in large part to weakness in the US and in Europe. In 2004, 2005, and 2006, economic growth returned to Japan. According to CIA World Factbook statistics, the country currently has approximately 127.5mm people with a population growth rate of 0.02%. In addition, GDP per capita as of 2005 was $31,500 with 4.4% unemployment and deflation of 0.3% in 2005. Japan maintains its own currency, the Yen. J:COM Services Jupiter Telecommunications, J:COM, was founded in January 1995 as a joint venture between Sumitomo Corporation and Liberty Global. In March 1995, branding of the legacy cable systems shifted over to the J:COM brand. The company followed its successful launch of cable television services with the launch of telephony services in July 1997 and the launch of broadband Internet services in January 1999. J:COM introduced a 30.0Mbps broadband Internet access service in September 2003 and began digital television broadcasts in April 2004. In 2005, the company launched VOD (video on demand) in January and VoIP (voice over Internet protocol) services (April). Also in March of 2005, Sumitomo and Liberty Global, through a jointly held company called Super Media, conducted an IPO of J:COM on the JASDAQ stock market in Japan. Liberty Global continues to retain effective control of J:COM through an approximate 36.73% voting interest 3 MORGAN JOSEPH & CO. INC.
in the company. This is held via a 58.66% ownership of Super Media (Sumitomo holds 41.34%), which owns 62.61% of J:COM. Table 3: Japanese Monthly Service Pricing (excludes tax) Service Provider NTT NTT J:COM Service FTTH (Home) ADSL Cable Video Channels 40 NA 80 Video Pricing ( ) 2,700.00 NA 4,980.00 Video Pricing ($) 23.38 NA 43.12 Broadband Speed 100.0Mbps 47.0Mbps 30.0Mbps Broadband Pricing ( ) 5,300.00 3,370.00 3,530.00 Broadband Pricing ($) 45.89 29.18 30.57 Telephony Pricing ( ) 500.00 1,700.00 1,330.00 Telephony Pricing ($) 4.33 14.72 11.52 Note: Telephony pricing represents monthly service cost and does not include per call charges Total Monthly Pricing ( ) 8,500.00 5,070.00 9,840.00 Total Monthly Pricing ($) 73.60 43.90 85.20 Source: NTT; J:COM J:COM is easily Japan's largest provider of cable television services based on both the total number of total homes passed and total customers. Excluding Cable West, the company's network currently passes about 7.6mm homes in its footprint, serving subscribers through 18 franchises and one unconsolidated franchise, of which J:COM owns 50%. Eighteen of the company's 19 franchises are in the Kanto region (Tokyo), Kansai region (Osaka and Kobe), and Kyushu region (Fukuoka and Kita-Kyushu), while one franchise is in Sapporo. On a consolidated basis, the company currently has 2.2mm subscribers and 3.8mm total RGUs (revenue generating unit). This includes 916,400 analog cable television RGUs, 867,600 digital cable television RGUs, 961,600 broadband Internet RGUs, and 1.1mm telephony RGUs who take a mix of circuit switched and VoIP telephony. In its unconsolidated franchise, J:COM serves 50,000 analog cable RGUs, 36,600 digital RGUs, 39,700 broadband Internet RGUs, and 52,400 telephony RGUs. We also highlight that the company's current bundle ratio is 1.76 services per customer. During 3Q06, the company acquired Cable West, which adds 360,000 total subscribers and 472,900 RGUs. This includes 172,400 analog and 154,800 digital television RGUs, 127,000 broadband Internet RGUs, and 18,700 telephony RGUs. Given the fiercely competitive nature of the Japanese telecommunications market, and in particular, the Japanese broadband market, substantially all of the company's plant has been upgraded to two-way 750MHz-770MHz plant. Finally, in Table 3 above, we have provided a look at typical J:COM a-la-carte service pricing vs. its primary competitor, NTT (NTT - $25.29 - NYSE). While J:COM's a-la-carte pricing may be more expensive than NTT's, we note that when selecting J:COM, subscribers get a number of added benefits, including additional broadband services (virus protection, additional email addresses), the ability to take unbundled telephony, and a significantly better video service. Also, we note that when subscribers begin to take bundled packages, J:COM's pricing plans look even more attractive compared to its competition. On the video side, the company offers both analog and cable television services in all of its managed franchises, with analog service encompassing 47 channels, including retransmissions of standard terrestrial and satellite channels plus a suite of premium channels (i.e., MoviePlus, the Shop Channel, J Sports 1, J Sports 2, J Sports Plus, J Sports ESPN, the Discovery Channel, the Golf Network, the Disney Channel, and Animal Planet). The company's digital service begins with a basic tier of about 66 channels (including the basic analog set of channels) and up to 15 high-definition channels. The company's service also includes audio and data service channels. Other additional services available only to digital cable subscribers include VOD under the 4 MORGAN JOSEPH & CO. INC.
