A New Cable Giant

AT&T Comcast will be unprecedented in size and influence--but must win over skeptical investors and sell unproven services

You would never know that Brian L. Roberts was about to be catapulted into the media elite. In mid-November, his company, cable operator Comcast Corp. (CMCSK ), is expected to close its $54 billion acquisition of AT&T Broadband, the biggest deal in the industry since the AOL Time Warner (AOL ) merger in 2001. But on this evening in early October, Roberts, all 6 feet, 2 inches of him, is in a decidedly unglamorous position: He's scrunched into the back of a Ford Econoline van, barreling back to Philadelphia after a long day of volunteer work on behalf of his company. The 43-year-old executive, in jeans and a black Comcast T-shirt a size too large, is literally on the edge of his seat as his teenage daughter dozes beside him. Several executives are nodding off as well. But Roberts is a live wire as he recounts his decision to bid for AT&T's (T ) huge cable business. "You only get one chance to redefine your company, and this was ours," he says.

Roberts practically grew up in the cable business (his father, Ralph, founded Comcast in 1963) and has a reputation as one of the best operators and toughest negotiators around, but he has never faced a challenge like this. In fact, no one in the industry has. Roberts' new company, AT&T Comcast Corp., will be unprecedented in size and influence. Before the merger, he could count a respectable 8.5 million customers in four major cities. Now, 21 million customers in 17 of the top 20 cities will be hooked up to his systems. That's nearly twice as many as the next biggest operator, Time Warner Cable. Put another way, it's in one of every five homes in America that has a television. AT&T Comcast could bring in some $24 billion in 2003, more than Time Warner and Charter Communications combined.

Indeed, everything is increasing exponentially for Roberts. The company will have to handle nearly four times as many customer-service calls this year as Comcast did last year. The number of people working for him will just about triple, to more than 55,000. AT&T Comcast's debt will be a nation-size $30 billion. And this is an executive who does not like to travel so far that he can't return home at night to see his kids. Up until two years ago, he still held Comcast's annual meeting in the lunchroom.

Even more daunting for Roberts is that AT&T Comcast will be so big that it is certain to shift the dynamic of power in the media business. Roberts, who likes to say his favorite TV show is the midnight special on his own QVC shopping channel, will effectively be the nation's top entertainment gatekeeper. Think about it: Nobody will have more control over which TV channels, Internet services, and movies are piped into U.S. homes--not News Corp.'s Rupert Murdoch, not Sumner Redstone at Viacom Inc.

Right from the start, Roberts will have the clout to do what cable executives have wanted to do for years: dictate what shows will reach a mass audience and at what price. One crucial issue for cable operators, for example, is the cost of programming, their single largest expense. For years, content-driven companies such as Walt Disney (DIS ), News Corp. (NWS ), and Viacom (VIA ) have had the upper hand. That's about to change. Roberts, with his vast system, can now hold out for better terms, and other cable operators will ultimately benefit, too. Consumer advocates, though, worry about how thoroughly Roberts will dominate the industry. "AT&T Comcast will be the single most powerful media company in the U.S.," says Jeffrey Chester, executive director of the Center for Digital Democracy, a public-interest group that is a staunch critic of the Comcast-AT&T deal. "They will most certainly determine everyone's digital destiny."

The lanky Philadelphia native may not have been plotting to control cable, but he has methodically assembled the pieces of what could one day be a full-fledged media enterprise. He now has the cable subscribers. And to many people's surprise, he could be on his way to getting a critical mass of broadband users--a total of 342,000 new subscribers signed up at both AT&T and Comcast in the third quarter. Over the years, Roberts has accumulated a modest programming collection, too. He bought big stakes in several cable channels, including QVC Inc. and E! Entertainment Television, as well as two Philadelphia sports teams (not for vanity, either--the unassuming Roberts has only met the 76ers All-Star point guard Allen Iverson twice in six years).

Still, Roberts doesn't talk about transforming the industry; he won't even use the words "synergy" and "convergence." He's not much of a visionary and isn't even sure he needs to get mixed up in programming, a business that has brought grief to so many. "We don't have a clearly defined content strategy at this time," he says. His most cosmic pronouncement comes out like this: "We will go from a regional cable company to being a premiere provider of entertainment and communications services into people's homes."

Translated, that means AT&T Comcast could be the first company to make good on the long-awaited promise of broadband. Consumers are just beginning to experience the benefits--and, for now, are willing to pay the costs--of faster and continuous connections to the Internet. With 21 million potential customers, AT&T Comcast will have the scale to actually make money selling all the services that can go with it, from streaming video to music to video games. If broadband still proves elusive, though, the company's prospects could be jeopardized.

