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Pipe Dream?

Will AT&T and AOL Time Warner put aside their differences and create the Godzilla of cable TV systems? That's the big question on Wall Street as the massive telco and the country's largest content and Internet service provider checked each other's teeth in preliminary talks over a reportedly friendly merger of their cable units.

This turn of events must be delicious irony for AT&T's embattled CEO, Michael Armstrong. In February, 2001, AOL TimeWarner Chairman Gerald Levin held Armstrong's corporate feet to the fire with what was considered a lowball offer for the cash-strapped telco's 25% stake in Time Warner Entertainment. Armstrong needed to dump the closely held shares -- then estimated to be worth $9 billion to $10 billion -- to allay the Federal Communications Commission's antitrust concerns over his deal to buy cable company MediaOne.

WHAT'S LEFT? Today Armstrong looks to be in a much stronger position and he should be able to command a decent price from AOL for his broadband assets. Thanks to strong subscriber growth for high-speed Internet access, AT&T reported surging revenues in its cable television unit in mid July. That news also provided some justification for Armstrong's rejection of the unsolicited $50 billion buyout offer from No. 3 cable company Comcast, which was tendered on July 8.

At first glance, a deal with AOL would seem to be a huge plus for AT&T. It could unload its TWE stake as part of the transaction, and the deal would give AT&T the cash to free itself of billions of dollars in debt accrued during Armstrong's buying binge of the past two years. Also, it would be vindication of the company's strategy to split into four units and sell off the pieces.

Shareholders, however, might find the deal less than appetizing. AT&T initially paid $100 billion to build its broadband unit. Then it sunk billions more into upgrades to create Armstrong's dream data network. Now, just as the revenues start to roll in and the tide looks to be turning, selling the cable system would render most other parts of AT&T's business worth very little in Wall Street's eyes.

NEW STRATEGY. AT&T Wireless, which reported stellar earnings on July 24, is already off on its own and has a bright future. But earnings potential for its consumer long-distance business is likely to diminish further. Price wars have turned that one-time cash cow into a commodity white elephant. AT&T looked set to turn the corner in the consumer business, too, by selling local phone service bundled with its Internet services over cable pipes, but it will have to reassess that strategy if AOL ends up managing the cable assets.

For AOL shareholders, it's a completely different picture. The more cable pipes AOL controls and the larger its customer base, the better the company can leverage its massive content holdings and sell directly to subscribers. Plus, AOL would get a zippy cable system with lots of fresh technology upgrades at the bottom of the market. Considering that its stock has held up far better than many other companies', AOL is thinking about acquisitions. Witness the $100 million stake it took in beleaguered on July 23. That deal contained a buyout clause that would allow the ISP to swallow the online bookseller.

The upshot? Armstrong shouldn't play his hand until AOL comes in with an offer that dwarfs the Comcast bid. The Street seems to be fixated with a price tag of $70 billion. Both AOL Time Warner and AT&T are mum for the time being. The debt relief would be nice for AT&T, but selling just as he's bouncing off the bottom could make Armstrong look like an amateur poker player. By Alex Salkever in New York

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