J:COM On Demand brand (including the August 2006 launch of MoviePlus HD and the October 2006 launch of KBS World) and up to nine pay-per-view channels. Additional services available to all subscribers include various premium programming tiers (movies, sports, horseracing and special entertainment programming) and the "HDR" DVR (digital video recorder) service, which was launched in April 2006 and today has nearly 70,000 users. On the broadband side, the company offers a full-featured Internet access service suite through two subsidiaries, @NetHome and Kansai Multimedia Services. These two subsidiaries allow J:COM to provide high-speed broadband services in two tiers, 8.0Mbps and 30.0Mbps. In addition, the company offers high-speed broadband services over optical plant to multi-dwelling units in Japan using the J:COM NET Hikari brand. This service provides high-speed broadband access at up to 100.0Mbps. Finally, the company's telephony services are provided to its franchise areas generally using legacy circuit-switched technology. Customers are charged a basic flat rate for basic dial tone service and then charged on an a-la-carte basis for a variety of premium telephony services, including call-waiting, call-forwarding, caller ID, and three-way calling. During 2005, J:COM began deploying VoIP services and it launched a mobile phone service alongside WILLCOM in March 2006. J:COM's Jupiter TV affiliate gives it access to a wide range of content that the company has made available through its own channels and also through its VOD services. Together, J:COM and Jupiter TV own Jupiter VOD, a joint venture formed in 2004 that allows the two companies to obtain and own VOD programming content and services. Satellite Competition Sky Perfect Sky Perfect Communications (4795-77,300 - TSE) is the largest provider of satellite television services in Japan and is the successor company to two earlier companies. One predecessor company, PerfecTV Corporation, was founded in November 1994 and began satellite broadcasting on the CS digital platform in June 1996. The other predecessor, Japan Sky Broadcasting, was founded in December 1996. The two companies agreed to merge in May 1998 and became Sky Perfect Communications in June 2000. Today, the company operates five different service lines, including CS digital broadcasting through satellites at 124 and 128 degrees, CS digital broadcasting through a satellite at 110 degrees, FTTH (fiber to the home)-based content distribution, broadband content distribution, and mobile content distribution. Currently, Sky Perfect serves 4.1mm total satellite subscribers, including 3.7mm subscribers on the CS 124/128 degree digital platform and 405,240 subscribers on the CS 110 degree digital platform. In terms of its fiber reach, 18,562 subscribers currently take the product. 5 MORGAN JOSEPH & CO. INC.
Table 4: Network Topography - J:COM and Satellite Broadcasters Source: Company reports On October 26, 2006, Sky Perfect and JSAT Corporation, Sky Perfect's programming transmitter, announced that they would merge by setting up a joint holding company worth approximately $830.0mm. The company expects the transaction to allow it to better compete in the market because it will, for the first time in Japan, combine satellite ownership, operation, and content generation/delivery into a single company. Under the terms of the deal, one Sky Perfect share and four JSAT shares will each be swapped for a single share in the new holding company, which will be called Sky Perfect JSAT Corporation. According to the two companies, they expect to have 7.0mm-8.0mm total subscribers by the end of 2011 vs. 4.2mm total Sky Perfect subscribers today. On the digital satellite television side, the company operates two separate digital services, with access to its two core communications satellites (CS) at 124 and 128 degrees or access to a communications satellite (CS) at 110 degrees, where Japan's free broadcasting satellites (BS) are located. The company's Sky PerfecTV! Broadcasting services feature all digital video broadcasting using small-sized dishes and set-top boxes that are either sold or rented to consumers. The company's 110 degree CS digital service is gaining traction in the marketplace because there are a number of televisions on the market that come equipped with the appropriate tuner for the service, allowing Sky Perfect to drive services into additional homes. Subscribers on the 124/128 degree platforms have access to up to 188 digital television channels and 101 radio channels while subscribers 6 MORGAN JOSEPH & CO. INC.
