Tci And At&T May Connect, But Can They Work?

John Malone and Mike Armstrong are about to hatch some big deals

In January, as he made his first major presentation to Wall Street analysts, AT&T CEO C. Michael Armstrong found himself violating the company's policy of not commenting on possible deals. The reason? The market buzz about a merger with Tele-Communications Inc. (TCI) had become a roar. "We won't be announcing a cable acquisition at the end of the meeting or in the near future," he told the crowd.

Well, maybe not an acquisition. But more deals between Armstrong and TCI's CEO John C. Malone seem about to hatch. The two execs are negotiating a pair of investments that would bind the two companies more closely together and give AT&T a critically important path to enter the $100 billion local phone market. AT&T is discussing a $1 billion-plus investment in @Home Corp. in exchange for an equity stake in the high-speed Internet access provider, whose largest shareholder is cable giant TCI.

On Feb. 20, @Home confirmed the AT&T talks, sending its shares soaring. AT&T would market the @Home service to its customers, and it would probably fold its WorldNet Internet service's 1.1 million subscribers into @Home. According to one AT&T source, the giant is looking to get a 20% @Home stake--as large as TCI's--so that it will have an equal say in management.

AT&T is after more than fast Internet links. What AT&T hopes for is a means to end-run the Baby Bells and provide local phone service over the cable network. That would not only save $16 billion in access charges AT&T pays local carriers annually but also give it control over its service. To that end, AT&T is discussing a separate investment in TCI that could reach $1 billion. That could be a flat equity investment--or the phone company may chip in $100 for every set-top box when TCI starts deploying telephone-capable boxes in 1999.

While a TCI investment could come by mid-March, the @Home deal may take longer. @Home is talking about merging with the Net access businesses of Time Warner Inc. and U S West Media Group. Since that would make @Home more attractive to AT&T, Malone wants the deal cut before moving forward. TCI, however, is motivated to make a phone deal: Malone regards Internet telephony as one of his most promising avenue for growth. Neither AT&T nor TCI would comment on negotiations.

Even if Armstrong and the notoriously tough Malone come to terms, cable telephony is far from a sure bet. They need to agree on who will invest the billions needed to upgrade the cable network for voice and how to divvy up calling revenues. Even then, AT&T could end up with poor-quality service that would hurt its reputation. The Internet technology that AT&T and TCI plan to use has proved problematic, and what's more, cable networks are so far not as reliable as phone systems. "If they're trying to use this as a bridge to the local customer, it's a very weak bridge," says Scott C. Cleland, an analyst at Legg Mason Inc.'s Precursor Group.

LITTERED PATH. Armstrong may have to chance the crossing. AT&T's acquisition of Teleport Communications Group, an "alternate access company" partly owned by TCI and other cable companies, gives it an entree into the $20 billion local business market. But Armstrong still needs an economical way into the $80 billion residential market--before the Baby Bells start offering long-distance service. Potentially, cable telephony gives AT&T what it needs to match the new competition with a local and long-distance bundle.

Still, more cable-telco deals have been drawn up than carried out. In 1993, Malone agreed to merge with Bell Atlantic Corp. That fell apart two years later, when Bell Atlantic went sour on cable. In 1996, Sprint Corp. had big plans to provide local phone service over the cable network. That prospect died because the costs were prohibitive. "What does AT&T know that Sprint didn't know?" says Cleland. Another question for Mr. Armstrong.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE