Mike Armstrong's Last Stand

Can AT&T's CEO untangle the telecom's assets and reconnect with investors? Here's an inside look at his strategy -- and its prospects

In November, during a course she teaches at Northwestern University's Kellogg Graduate School of Management in Evanston, Ill., Oprah Winfrey delved into the topic of fear the way only the famous talk-show host can: She talked about her own trepidation in trying to teach a graduate course. Then she turned for more insight to her special guest for the class—none other than C. Michael Armstrong, chairman and CEO of AT&T. "What I tried to share with the students is that fear is part of life," he says. "To deny fear will really keep you from dealing with fear."

Armstrong ought to know, given the scary state of AT&T (T ). The company's core long-distance business is melting like a chocolate bar on a hot dashboard. Revenues for the business, which accounts for about half of AT&T's $67 billion in sales, tumbled about 11% last year, to $34 billion. The pace of decline is expected to accelerate to 17.5% this year, according to J.P. Morgan Chase. Armstrong's efforts to buy his way out of the mess by acquiring cable giants tele-Communications Inc. and MediaOne Group have saddled the company with an alarming $62 billion in debt. And new initiatives, such as selling high-speed Internet access and local telephone service over the cable-television network, are still too small to pick up the slack.

In a desperate attempt to rescue AT&T, Armstrong announced on Oct. 25 that he would break the 123-year-old flagship of the American telecom industry into four pieces. Armstrong argued that the restructuring would unlock shareholder value because the growth of the wireless and cable businesses won't be obscured by the declining long-distance business. But investors and analysts balked. The company's stock was whacked 13%, falling to 23 3/8 the day the restructuring was announced. And it ended 2000 down 66%, at 17 1/4, though it has recovered somewhat since then. "I think the plan is completely flawed," says Rob Gensler, manager of T. Rowe Price Associates Inc.'s Media & Telecommunications Fund.

If that wasn't bad enough, the plan has sparked a mutiny inside AT&T. The Communications Workers of America (CWA) and other unions, which represent about 35,000 of the company's 165,000 workers, are fighting tooth and nail to block the breakup. Worried that it will cost their members jobs, they're trying to persuade AT&T shareholders to vote against the restructuring. Union leaders even recruited New York State Comptroller H. Carl McCall, an ambitious politico who's considering a run for governor, to lure Armstrong to a meeting of institutional investors in December. Only the night before did Armstrong discover that the attendees were managers of union pension funds -- and largely hostile to his plan. "He sandbagged me," Armstrong said after the meeting, according to one insider.


  Now, Armstrong is making his last stand. Under attack from all sides, the fiercely proud 62-year-old in the twilight of his career needs to pull off one of the most complex and controversial restructurings ever. At stake is the future of AT&T -- and his own reputation. Armstrong was widely considered one of Corporate America's best and brightest when he landed at the telephone giant in 1997 after a sparkling career at IBM and Hughes Electronics Corp. But his ambitious attempt to restore Ma Bell to her former glory by making it the most important communications company of the Digital Age lies in tatters. If he can't make the breakup a success, he risks being remembered as the man who oversaw the demise of an American icon.

No question, Armstrong's struggle to remake the telephone giant is personal. He has been working 18 hours a day, spending his weekdays on AT&T's operations and his nights and weekends on the breakup. In between, he has crisscrossed the country, wooing investors, customers, and employees. He sees his family less and doesn't have time for the long Harley rides he once enjoyed. He even brought in a new president, David Dorman, previously CEO of the Concert joint venture between AT&T and British Telecommunications PLC, to run the core telephone business while he takes charge of the committee that is overseeing the restructuring. "Hopefully, that will give me some of my life back," he says. All the while, he exudes optimism. "For the next decade, several AT&Ts will prosper and grow and create value for share owners, whereas just three years ago, that was very uncertain."