on the 110 degree platform have access to up to 72 television and data channels. At the end of 2005, the company augmented its video services with two new packages on its core broadcasting platform. The Sky PerfecTV! Valuable Pack includes 69 of the company's most popular channels while Sky PerfecTV! Select 15 allows viewers to subscribe to 15 out of the most popular 69 channels on an a la carte basis. On the fiber to the home side, the company is working through its Opticast marketing subsidiary to deliver digital television and other telecommunications services under the SKY PerfecTV! HIKARI brand to subscribers over the FTTH access lines operated by NTT East and NTT West in most areas and over the FTTH access lines operated by other providers (Chugoku Electric and Adachi, among others) in some limited areas. The service allows MDU (multi dwelling unit) dwellers to receive CS broadcasts, BS broadcasts, and terrestrial broadcasts over a fiber-based network. The network was rolled out initially in the 23 wards of Tokyo, Osaka, Yokohama, and Kawasaki and now is available across NTT's fiber platform. Currently, the company serves 18,562 total subscribers through its fiber service. The company is also deploying the service to single-unit homes and other small-scale housing developments beyond its initial push for MDU dwellings. Subscribers to the service have access to up to 188 digital television channels, 101 radio channels, and a wide range of analog broadcast channels depending on their viewing area. WOWOW WOWOW is Japan's second largest provider of digital satellite television services, reaching approximately 2.4mm total subscribers. The company was started in December 1984 and began commercial broadcasting of its initial analog signal in April 1991 and switched over to digital broadcasting in December 2000. Today, WOWOW offers both BS digital and BS analog broadcasting via satellites in the 110 degree orbital slot. WOWOW operates three channels and primarily acts as a rebroadcaster of movies, anime series, and other special Japanese programming. In addition, WOWOW is Japan's only source of some American programming, including The Simpsons and South Park. Cable Competition The Japanese cable market is characterized by the wide separation between the market leader, J:COM, and the rest of the market. Outside J:COM, the market consists of dozens and dozens of small operators that tend to serve highly localized footprints. Over the past several years, some of the biggest cable operators in Japan have been rolled up into the larger players as industry consolidation continues. While most of Japan's cable operators have fewer than 100,000 total subscribers within their limited footprints (operators serving less than 100,000 subscribers account for about 51% of the total market), there are some larger operators that do make a dent in the cable market. These include Japan Cablenet (a 351,000 subscriber operator that was acquired by KDDI [9433-794,000 - TSE] in March 2006), Bay Communications (approximately 138,000 subscribers), itscom (approximately 130,000 subscribers), and Mediatti (approximately 123,000 subscribers). We note that J:COM currently owns approximately 40% of Mediatti. Despite these competitors, the largest source of competition for J:COM in the Japanese market is not cable providers, but rather the group of powerful telecommunications service providers and the two main satellite operators in the market. We will explore these competitors later in this report. The most recent example of cable consolidation in Japan was J:COM's acquisition of a controlling stake in the country's third largest operator, Cable West, on August 28, 2006. J:COM acquired 76.40% of the total outstanding shares of Cable West from Matsushita Electric Industrial (MC - $19.85 - NYSE) and Kosaido 7 MORGAN JOSEPH & CO. INC.
Corporation (7868-626 - TSE) for 55.8bn (or approximately $472.5mm based on current exchange rates). Based on Cable West's F2006 results, this transaction represents a current EBITDA multiple of about 8.0x and will give J:COM control of 84.94% of Cable West (prior to the transaction, J:COM held 8.58% of the operator's total outstanding shares). As of the end of October 2006, Cable West serves 360,000 subscribers and 472,900 RGUs in its footprint of approximately 1.3mm total homes passed, including 327,200 video RGUs, 127,000 Internet RGUs, and 18,700 telephony RGUs. This acquisition will expand J:COM's nationwide cable television market share to 35% from 30%. Incumbent Competition - NTT NTT (Nippon Telegraph and Telephone Corporation) was founded by the Japanese government in 1952 as a monopoly public company tasked with building/operating a nationwide telecommunications network, conducting telecommunications-related research services, and providing telecommunications services to all Japanese citizens. In 1985, the Japanese government partly privatized the public company (the Japanese government remains the largest shareholder) and in 1987, shares of NTT were first listed on the Tokyo Stock Exchange. Today, the company operates one of the largest and most advanced networks in the world (unlike most incumbent providers, which have been making and executing plans for next-generation 21 st Century networks in recent years, NTT first began implementing its next-generation network plan in 1996) and serves its residential consumer customers using both traditional copper facilities and next-generation optical facilities. NTT is Japan's largest telecommunications service provider. The company's operations are split across a vast number of businesses and territories. NTT provides fixed-line telephony services via standard copper and ISDN (integrated services digital network) lines, data services over ADSL (asymmetric digital subscriber line) and FTTH networks, leased line services, and mobile communications services. NTT's main fixed line businesses are split between two regional subsidiaries (NTT East and NTT West) and its long distance/international subsidiary (NTT Communications). In addition, the company has a mobile subsidiary (NTT DoCoMo), which handles all of its mobile services. We also note that NTT has three subsidiary companies (On Demand TV, 4th Media, and OCN Theater) that provide video-on-demand content across all genres to online and television subscribers. Today, the company's traditional copper business serves 46.0mm total standard fixed voice lines and 7.7mm total ISDN lines. At the same time, NTT provides ADSL-based broadband services to 5.7mm total lines, optical-based broadband services to 4.1mm total lines, and optical-based IP telephony services to 1.4mm total lines. In addition to its fixed line businesses, NTT is also Japan's largest wireless service provider and is experiencing, like most other telecommunications service providers, a bit of line loss to fixed-to-mobile substitution trends. Currently, NTT serves 51.7mm cellular subscribers, of which 26.2mm subscribe to the advanced 3G services. On the voice side, the company continues to see a squeeze from fixed-to-mobile substitution as its fixed-line telephony subscriber numbers continue to track lower. To stem the trend, the company has been migrating some of its traditional fixed-line telephony subscribers over to optical-based telephony, which has seen continued subscriber gains over the past several quarters, albeit at a lower rate than the copper-based telephony declines. Regardless of the service type, NTT offers a full range of voice services that are comparable to those at any other incumbent provider worldwide. More importantly, on the data side, the company offers both copper plant-based and optical plant-based high-speed broadband services. Copper-based ADSL services and optical-based broadband services have begun to replace NTT's traditional ISDN-based services. 8 MORGAN JOSEPH & CO. INC.
