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Why the Cloud Is Key to Charter’s Big Deal for Time Warner Cable

Anyone looking to understand the reasons behind the $78.7 billion deal that Charter Communications struck with TW Cable last week need look no further than their own set-top box.

Cable boxes, and more broadly the platforms and apps that TV services are being delivered on, have become a battleground for an industry trying to reinvent itself, with innovation being driven by fast-moving tech companies from Netflix to Apple.

In that context, the Charter deal shows that innovation can come in myriad ways.

For instance, had Comcast been permitted to acquire Time Warner Cable, then the Philadelphia-based company’s souped-up, state-of-the art X1 box would have become the standard for transitioning TW Cable customers. But if regulators approve Charter’s offer, it’s doubtful current boxes will get swapped out any time soon — and yet they won’t go without upgrades.

Think of the X1 as the Mercedes of cable boxes. It’s new, shiny and powerful, and offers access to next-generation services. But like a German auto maker, Comcast is very protective of its X1 platform; the company hasn’t added any third-party video apps to the X1 — no Netflix, no YouTube, no Hulu — with Comcast executives reticent about opening up the X1 platform to perceived competitors. And just like a new Mercedes, the X1 box still carries a mark of exclusivity: It has taken Comcast years to roll out the platform; only 25% of the company’s triple-play customers have an X1.

Charter, on the other hand, is using a much more prudent approach to upgrade its aging set-tops — and one that’s faster to roll out: Instead of replacing boxes in every single household, the company has built a user interface in the cloud that is being sent to existing boxes in the form of a video stream. A Charter customer can even continue to use his old remote control; his set-top box simply sends each key stroke to servers that take milliseconds to register updates as the customer browses the list of channels, or programs a DVR.

This cloud-based technology has been developed by ActiveVideo, a startup Charter jointly acquired with set-top maker Arris in April. The upside for Charter is that the technology is a lot cheaper than developing new hardware. In fact, cable analyst Craig Moffett believes it was key in making the numbers line up for Charter’s acquisition of Time Warner Cable. “This deal may not have been possible, at least at this price, without ActiveVideo’s technology,” he said.

But Charter’s take on the future of the set-top box isn’t just about the pocketbook. Shifting development to the cloud also allows the company to iterate more quickly, which mixes well with a willingness to open up the box to third-party services — and may even be the kind of inclusive technology that helps ease regulators’ concerns over a combined Charter-TW Cable being predisposed to conform to conditions of net neutrality. Charter CEO Tom Rutledge suggested in an interview with CNBC recently that Charter customers may eventually also have access to online video services from companies like Apple and Amazon through the company’s hardware. “All of that product can be integrated into our new user interface that will allow customers to seamlessly move between over-the-top and cable,” he said. “We think that’s a game changer.”

Others agree. “The natural evolution for pay-TV providers is to fully embrace OTT offerings,” said digital media veteran Jeremy Toeman. “Why shouldn’t Charter offer a customer Hulu as a premium bundle?”

For Charter, moving in that direction seems like a natural fit. John Malone’s Liberty Global empire, which owns a significant stake in Charter, already has begun to add YouTube to some of its cable TV properties in Europe, with impressive results: Ever since Liberty subsidiary UPC Direct in Hungary added YouTube’s app to existing cable boxes through Active-Video’s technology, 68% of UPC’s subscribers with access to the app have used it to watch YouTube through their cable box, with sessions averaging 45 minutes a day — while still watching lots of cable TV as well.

Most U.S. customers still use cable boxes, but the tide is turning. With the growing popularity of streaming devices like Roku, Apple TV and Chromecast, and the launch of new online TV subscription services from companies like Sling and Sony, cord-cutters and other young viewers are increasingly moving on from cable to stream everything to the screens of their choice. Cable boxes may eventually become obsolete altogether, as pay TV evolves to become just one app or online service among many — a future that seems much more aligned with Rutledge’s inclusive point of view than with the exclusivity of Comcast’s X1.

Said Toeman: “I’d be shocked if my 6-year-old son ever uses a cable box.”

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