For now, however, Armstrong is waging a grueling, inch-by-inch struggle to pull the company out of its morass. Interviews with more than a dozen AT&T insiders and 30 outsiders show that Armstrong is making progress in creating more valuable enterprises out of the wreckage that AT&T had become. Corporate customers, such as bookseller Barnes & Noble Inc., say the CEO's personal appeals have helped persuade them to stick with AT&T. Armstrong has raised billions of dollars to finance the company during its transition. And he has made progress in shoring up morale, with both pep talks and cash. In a development not yet made public, Armstrong persuaded his board to issue a special batch of new options for as many as 56,000 eligible employees.

What's more, AT&T's operations are providing some cause for hope. AT&T Wireless Group is expected to report a 35% rise in revenues last year, to $10.4 billion, about seven percentage points more than the industry's average growth. The cable-TV unit, called AT&T Broadband because it also offers high-speed Net connections, is expected to post revenue growth of 10.4% for 2000, slightly ahead of the cable-industry average of 8.9%.

J.P. Morgan Chase telecom analyst Marc B. Crossman estimates that with the tailwind of selling Internet access and cable telephony, the unit's revenue growth will accelerate to 16% this year. And BusinessWeek has learned that significant cost cuts are planned to boost the unit's profitability. AT&T Broadband could eliminate up to 2,000 positions, out of 53,000, over the next 12 months, people familiar with the matter say. Some of those workers will be reassigned to faster-growing markets.


  Investors are beginning to take notice. On Jan. 9, analyst Simon Flannery of Morgan Stanley Dean Witter, who has long been bearish on the company, reversed course by upgrading the stock to a strong buy from neutral. The breakup should be a "catalyst for outperformance over the next several months," he wrote in a research report. Since the beginning of 2001, AT&T's stock has climbed 35%, to 23. The rise, in part, came as experts realized the deterioration of the long-distance business was an industrywide phenomenon brought on by increased competition—not just an AT&T problem. And a similar restructuring at rival WorldCom helped to further vindicate AT&T's strategy, says Armstrong.

Not that it's time for Armstrong to take a victory lap. AT&T's stock is only back to where it was when the restructuring was announced. And BusinessWeek has learned that the company has run into substantial trouble in developing new cable-telephony equipment. The result is that the cost of signing up customers for local telephone service over the cable network will continue to be $600 per home for another year or two instead of dropping to $400 per home in 2001, as Armstrong had promised investors. AT&T confirmed the delay.

Meantime, the long-distance business continues to cast a pall over the rest of the company. Consider this: Long-distance revenues are expected to shrink by $6 billion this year, to about $28 billion, Crossman says. That means other lines of business would need to grow nearly 20% just to keep AT&T's total revenues even at $67 billion.

The two units that provide long distance have problems beyond evaporating revenues. AT&T Business, which gets more than half of its $29 billion in sales from long distance, lost corporate customers in late 1999 because of a chaotic sales-force reorganization. Insiders also say that Rick Roscitt, the unit's fourth president in three and a half years, may leave soon for another job. And AT&T Consumer, with 95% of its $19 billion in revenues coming from long distance, may need a cash infusion in the next two or three years just to survive. It's being loaded up with $9.5 billion in debt as part of the split, and its cash flow may not last the seven years necessary to pay that off, analysts say.

Armstrong believes only the strong medicine of a breakup can fix things. By busting up the company, he will make employees more responsible for the performance of their own businesses, force the four unit chiefs to slash costs, and enable investors to value each piece of the business on its own merits. That should boost the stock price because many investors want equity in one piece of the company but not the entire AT&T. If the four new businesses receive market valuations on par with those of comparable companies, says Crossman, AT&T's stock should rise 50% more, to the mid-30s, within the next 12 months. "If you buy the stock now, will you make money? Absolutely," says Crossman. "Long distance is melting down, but the outlook for the rest of the businesses isn't bad."