Even if Roberts gets broadband right, he couldn't have picked a worse time to burst on the scene. Media and cable companies have crumbled all around him. Investigations into the accounting practices at several cable outfits have cast suspicion on the entire industry. Questions about the quality of earnings persist. And the fact that companies spent tens of billions of dollars to upgrade systems with relatively little to show for it after nearly a decade raises fears among some that cable might be the next telecom. Meanwhile, satellite services are proving to be formidable competitors to cable operators' de facto regional monopolies. Over the next five years, the number of satellite subscribers is expected to grow by 37%, to 26 million, while the number of households that receive cable, now 70 million, may not increase at all, according to PricewaterhouseCoopers. And the collapse in October of the proposed merger of satellite services DirecTV (GMH ) and the Dish Network seems to have only galvanized EchoStar Communications Corp. (DISH ) Chairman and CEO Charles W. Ergen to go after cable subscribers even more aggressively.

Any one of these problems would be worrisome enough. Together, they have led many investors to give up on the industry for now. Cable shares have lost 57% of their value in the past year, vs. a 15% decline for the Standard & Poor's 500-stock index. Comcast's shares alone have fallen nearly 34%, to about $25, since it reached an agreement with AT&T last December. "Investors want to see the proof in the pudding. Where's the cash? It's that simple," says industry analyst Alan Bezoza of CIBC World Markets.

Roberts has even more to prove: From the start, AT&T Comcast will be shouldering its enormous debt in a weak economy. Roberts will need to reassure impatient investors that he can pare it down and get cash flowing again. At the same time, to keep disgruntled AT&T customers from defecting, he has to spend about $2 billion or so over the next two years to upgrade AT&T's poorly run cable systems, which turn in some of the lowest margins in the industry. There is also the tricky task of combining a regionalized cable company with a heavily centralized organization whose focus has been phone services. And Roberts will have to work with the man who initially and vehemently opposed the merger: Former AT&T Chief Executive C. Michael Armstrong, 64, who will become nonexecutive chairman of AT&T Comcast, could be a disruptive force at a difficult time, pushing for phone services over cable lines even though cable operators don't make much money from that business right now. "I wonder if [the Robertses] realize yet what a hornets' nest they bought," asks a cable executive familiar with the AT&T system.

As Roberts takes control of the biggest cable empire ever, he will rely on the two people he trusts implicitly. The first is his 82-year-old father, Ralph. When they finally sealed the AT&T deal, after five long months of negotiations, Ralph walked his exhausted son to his room at the St. Regis Hotel in Manhattan. They had talked often about their dreams for the company, which Ralph built up from a single system in Tupelo, Miss. On this night, Ralph whispered to Brian as he embraced him: "This is a miracle." Roberts' other confidant is Stephen B. Burke, 44, whom he hired away from Walt Disney Co. four and a half years ago to run the cable division. Burke and Roberts share an easy camaraderie. They talk by phone half a dozen times a day and still high-five each other whenever the merger comes up, which is often. These men have proven to be a capable triumvirate; together, they run one of the few cable companies that has generated positive cash flow.

But the financial, management, and strategic challenges Roberts is now up against are immense. It's no surprise, of course, that his father thinks he will succeed: "It's not like AOL and Time Warner," says the elder Roberts. "We are in cable, and we bought cable." AOL Time Warner Vice-Chairman Ted Turner, who has known Roberts for 20 years (Roberts sat on the board of Turner Broadcasting System Inc. from 1989 to 1996), thinks he will, too: "I'll bet my last dollar on Brian Roberts." As for Roberts himself, he says with typical understatement: "The first 24 months are all about execution."

He may be short on the vision thing, but Roberts has always had a head for figures. He used to drop in on his high school's financial adviser to chat and went on to study finance as an undergraduate at the University of Pennsylvania's Wharton School. For the next few years, he will be focused on just two numbers: $30 billion in debt and 21 million subscribers. Back last December, many believed he had gotten carried away in the bidding war for AT&T Broadband. But Comcast's falling share price has had one benefit: Because Roberts negotiated an all-stock deal, his effective cost per subscriber has dropped from about $4,500 to $2,400. Still, AT&T Comcast will start out life with more debt than Time Warner and Charter combined. Although the company still maintains its investment-grade rating, $30 billion doesn't sit easily with shareholders. "We're being tarred as a telecommunications company with a lot of debt and overhang from the deal," says Burke. "We are just going to keep our heads down and deliver."