Other Competition KDDI KDDI Corporation was formed in October 2000 through a three-way merger between DDI, KDD, and IDO Corporation (KDD was founded in March 1953, DDI was founded in June 1984, and IDO was founded in March 1987). While the company's largest business is its mobile voice and mobile data services, KDDI is also one of Japan's largest providers of fixed voice and data services, and recent transactions are moving the company into the video business. As part of its Dion subsidiary, KDDI offers optical fiber services under the Hikari Plus brand (triple-play services including voice, video, and broadband Internet access) and copper-based services under the Metal Plus brand (ADSL broadband and IP telephony). As of the end of October 2006, total Dion subscribers totaled 2.8mm across the product offerings (the company does not break out its subscriber base by service type). KDDI, we also note, is working to transition its core network to full IP by March 2008, which will enable the company to continue to expand its network services, including improved and faster broadband, converged fixed and mobile services, among others. In March, the company acquired a 38.18% stake in Japan Cablenet (JCN), the second largest cable operator in Japan. KDDI acquired the stake in JCN from SECOM Corporation (SOMLF.PK - $52.17 - OTC) and Marubeni Corporation (MARUF.PK - $4.95 - OTC) and, if the company completes the transaction to buy out a series of minority shareholders, the total ownership stake would rise to 47.30% for a total price of 33.5bn. The acquisition will allow KDDI to expand its optical services footprint and also give the company the initial framework through which it will offer quadruple-play services, now that it has ownership of a video delivery platform. In addition to this acquisition, the company announced that it would merge with Tokyo Electric Power (TKECF.PK - $31.80 - OTC) or TEPCO's POWEREDCOM business in order to further expand its fiber-based telecommunications services. Furthermore, the company is also exploring the purchase of TEPCO's traditional cable services business. KDDI's Metal Plus business is an ADSL-based product that features direct-access, fixed-line telephony services over a KDDI provided line that also generates additional revenues for the company because they must pay for calling services, a basic monthly charge, and optional ADSL broadband Internet. The company is planning a significant footprint expansion for its Metal Plus service in 2H06 in an effort to significantly update and expand its subscriber base. We note that as of the end of March 2006, the company had extended its Metal Plus service to 1,470 of NTT's central offices, encompassing about 65% of the Japanese market. On the fiber side, the company's Hikari one services are being offered in partnership with TEPCO and were launched in June 2006 in Tokyo. Services are being marketed to residential customers in condos and MDUs under the Hikari one Condos brand and to separate homes under the Hikari one Home brand. The network is based on GE-PON (gigabit ethernet-passive optical network) technology. Over this advanced network, KDDI is delivering a full triple-play service, including voice, data, and video. SoftBank SoftBank Corporation (SFTBF.PK - $20.90 - OTC) was founded in Tokyo in September 1981 as a packaged PC software distributor and, heading into the late 1990s, had become a leading technology and Internet investment company in Japan. The company established its Yahoo! Japan (4689-45,900 - TSE) business in 1996 and began Yahoo! Broadband ADSL service in September 2001. In July 2004, the company acquired 9 MORGAN JOSEPH & CO. INC.