To understand why AT&T's prospects are changing, look at how Armstrong has spent the past 90 days. He has set an exhausting pace, trying to convince investors, bankers, customers, and employees that his plan is a winner. He has called the CEOs of insurance giant MetLife Inc. and hotel company Cendant to help close big contracts. He has cracked the whip like never before, weeding out the bottom 10% of the 8,000-person sales force at AT&T Business. "We're playing to win," he says.

The tale of how Armstrong started down this path begins further back than most would suspect. It was in November, 1999, that he first considered busting up the company. He was trying to persuade his close friend and confidant Charles H. Noski to join him at AT&T. Daniel E. Somers, the chief financial officer at the time, was moving over to head the cable business, and Armstrong needed a CFO who would carry weight on Wall Street. Noski, then president of Hughes, met Armstrong for breakfast at the Hyatt Regency Greenwich in Connecticut. Noski remembers the meeting well -- Armstrong had waffles, and he had eggs.


  Armstrong had spent the previous two years trying to rebuild AT&T into a juggernaut that could supply soup-to-nuts communications services. His $105 billion in cable acquisitions were designed to allow him to sell consumers high-speed Net access and local telephone service over the cable-television network, along with AT&T's existing long-distance, wireless, and data services for corporations.

But at their breakfast, Noski questioned whether AT&T might benefit from the sort of restructuring the pair had done at Hughes, where they created a tracking stock to separate Hughes from General Motors Corp.'s car business. Was AT&T getting credit in the stock market for each business, Noski wondered? Did they all have to be part of the same company? Armstrong agreed that if investors didn't recognize the value of each business, a change might be necessary. "We challenged the theory that everything needed to be under one roof," says Noski.

By the summer of 2000, the old theory was creaking under the strain. Consumer long distance, which Armstrong thought would shrink 5% last year, was crashing at an 11% rate. Investors pummeled AT&T's stock, which fell from 61 in March to 31 in June. At the same time, Armstrong and Noski, who became CFO in January, had been researching how much the different AT&T businesses relied on each other. The answer? Not much.

They estimated that less than 15% of AT&T's revenues came from cross-selling between two business units. That approach "is not anything that either keeps customers or gets customers," says Armstrong. Over the summer, Armstrong worked out the details of the four-way breakup. By the time the company's two-and-a-half day management retreat began on Sept. 23 at AT&T headquarters in Basking Ridge, N.J., the restructuring was a working plan. The ever-optimistic Armstrong dubbed it "Grand Slam," and it was unanimously approved by AT&T's board of directors on Oct. 23.

Two days later, Armstrong did his best to sell the idea to the public. A car whisked him from his home in Connecticut to the Sheraton New York Hotel and Towers in Manhattan by 6:15 a.m. He began his pitch with a series of TV interviews and continued schmoozing with Wall Street analysts, investors, and others until 11 p.m. His central point was that AT&T was splitting into four pieces because the troubles in long distance were overshadowing the strong growth in other areas, such as wireless and Net services. He insisted the breakup wasn't a change in strategy: People may have thought that Armstrong intended to bundle together every communications service under the sun, but he says he really only intended to bundle services such as cable television and cable-modem Internet access that used the same network. Companies with different networks could strike marketing agreements to provide broader bundles to consumers and businesses. "I see the restructuring as a sign of accomplishment because it means these companies are ready for public investment," he maintains.


  Still, Grand Slam was a strikeout. Many investors felt Armstrong was conceding that his acquisition spree was a bust. "Clearly, this is a complete reversal of strategy," says telecom analyst Adam Quinton of Merrill Lynch & Co.

Armstrong was crushed. The next morning, on his way to Basking Ridge, he got his first look at the morning's headlines. The Wall Street Journal said AT&T needed "a little less vision and a lot more focus." The New York Times carped: "If only AT&T worked as hard at telecommunications engineering as it does at financial engineering, maybe investors would treat it with more respect." Armstrong says it was one of the lowest points in his career: "It was a huge disappointment."

