At&T Tci: Telecom Unbound

The merger could deliver on the promise of melding telephones, TVs, and computers

We've all seen it before--two powerful executives, presiding over a hastily convened news conference to announce their new world-shaping combination. They stand, gripping and grinning for the cameras, zipping off sound bites for the evening news, and predicting that their megamerger will be the combination of resources, talents, and technology that finally brings the future into the present.

Indeed, as John Malone stood on stage with AT&T CEO C. Michael Armstrong on June 24 to announce their $48 billion deal, it was impossible not to recall how five years ago, he stood with Bell Atlantic CEO Ray Smith to announce a similar groundbreaking deal. That botched merger attempt led many to question the whole concept of "digital convergence"--the notion that telecommunications, television, and computers would all come together in a single, digitized system of electronic communications.

Well, a lot has changed since then. The technology to transport high-speed digital signals--for voice calls, video, or virtually any form of communication you can name--is vastly more powerful and less costly. The Internet and the Web have created a standard "platform" for managing all this digital traffic, and the Telecommunications Act of 1996 has reduced--but not eliminated--anachronistic barriers between communications markets.

And in an ironic twist, AT&T, the company that has perhaps missed the most opportunities in the new world of digital communications, has come up with the deal that, if it works, will take advantage of all these trends--and could be the catalyst for other deals and business plans that break the bottleneck and finally deliver on the promise of digital convergence. "This is the deal that's going to get competition going," says former FCC Commissioner Reed Hundt. "This is exactly what regulators envisioned--consumers having choice."

What will that choice be? For starters, the new AT&T is now in position to be the first nationwide communications company--since the breakup of the old Bell system--that solves the "last mile" problem. Now, the only way to bridge that final gap to the user's home is via a local phone company. Because of the last mile bottleneck, there has been virtually no competition in local residential phone service, innovation is almost nonexistent, and connections to the Internet have been painfully slow. Once TCI's cable network and set-top boxes are upgraded to handle a two-way flow--no easy feat, mind you--AT&T can use the cable company's coaxial connections to transmit local and long-distance voice calls, Internet traffic and the usual cable fare.

And then? Let your imagination run wild. Video voicemail will be a cinch. If a guest comes to stay for the weekend, you'll be able to order him a second phone line--and probably even give him the same number he has at home. Electronic commerce is likely to flourish as consumers can more easily cruise the Internet and as television melds with the Net. As TCI Chairman and CEO John Malone puts it, you'll be able to order Viagra online while you're watching your favorite show. "Just point and click," he says. "Do it on the fly."

What puts this vision within reach now is a host of new technologies that are smoothing digital connections. Most important, the technology for providing telephone service over the cable network is now developed enough to offer an economically feasible--and potentially much better--alternative to the existing copper wire. While the costs of cable telephony have been prohibitive in the past, they've now dropped to the point where Armstrong expects to spend as much as $400 to $500 per home. Other cable companies have also shown that it works. MediaOne Group is offering cable telephony in Atlanta and Los Angeles--and says it has captured a 10% market share in the slices of those markets it has entered.

Cable isn't the only way to bridge the final mile, either. While TCI and its affiliates can reach 33 million homes in the U.S., AT&T plans to continue to experiment with wireless technology that it will deploy outside of the TCI region. That technology will be tested in several thousand homes next year and, if the tests are successful, it will be rolled out commercially in 2000. "We need to own our own facilities," says Armstrong. "We need to control our service, and we need to control our costs."

However AT&T--and rivals that follow--approach these new networks, it won't be cheap. The costs of upgrading TCI's entire infrastructure so that it can provide telephony and high-speed Internet access are enormous--about $15 billion for TCI and its affiliates, by Armstrong's reckoning. And some analysts think those numbers are low. They forecast that the costs could hit $20 billion or more.

Think of it this way: AT&T has bought the dirt road that leads to American homes. Now it must grade it and pave it to carry all the new traffic. "What's wrong about this deal is that TCI is not in the local phone business," says Mark R. Bruneau, president of Renaissance Worldwide Inc. "So it is a big gamble." On the other hand, AT&T is one of the few companies that can fund such an undertaking: It has $8 billion in annual cash flow and little debt.

