How Comcast Jerked AT&T's Cable

The bold bid puts it to shareholders to decide between Brian Roberts' experienced cable guys or Mike Armstrong's untested telecommers

By Jane Black and Steven Rosenbush

When AT&T announced in October, 2000, that it would spin out its cable operations as a separate business, many wondered whether AT&T CEO Michael Armstrong might want to run the new company. Turns out Brian Roberts, CEO of cable operator Comcast, wants the job -- and may get it. On July 8, Comcast (CMCSK ) made a surprise, unsolicited $44.5 billion bid for AT&T's (T ) cable and broadband operations. The merger would turn Comcast -- now the nation's third-largest cable operator -- into the King of Cable, with 22 million cable-TV subrscribers and a leading position in 8 of the top 10 U.S. markets.

For Comcast, it's not simply a case of bigger being better. The Roberts family, which has been in the cable business since 1963, believes it can unlock value in AT&T Broadband through better, more experienced management. AT&T got into the cable business only in 1998. And in hindsight, its entry seems to have had more to do with a loose vision of "digital convergence" than with building an efficient cable system quickly enough to compete.


  The bursting of the dot-com bubble has shelved expectations of convergence, at least for the time being. And with the cable-subscriber base reaching saturation, keeping up profits becomes increasingly a game of wringing the inefficiencies out of existing systems. Comcast says with AT&T in its fold, it could generate savings of at least $1.25 billion annually, with a potential upside of from $2.6 billion to $2.8 billion. In its 29-year history, Comcast has delivered a compound growth rate of 24%. "This deal is the best opportunity we have to give us a future that replicates our past," Comcast CEO Brian Roberts said in a July 9 conference call.

Comcast's public bid for AT&T Broadband is a direct appeal to AT&T's shareholders, who, under Armstrong's leadership, have watched their shares drop by 50% against their 52-week high. On July 9, AT&T reiterated that it had no plans to sell the unit. But it may have little choice. AT&T may have a lock on the long-distance telephone market. But when it comes to an unfamiliar business, like cable, experience is what counts.

It's not a great offer from AT&T's perspective: Comcast is offering the debt-laden giant a little less than 50 cents on the dollar for what AT&T paid for its broadband and cable assets just three years ago. Still, it may be close to the best AT&T can do, and analysts are giving the deal a better than 50% chance of success.

Another attractive aspect of the offer: Comcast would pick up $13 billion in debt that AT&T is desperately trying to unload. If the deal succeeds, it would be an expensive lesson for Armstrong and AT&T's shareholders.


  Comcast's offer has met fierce resistance from the AT&T board, people close to the discussions say, and the board's opposition still presents a significant hurdle to any deal. AT&T directors include Citigroup Chairman and CEO Sandy Weill, who has considerable influence among the institutional investors who will ultimately decide whether AT&T Broadband is sold. And John Malone, whose company used to own the cable and broadband assets now in play, is said to be opposed as well. But investors could force the board's hand.

Comcast's offer to buy AT&T's cable business was laid out during a series of informal dinner meetings, the last one on June 17 in Philadelphia, between Roberts and AT&T CFO Chuck Noski, people close to the talks say. No formal offer was made, and nothing was put in writing. But AT&T board members didn't like what it heard when Noski briefed them on June 20. No vote was taken. Still, the board gave management clear, unanimous direction to pass on the Comcast offer, people familiar with the discussions say.

Comcast has suggested that the companies pretty much agreed on price, but were at odds over who would run the company. AT&T directors don't like the fact that the Roberts family would end up with 49% of the voting shares, even though it would actually own just 1% of the company, say people close to the talks. That prompted Comcast to take its plan directly to shareholders.

"Social issues, or management control, have not been an issue," a source inside AT&T insists. Board members feel the offering price is too low, and that there needs to be a so-called price "collar" to protect AT&T investors. In stock transactions such as this, where the value of the deal fluctuates with the acquiring company's share price, a collar sets a minimum price for the deal. On July 9, Comcast shares fell nearly $3 a share, to $39.30, lowering the value of the equity portion of the deal to just over $41 billion.


  AT&T's foray into cable has had its share of ups and downs. The phone giant acquired a 11 million subscribers with its acquisition of Tele-Communications Inc. in 1998. Trouble was, TCI's cable systems used a patchwork of different standards and technologies that thwarted AT&T's attempts for a unified strategy.

Meanwhile, AT&T's desire for fast-track expansion cleared regulatory hurdles that might have prevented an earlier Comcast bid. After its 1999 purchase of MediaOne, AT&T joined forces with fellow cable giant Time Warner in its push to liberalize the Federal Communications Commission's cable-ownership limits, which capped cable holdings at 30% of total U.S. subscribers. On Mar. 2, the two companies celebrated victory when the U.S. Court of Appeals in Washington, D.C., struck down the rules, and the FCC indicated that it was disinclined to restrict cable ownership below 50%, possibly even 60%.

That small victory has come back to haunt AT&T. "Ownership caps will not be a deal-breaker" with the FCC, says Scott Cleland, an analyst with Washington (D.C.)-based Precursor Group, which follows regulatory affairs in the cable industry.


  AT&T has already invested $1.8 billion to upgrade the network it bought so that it could offer cable and phone service. Such a heavy investment explains why AT&T Broadband's gross margins are about 19% -- less than half the industry average. AT&T had believed those investments would start to pay off because its capital expenditures in the upgrade are largely a thing of the past.

That may be wishful thinking. "AT&T has done the heavy lifting, and now Comcast wants to come in with their management skills and start to offer advanced services. Comcast knows its business, and it is taking advantage of AT&T's inexperience," says Mark Snowdon, a cable analyst with research firm, GartnerG2.

Comcast clearly believes it's up to the task. In its July 9 conference call, executives trotted out statistics that demonstrate how successfully Comcast has integrated operating performance on cable systems already acquired from AT&T. Based on 765,000 subscribers acquired in swaps through Dec. 31, 2000, Comcast says it has increased revenue by 8%, from $426 million to $461 million. It also increased operating cash flow per subscriber by 30%, from $148 per subscriber to $193. That's impressive. By contrast, AT&T purchased MediaOne more than a year ago -- only to see cash flow decrease across its properties.


  The AT&T board might very well consider scuttling its plans for a Broadband spin-off and selling the business to another cable operator instead. Other bids could come from Charter Communications or Cox Communications, analysts say. AT&T Broadband is already the largest cable operator in the land, but a combined company would have even more leverage with programmers and equipment makers.

Comcast's bid, while bold, is not yet a done deal. Though AT&T's stock has faltered, it isn't alone. Plenty of telecoms have been caught in the downdraft of the economic slowdown. Independent telecommunications analyst Jeff Kagan sees it all coming down to which side can craft a more convincing argument. "This is going to be a test of debating-club skills," says Kagan. "Is it a good deal? It's not yet clear, so it will be decided on the believability of Michael Armstrong's and Brian Roberts' arguments."

In the end, Comcast's quest to wrest AT&T Broadband from Armstrong's control comes down to a battle of wills between experienced cable guys and the unfulfilled promise of a stand-alone AT&T Broadband. Chairman Armstrong should remember how his ego landed AT&T in this mess. A little bit less ego might help get AT&T Broadband out of it.

Black and Rosenbush both cover the cable and broadband industries from New York, Black for BW Online and Rosenbush for BusinessWeek magazine

Edited by Beth Belton

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