There was no time to wallow in misery, though. AT&T needed a lot of cash to make it through the restructuring. Noski figured they had to raise $25 billion over the next few months. It wasn't the best time to launch the second-largest short-term debt offering in history. Currency officials in Europe were concerned about bank exposure to highly leveraged telecom companies. And AT&T no longer had the pristine balance sheet it once did.

Still, on Oct. 26, Armstrong and Noski met with bankers at AT&T's former headquarters in lower Manhattan. The pair sat on one side of the table in the Art Deco boardroom, while reps from Chase Manhattan, Merrill Lynch, Goldman Sachs, and Credit Suisse First Boston faced them. It was Armstrong who led the pitch, like the hard-charging football star he used to be. He argued that AT&T's debts were reasonable because it planned to sell assets, such as its $4 billion in Microsoft and Comcast stock. Reassured, the four banks agreed to put up $2.5 billion each, for a total of $10 billion.

Winning the support of equity investors was another matter. On Oct. 31, after the stock had slid even further, to 22, Armstrong boarded a company jet to talk to shareholders on the West Coast. The following morning, he met Jeffrey E. Heil, who oversees $55 billion worth of investments for the Regents of the University of California, for a 7:30 a.m. breakfast at the Mandarin Oriental Hotel in San Francisco. Heil held 24 million shares of AT&T and had the power to buy more, but he was worried that the breakup would hinder cooperation among the various businesses. "I can't see how the marketing agreements between the companies will last more than a year or two," he says. Armstrong assured him that AT&T Business, for example, would still be able to buy service from Wireless and Broadband. But he didn't sway Heil. "His response was a little pie in the sky," Heil says. Armstrong concedes that "I didn't feel I had connected."

Heil was hardly the only dissenter. Brian Hayward, manager of the $2.4 billion Invesco Telecommunications Fund, sold his remaining shares in AT&T after Armstrong announced Grand Slam. Even when Armstrong gave a speech in New York in November to persuade money managers that his strategy was sound, Hayward wasn't convinced. "They've been telling us up until now that bundled service is the way of the industry, and now they're telling us these companies are ready to be broken apart," he says. "It insulted my intelligence."

Fortunately for Armstrong, customers were more receptive. On Nov. 6, Armstrong and Kenneth E. Sichau, president of sales at AT&T Business, met for breakfast with one important client, Barnes & Noble Chief Information Officer Joseph Giamelli. AT&T had stumbled in delivering high-speed Net access to the bookseller two years earlier, and Giamelli was worried that the breakup could trigger another episode of poor service. Armstrong and Sichau reassured him that the sales force wouldn't be distracted by the restructuring. "I left with enough confidence to say I think they will deliver on their promise," says Giamelli.

One of the thorniest issues of the restructuring was how to resolve differences among the four new businesses. On Nov. 7, Election Day, one such dispute was on the table. Early that morning, a group of AT&T execs rose early to vote, then boarded a company plane for Seattle. Wireless chief John D. Zeglis was upset because the AT&T Business unit wanted exclusive rights to use the AT&T brand in marketing to corporations. But Wireless wanted to use the brand to sell its high-speed data services to companies. Armstrong didn't think two units should use the brand in the same market, fearing it might alienate customers.

There was much at stake: AT&T's 100-year-old brand is one of the most recognized in the world, and using it would be a boon for a new company such as Wireless or Broadband. Conversely, the loser in the battle would be forced to spend millions of dollars building consumer awareness. Execs from both sides met in Redmond, Wash., and tried to hammer out their differences from 1 p.m. to 8 p.m. As the TV in the conference room blared that Vice-President Al Gore had won Florida, Zeglis and the lawyers spent a half-hour debating the meaning of the phrase "change of [brand] control." Their discussion seemed no more conclusive than the Election Night returns. With Armstrong's blessing, they agreed that Wireless could use the AT&T brand to sell some data services to businesses with 10 or fewer phone lines in no more than three locations.


  As November drew to a close, Armstrong got a dose of good news. AT&T Wireless had been stymied from raising several billion dollars because of a slump in wireless stocks and because one potential partner, Japanese mobile-phone giant NTT DoCoMo Inc., wasn't willing to make an investment as long as AT&T Wireless was part of AT&T. The restructuring turned the Japanese execs around. On Nov. 30, DoCoMo agreed to invest $9.8 billion in AT&T Wireless. With that kind of dough, Wireless will be able to rebuild its network with new technology, expand overseas, and buy crucial radio spectrum. "We've taken a giant step with DoCoMo," says Zeglis.

That wasn't the only reason Armstrong would have fewer money worries. One day later, at the Pierre Hotel in New York, Noski met with bankers to find out if he could borrow the additional $15 billion in short-term capital AT&T needed to finance its restructuring. Reassured that asset sales would keep its debt manageable, the bankers offered Noski $40 billion, allowing him to bargain for the best rates.

At the same time, trouble was brewing with AT&T's unions. The caw had even set up a Web site, www.attinsider.com, that railed against the breakup. Then New York State Comptroller McCall, who helps oversee pension funds that hold 25 million AT&T shares, asked Armstrong to speak to the Council of Institutional Investors in New York on Dec. 12. It was an ambush: The crowd was full of union supporters who had been given pension-fund credentials for the day. After the meeting, McCall held a press conference where he dismissed Armstrong's explanation of the restructuring as unsatisfactory. Armstrong was "steaming mad" and complained that McCall had used him as a press-conference prop for his own political gain, according to one AT&T executive. McCall did not respond to requests for comment.

The union opposition isn't just bluster. Their most threatening argument is that the breakup requires approval from two-thirds of AT&T's shareholders, while management insists it requires only a simple majority. If the unions are proved right in the courts, Armstrong may not get his plan past stockholders. AT&T's acquisition of TCI, after all, was approved by only 72% of the voted shares.

Undeterred, Armstrong and senior managers have been touring the country to rally the troops. On Dec. 13, Armstrong stopped in New York to meet with about 200 employees. He had bought a cup of coffee from a lunch truck on the street and walked into the auditorium, paper cup in hand. He tried to convey a sense of optimism and hope. "I went in thinking he was a figurehead," says Rich Doyle, 30, who manages the installation of phone equipment in AT&T's own offices. "I came out grasping every pain that he feels every day about this company."


  Armstrong knew that words would never fully raise the spirits of employees whose stock options were under water. So on Dec. 19, he met with the board's compensation committee in New York and asked it to approve a plan to issue more options. The company had issued new options back in August, when the stock was trading at 32, but they were now worthless. So the committee agreed to issue the new round, which is planned for February.

When the board met on Dec. 20 in New York, the pressure was growing more intense. The board voted to cut the company's dividend for the first time in its history, slashing it by 83%, to 3.75¢ a share per quarter. Worse, Armstrong was forced to lower earnings and revenue forecasts for the second time in two months. Still, the CEO argued that there was reason for hope. The shortfall wasn't due to the kind of sloppy execution that had plagued the company in the past. Rather, it was because four big contracts had been delayed, and Armstrong assured the board all four would close within the next few weeks, which they did.

At the end of the day, the board asked Armstrong to leave the room so they could discuss his annual performance review. In a year when such CEOs as Richard A. McGinn of former AT&T unit Lucent Technologies Inc. have been fired for missing earnings targets, the board could have tightened the screws on Armstrong. Finally, after more than an hour, the directors dispatched General Counsel James W. Cicconi to fetch Armstrong. As he entered the room, the directors exploded with a standing ovation.

Finally, Armstrong is earning some cheers both inside and outside AT&T. Oprah may be his biggest fan. "If he were running for President, he is one of the few people I have ever known for whom I would quit my job and personally campaign," she says. "He's a leader with guts, vision, and the balls to back it up." But AT&T is a company that has been in decline for a long time. It may be that even someone with Armstrong's talents has arrived too late to achieve more than a modest victory.

By Steve Rosenbush in Basking Ridge, N.J.

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