Cost isn't the only issue, however. Although the technology for pushing voice traffic over cable works with small numbers of customers, some experts think it will be problematic if used widely. "That technology is just not at hand," says Michael Noll, a business professor at the University of Southern California.

Another risk to the deal? Under current telecom law, if AT&T pays to upgrade TCI's network for telephone service, AT&T will have to let competitors also use the infrastructure at a wholesale discount. That prospect convinced Sprint Corp. CEO William T. Esrey to walk away from a similar deal with a group of cable companies including TCI. "If we provided telephony service over cable, we recognized that they would have to make it available to competitors."

That may not be such a big issue for AT&T, however. By using the cable network to provide high-speed connections to the home that are 20 to 30 times faster than what the Baby Bells and GTE now provide, AT&T expects to produce a massive pipeline that can carry all sorts of traffic at relatively low cost. "We could have a universal pipe in the home that handles all flavors of what will then be digital, including video, voice, and data," says Van Baker, director of consumer research at market researcher Dataquest.

That opens up a potential bonanza of services beyond telephony. Web sites will be able to incorporate video. You'll be able to jump from a commercial to the advertiser's Web address. And video telephony will become much simpler and more affordable. "Your grandkids are going to laugh at us for using these little black things to talk on without looking at each other."

That poses the most profound challenge the local phone companies have ever encountered. So far, the Baby Bells have rolled out broadband services for consumers slowly--if at all. Few want to market a low cost alternative that could cannibalize their high-margin sales to businesses. But with AT&T planning to roll out high-speed services, the Bells will have to get serious about providing high-speed access of their own or face a revolt from customers. "If the AT&T-TCI deal goes through, that will create more competition, which in turn will accelerate the buildout of high-bandwidth connections to the home," says Lawrence E. Ellison, CEO of Oracle Corp.

AT&T isn't the only company using new technologies to muscle in on the local phone companies' markets. Earlier this summer, Sprint announced plans for a number of "integrated services," including local service, over high-speed connections. And cable companies trying to sell telecom services think AT&T's entry into cable telephony will help them. "By virtue of AT&T battling, that helps any cable operator, even those that aren't affiliated with AT&T," says Dallas Clement, treasurer for Cox Communications.

Local phone companies will have to scramble to find ways to provide similar services to their customers. So far, U S West is the only Bell that has announced aggressive plans to roll out high-speed Net connections.

The Bells certainly have the opportunity to provide high-speed connections--and the additional services that they make possible. The Bells have started to deploy digital subscriber lines (DSL), which provide speeds as fast as 1.5 megabits per second over copper wire. Although there are now several different flavors of DSL, which has contributed to a delay in wholesale rollout, many experts think the phone companies are further along than the cable companies.

Time to market, rather than technology, is likely to separate the winners from the losers. The first to offer high-speed connections is likely to be able to skim off the cream of consumers, who most value use of the Internet. Since there are economies of scale to be had from rolling out high-speed connections, the company that gets a headstart will have a significant advantage. Asks Christopher Mines, telecom analyst with Forrester Research, "Can AT&T-TCI be the first one there? They take a giant step with this deal."

It's a step that some observers say AT&T almost had to take. "Frankly, it allows AT&T to diversify out of the consumer long-distance business before it completely collapses," says Craig Moffett, vice-president and telecom specialist at Boston Consulting Group. In fact, as part of the June 24 announcement, AT&T disclosed its plan to separate the consumer business into a new unit with TCI's cable service called AT&T Consumer Services. The $33 billion group, with AT&T President John D. Zeglis as its CEO and TCI's Leo J. Hindery as president, will have its own stock. It's mission will be to sell all sorts of consumer services--cable, wireless, local and long-distance, and Internet services. What remains of AT&T will be the long-distance network and the corporate business.

Armstrong describes the new consumer company as the high-growth--and high-risk--portion of the AT&T portfolio. Indeed, there are plenty of doubters who wonder why AT&T, which has failed so often in its attempts to conquer cyberspace, will now prevail. Such concerns helped knock AT&T's stock down 8%, to $60, on the day of the announcement.

Still, AT&T's deal with TCI likely marks a turning point in the evolution of communications. It's the beginning of the breakdown of the Baby Bells' monopoly over the last mile. "This looks like the break in the dam," says Kevin Costello, a partner in global communications and entertainment at Arthur Andersen. A flood of new communications services is on the way.

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