Japan Telecom and later, in December 2004, began fixed-line communications services using DSL technology. Overall, SoftBank today is a diversified multimedia company that provides next-generation broadband content through its extensive suite of broadband services and telecommunications services. Of the company's five core business lines, we will focus on broadband infrastructure and traditional fixed-line telephony. The company's broadband infrastructure business delivers high-speed Internet access and limited IP-based telephony services using the Yahoo! Broadband brand name. SoftBank delivers ADSL-based broadband services using NTT's local access copper loops, which are currently capable of delivering download speeds of up to 47.0Mbps. At the same time, SoftBank is now using IP telephony technology to deliver telephony services to customers taking a broadband access product. Today, SoftBank has approximately 35% share of the Japanese ADSL-based broadband access market (a close second to NTT) but is losing some share in the overall broadband market due to the expansion of FTTH services in Japan. On the fixed-line telephony side, the company's acquisition of Japan Telecom in July 2004 brought with it over 6.0mm voice and data access lines, of which only 27% represented business customer relationships. These lines are all fully unbundled and give Japan Telecom the ability to completely own the access portion of the network to the customer premise. Since the acquisition, Japan Telecom has continued to expand its retail presence and its "Otoku Line" service. On the mobile side, Softbank recently entered the business in a big way through its acquisition of Vodafone Japan (VOD - $27.74 - NYSE) earlier this year. In March 2006, SoftBank announced that it would acquire 97.68% of Vodafone Japan, valuing the company at an enterprise value of about 1.8tr or about $15.6bn. The deal closed in late April 2006. The acquisition brings SoftBank 15.2mm mobile subscribers in the Japanese market and gives the company a business that Vodafone thought would fit better with local leadership. The business is now called SoftBank Mobile and it offers a full suite of mobile services, including high-speed 3G mobile broadband, video calling, a full suite of messaging, and mobile web. In addition, the company offers prepaid service plans and global calling plans. We note that services are available across Japan but are primarily offered in the more urban areas of the country. One other piece of the Softbank puzzle is Yahoo! Japan, a joint venture between Yahoo! and Softbank that was started in January 1996 and began service using the Yahoo! JAPAN search engine in April 1996. In late 1997, the company began introducing additional services, including My Yahoo!, Yahoo! Shopping, Yahoo! Auction, Yahoo! BB, and BB Mobile, among others. Today, Yahoo! BB has over 5.0mm ADSL service subscribers and is now shifting its focus towards other broadband service providers. In October 2004, the company launched its Yahoo! Broadband Optical services. The company's broadband services offer data speeds that are identical to those offered by NTT (a maximum of 100.0Mbps upstream and downstream) given that service is provided over NTT's access lines. In addition, the company offers 24 video programs in its basic package and even offers VOD services to subscribers. Finally, Yahoo! BB offers triple-play bundles in partnership with other providers. K-Opticom Corporation (Kansai Electric Power Corporation) Kansai Electric Power Corporation (9503-3,070 - TSE) founded its K-Opticom subsidiary in October 1985 and began telecommunications services in March 1987 in the Kansai region of Japan. The company began deploying its optical broadband Internet service in June 2001, deployed its optical cable television services in 10 MORGAN JOSEPH & CO. INC.
November 2003, and its optical telephony services in April 2005. Today, K-Opticom provides a full suite of triple-play services over its optical network in Kansai and can deliver extremely high speed data services, with download speeds of up to 100.0Mbps. Usen Corporation Broadcaster USEN Corporation was founded in 1961 and began its cable music broadcasting operations in September 1964. In July 2000, the company acquired a telecommunications carrier license and began commercial FTTH-based telecommunications services in March 2001 under the BROAD-GATE 01 brand. USEN has since transitioned its commercial services business to the BROAD-GATE 02 brand name and can offer access at up to 1.0Gbps to certain commercial customers. On the consumer side, the company launched its GyaO Hikari FTTH business in April 2005 and can offer high-speed residential broadband Internet access (at download speeds of up to 100.0Mbps), IP telephony services, and other transmission services for consumers. Currently, the company's broadband and telecommunications business has 543,000 total customers with 423,000 FTTH subscribers. eaccess The company's eaccess (ECLTF.PK - $705.00 - OTC) was founded in November 1999 in Tokyo and has grown into the largest ADSL wholesaler in Japan. eaccess began commercial ADSL service in April 2000 using the backbone infrastructure of NTT. The company today offers a wide range of high-speed broadband services and a IP-based telephony service as well. The company offers broadband speeds that range from a minimum of 1.5Mbps downstream all the way up to a maximum of 47.0Mbps downstream (including upstream data speeds of up to 5.0Mbps). Broadcaster Competition The Japanese market's most high-profile television content providers are the country's publicly funded broadcaster, NHK, and the five major private broadcasters (NTV [NPTVF.PK - $125.18 - OTC], TBS [TKOBF.PK - $22.25 - OTC], Fuji TV [4676-240,000 - TSE], TV Asahi, and TV Tokyo [9411 - $4,410 - TSE]). In addition, Jupiter TV is the content asset owned by Liberty Global in Japan. NHK is essentially the equivalent to PBS in the US (with the primary exception of funding, which is explained below) while the five major commercial operators are equivalent to the major broadcast networks in the US. Unlike in the US, where the broadcast networks carry many viewers but compete with a full range of television programming that is accessed through cable and satellite broadcasters, the Japanese broadcast networks and public broadcaster dominate the television market, with a vast majority of Japanese television viewers getting their programming through these six sources. 11 MORGAN JOSEPH & CO. INC.
Table 5: Japanese Broadcasters - 2005 Revenues (in millions) F2006 Revenue ( ) F2006 Revenue ($) Revenue Share NHK 600,000.0 $5,194.2 28.6% NTV 346,642.0 $3,000.9 16.5% TBS 306,041.0 $2,649.4 14.6% Fuji TV 381,564.0 $3,303.2 18.2% TV Asahi 249,384.0 $2,158.9 11.9% TV Tokyo 119,707.0 $1,036.3 5.7% Jupiter TV 91,629.5 $793.4 4.4% Total 2,094,967.5 $18,136.3 100.0% Source: Company reports Jupiter TV Jupiter TV, a joint venture operated by Sumitomo and Liberty Global, is a multi-channel content provider whose television content appears on multiple delivery platforms, including cable, digital communications satellite, and IP broadcasting. The joint venture company is involved with 18 separate channels in various ways, including direct investment, management, back office support, and program production, among others. The channels include MoviePlus, LaLa TV (lifestyle and entertainment for women), Golf Network, Shop Channel (live TV shopping), Reality TV, Discovery Channel, Animal Planet, Discovery HD, J Sports 1, J Sports 2, J Sports Plus, J Sports ESPN, AXN (action and drama programming), Kids Station, Anime Theater X (premium anime), Nihon Eiga (Japanese movie channel), Jidaigeki (samurai drama channel), and Nikkei CNBC. The company has, recently, started two additional businesses aimed at taking advantage of the growing demand for on-demand video services and for broadband video services. Jupiter VOD is a video content aggregator that provides cable operators and IP television operators with a variety of content (including films, dramatic shows, sports, animation, and documentaries) for use in their VOD services. This business draws on both the rights that its parent company holds worldwide and its own agreements that it currently holds with a variety of movie studios worldwide. On the broadband side, Online TV is a supplier of video content and video broadcasts to broadband customers who access the Internet using ADSL and FTTH broadband technologies. NHK NHK, the Japan Broadcasting Corporation, was founded by the Japanese government in 1925 as a radio broadcaster and began its first television broadcast in 1953. A publicly owned company, NHK is financed not directly by the government, but instead by a receiving fee (approximately $12.00 per month) that each household owning a television set is supposed to pay to the government (but is not mandated to pay). The company currently operates five television stations (and three radio stations) of which two are broadcast over terrestrial airwaves and three are broadcast via satellite. NHK began digital satellite broadcasts in December 2000 and terrestrial digital broadcasts in December 2003. NHK has been at the center of significant controversy during the past few years as a number of officials have been forced to resign following several embezzlement scandals (including one that totaled $855,000) and even a scandal in which a government official pressured the station to alter a documentary on WWII sex slaves. In large part due to the prolonged period of scandal at NHK, the company's most recent offense has pushed many 12 MORGAN JOSEPH & CO. INC.
Japanese to withhold their receiving fees in protest. This offense is centered around the head of sports news in Sapporo, Tetsushi Oshita, who requested repayment for $145,000 in fraudulent expenses over a four-year period. As a result, nearly 1.5mm households have refused to pay the receiving fee asked of them. On the terrestrial side, NHK provides two digital channels that are beginning to provide a growing amount of programming in HDTV (high definition television). General TV is the company's main channel, offering a wide range of general programming in each genre, including news/information, current affairs, creative programming, entertainment, animation, and variety programming. In addition, the channel broadcasts a series of NHK Special documentaries in primetime slots. Educational TV is the company's other terrestrial channel, an education centric channel, which presents a broad range of educational programming (including general education, hobbies, foreign language learning, and health) for all age groups. The channel also creates broadcast programming for schools, which is used to supplement the curriculum in about 80% of Japanese elementary schools. On the satellite side, the company began broadcasting in 1989 and now reaches over 17mm total households with three channels. BS-hi is the company's top satellite channel that broadcasts solely in HDTV, offering programming in all genres, including news, documentaries, sports, drama, music, and entertainment. NHK also includes data broadcasting and interactive TV applications on its BS-hi channel. The BS-1 channel includes national and international news and national and international broadcasts of live sporting events. It also features documentary programming from international sources. Finally, the BS-2 channel includes Japanese and Western movies, music, nature documentaries, travel documentaries, and other internationally made television dramas. The channel also broadcasts South Korean-made dramas. Nippon Television Network Corporation The Nippon Television Network Corporation began its first commercial television broadcasts in black and white in August 1953 before moving over to the color format in September 1960. The company operates the Nippon News Network and the Nippon Television Network System, which provide news coverage and nightly news broadcasts on the company's analog and digital stations. Nippon Television Network Corporation currently operates two stations, one analog station (Nippon TV Analog TV) and one digital station (Nippon TV Digital TV). Nippon TV's digital programming is now completely available to all its service territories. To take digital television programming beyond standard broadcasts, the company is now working to transition its digital programming to HDTV, which it will eventually offer to over 80% of Japanese households by 2007. In addition, the company is working to deliver data broadcasts over its terrestrial channels. Fuji Television Group The Fuji Television Group was founded in November 1951, began full-scale commercial television broadcasts in March 1959, and launched its first digital signal broadcast in December 2003. Today, Fuji Television Group operates both an analog station (Fuji Television) and a digital station (Fuji Digital Television) ahead of the analog switch-off planned for 2011. Fuji Television, like the other terrestrial broadcasters in Japan, is working on developing next-generation 13 MORGAN JOSEPH & CO. INC.
strategies for its broadcasts. First, the company is moving an increasing amount of its programming over to HDTV now that its digital signal reaches most of its coverage area. This is being accomplished by spending on new equipment for the company's studios, which produce everything from television series to news and information programs. Second, the company began, in April 2006, a service where its broadcasts can be viewed on mobile devices, including cellular handsets. This allows consumers to receive programs anywhere they may be and, secondarily, has given the consumer a news and information outlet during emergency situations. TV Asahi Corporation TV Asahi was founded in 1957 as Nihon Educational Television. The company was established as a commercial provider of educational television whose broadcasting license initially required that it devote more than half of its airtime to educational programming and nearly one third of its airtime to educational programming aimed at kids. In 1960, as the initial business model began to falter, the company began airing manga cartoons and movies before beginning color broadcasts in 1967 and fully transitioning to a general broadcaster in November 1973 when it received a general purpose station license. TV Asahi began digital broadcasts in December 2003 and today operates an analog station (TV Asahi) and a digital station (TV Asahi Digital Television). As we have pointed out with most of the broadcasters in the Japanese market, TV Asahi is expanding the scope of its digital programming to include HDTV and other mobile applications. The company's digital broadcasting is now delivered to devices such as PDAs (personal digital assistant) and cellular handsets while TV Asahi also delivers interactive programming to viewers as well. On the interactive side, the company is working with audience participation in certain programs like TV shopping and quiz shows, inviting viewers to guess along with contestants, buy products, and even vote with other viewers. Tokyo Broadcasting System Tokyo Broadcasting System was founded as Radio Tokyo in May 1951 and began its initial radio broadcasts in December 1951. The company began analog TV broadcasts in April 1955, initial digital TV broadcasts in December 2003, and full power digital broadcasts in December 2005 (which has driven coverage to over 90% of residents). Today, the company broadcasts via an analog television station (TBS Television) and a digital television station (TBS Digital Television). The company is driving HDTV programming deeper into its station lineup given the widespread availability of digital signals in Japan, having finished the HD conversion of its studios. Like the other broadcasters, the company is moving toward the one-segment services, which will allow it to deliver television viewing to mobile devices (like handsets and PDAs) while viewers are in cars, trains, at cafes, or in other locations. Tokyo Broadcasting System has also developed a movie distribution business in partnership with several other broadcasters (TRESOLA Corporation) to create broadband Internet-based VOD services. TV Tokyo Corporation Television broadcasting by TV Tokyo Corporation began in April 1964 when a station was started by the Japan Science Promotion Foundation to deliver educational and cultural programming to Japanese viewers. In 14 MORGAN JOSEPH & CO. INC.
July 1968, Tokyo Channel 12 Production was started and the company took over the station from the foundation in October 1973, changing its name to TV Tokyo in 1981. Today, TV Tokyo broadcasts solely in digital (since December 2003) to approximately 32.0mm total Japanese households, including 16.0mm total households in Tokyo alone. The company today broadcasts a wide variety of programming including business, news, anime, and infotainment (the company defines this genre as a mix of information and entertainment). TV Tokyo also licenses its television programming to local terrestrial stations, satellite broadcasters, cable operators, broadband Internet service providers, and other international media outlets. Regulatory Issues There are two major laws that govern cable operators in the Japanese market, the Cable Television Broadcast Law (1972), which deals specifically with the provisioning of cable television services and the Wire Telecommunications Law, which deals, in general, with all telecommunications in Japan. The MIC (Ministry of Internal Affairs and Communications) is the regulatory body that oversees these laws. However, for the purposes of discussing cable television regulations, we will focus on the Cable Television Broadcast Law. While the Cable Television Broadcast Law is one of the strictest outlines for provisioning of cable television services worldwide, in truth, the process to begin provisioning cable services is relatively routine. The law provides a very detailed framework and requires that operators provide an extraordinary amount of information to the MIC before they begin to deploy their network, provision services, and make any changes to their services. Initially, to install a network that will reach more than 500 drop terminals, an operator must apply for and obtain a license from the MIC. To be granted this license, the network operator must provide information to the regulator, such as planned installation facilities, planned frequency usage, and target financial estimates, among others. If, at any point during the installation and/or operation of the network, the operator decides that it wants to make a change to the initial plans, it must seek and receive approval from the MIC. Once the network is built out, the MIC requires that cable service providers give prior notification before the operator begins to provision its services. Information needed before the operator goes ahead includes planned service area, frequencies to be used, and planned broadcasting services, among others. Finally, before the operator provisions its services, it must also provide the MIC with its schedule of charges and service tariffs and planned tariffs in connection with the mandatory re-broadcasts of certain television content. As in most other cases, operators must also notify the MIC if they plan to change their charge and tariff structure, but approval is not necessary. Beyond the network and service deployment regulations that cable operators face, they must also comply with a number of very specific guidelines as they build out their networks and carry out their day-to-day business operations. These include: Editing standards Making facilities available for third party use for cable broadcasting services (subject to availability of capacity) Providing service to any customer who requests it (absent reasonable grounds for refusal) Obtaining retransmission consent where retransmissions occur unless required by law Obtaining permission to use public roads for cable installations Perhaps the most important piece of regulation within the Cable Television Broadcast Law surrounds 15 MORGAN JOSEPH & CO. INC.
retransmission. According to the law, any cable television service provider that operates in locations where standard satellite or terrestrial programming cannot reach single family homes or multi-dwelling units must provide free re-transmission services. The operator is obligated to receive all applicable programming, both satellite and terrestrial, and provide it intact to applicable homes. Given that J:COM is clearly the largest cable television provider in Japan, the company naturally serves the largest number of re-transmission customers (over 3.0mm subscribers in total as of the end of 2005) but does not include these subscribers in its paying subscriber count. One of the biggest pushes by J:COM is to convert these more than 3.0mm subscribers into actively paying customers who take advanced services like broadband Internet and telephony and advanced digital video. On the telecommunications side, the MIC also regulates broadband Internet and telephony services under the terms of the Telecommunications Business Law. Perhaps the biggest piece of regulatory lawmaking to come out of the MIC on the telecommunications side was the May 2001 debut of MyLine. The MyLine system was created with the goal of further deregulating and streamlining the interconnection structure of the telecommunications market in Japan. Customers register with their switchboard at NTT East or NTT West (these two operating companies under the NTT umbrella act as the main local loop providers in Japan and own the local loop access to subscriber homes), their preferred local access carrier. Following registration, customers no longer need to dial carrier access codes before dialing a telephone number, a significant change since subscribers used to avoid dialing carrier access codes only when dialing into the NTT East and NTT West systems. The services available to consumers fall into two categories, MyLine and MyLine Plus. MyLine is a carrier selection service that allows the consumer to select their preferred telecommunications carrier, register that selection with either NTT East or NTT West, and then make their calls using the services of the carrier they have selected without having to use the carrier's access code. However, customers who elect to use the MyLine service and make calls using the access code of a carrier other than the one they have selected and registered with will be connected over the carrier network whose access code they have dialed. Similarly, any customer using MyLine who has a phone capable of dialing out using automatic carrier routing technology will be connected by the carrier the phone selects. MyLine Plus is a carrier designation service that allows consumers to, like those using the MyLine service, select their preferred carrier, register that selection with NTT East or NTT West, and then make calls using their selected carrier without dialing the carrier's access code. However, unlike MyLine, subscribers using the MyLine Plus service who dial the access code of a different carrier will be connected using the network of the selected carrier, not the dialed carrier. However, in certain cases, different carriers can be selected using a certain preset code, which allows the subscriber to override the system. 16 MORGAN JOSEPH & CO. INC.