Almost from the moment he closed the deal, Roberts has been trying to figure out how to lessen his financial burden. He says he has a plan to decrease the debt by $5 billion in the first year; most of the money will come from a masterful arrangement he recently struck with AOL Time Warner to unwind Time Warner Entertainment Co., a complex partnership between AT&T and AOL. Roberts seemed to get the better of the deal with CEO Richard D. Parsons, who's supposedly the smoothest negotiator in the industry but who was also desperate to settle the issue. AT&T Comcast will receive $2.1 billion in cash, $1.5 billion in AOL stock, and a 21% stake in Time Warner Cable--which could be spun off by mid-2003. Comcast's stake is valued at about $5 billion. The company will also sell stock in AT&T and Sprint PCS to raise cash. Lawrence J. Haverty Jr., senior vice-president of State Street Research & Management, a Comcast shareholder, says resolving the TWE matter "was absolutely terrific."

But Roberts is laboring under an entirely different set of expectations than he is used to. "There's a real show-me attitude now," he says. "Everything [the industry] says and does are dirty words." The fraud charges against the Rigas family, which ran Adelphia Communications Corp., and the Securities & Exchange Commission and Justice Dept. investigations at AOL Time Warner and Charter have made many deeply wary of cable companies. It doesn't help matters that no one in the industry reports real net earnings, that each company seems to have its own definition of capital spending, that they can't even agree on what constitutes a subscriber. What's not to be suspicious about?

These scandals come at an unfortunate time for Roberts. And the charges of self-dealing against the Rigases must be galling to someone who prefers Amtrak to limos and buys sandwiches at the food court near his office. The outward resemblances to Adelphia are especially awkward; it is, after all, a family-run cable operator in Pennsylvania founded by a shrewd patriarch.

But the Robertses don't hide the fact that they still regard Comcast as very much their company. Even Brian's mother, Suzanne, an actress, has a weekly half-hour show about "living well" that airs on a Comcast channel. Brian pestered his father about joining the family business almost from the time he knew they had one. "When he was still in high school, I had him sit in the corner and watch me negotiate a loan with a banker. He was fascinated," says Ralph. Brian read The Wall Street Journal as a teenager--even invested in the stock market (and this was the 1970s). After college, in 1981, he started out as a controller in Comcast's Trenton office. By the age of 30, he was the company's president. At a recent industry dinner honoring Roberts, AOL Time Warner's Parsons said his ascension to the head of Comcast was his birthright: "The crown prince has assumed the throne." Then he joked that the mohel at Roberts' bris had used cable splicers. Roberts could only reply: "Geez, Dick, nice."

Now Roberts is trying to do what he can to set himself apart from his disgraced and disparaged colleagues. He worked closely with an industry task force that on Oct. 21 released a voluntary set of guidelines on how to report subscribers and capital costs, a framework meant to give more clarity to Wall Street. Comcast has also recently disclosed more information about its accounting practices, for the first time breaking down how it capitalizes expenditures.

Like all cable operators, though, Comcast reports EBITDA (earnings before interest, taxes, depreciation, and amortization), a metric that some investors say masks whether a company has real net earnings. Cable executives always argue that the more important measure is free cash flow; if so, then AT&T Comcast should start to show positive results of the merger in 2004, when it is expected to swing from negative $300 million to $2 billion in free cash flow. That will rise to $5 billion in 2005, estimates Merrill Lynch & Co. Investors looking for real net earnings might be able to see those results as early as 2004, once the investments in upgrades begin to wane, predicts Goldman, Sachs & Co. analyst Richard Greenfield. Indeed, though many still believe the entire industry is in trouble, over the next two years the leading operators could emerge from their spending sprees with better prospects. "You'll see more and more companies beginning to deliver on these long-promised services," says media analyst Tom Wolzien at Sanford C. Bernstein Co.

As Roberts begins to redefine the company his father founded, Ralph will not be too far away. They have always had a close partnership. Herbert Allen, the media power broker, once described it as "one of the most unusual relationships I've seen. I think they are equal in their respect for each other." At a time when some sons would be chafing under their father's watch, Brian still turns to Ralph for counsel. And at a time when some fathers would be heading for their vacation homes, Ralph will serve on AT&T Comcast's board and lead its executive committee. Ralph's and Brian's offices are next to each other, the doors always open. Brian can often be seen sitting across from his father's desk seeking advice. When asked why he didn't take off his jacket during a recent photo shoot, Brian said: "Oh, no. My father would have killed me."

Roberts hasn't had to hire many top executives--most have been at the company for years--but luring Burke away from Disney was a coup. Burke helped launch Disney's chain of stores and then fix the finances at the Paris theme park. Although Burke had no previous cable experience, he has quickly earned respect in the industry. "He's one of the best executives in media," says Jessica Reif Cohen of Merrill Lynch. Burke, who writes a dozen personal notes to rank-and-file workers each week, brings a certain polish and operational expertise to the company. As he says with the requisite modesty: "I take care of the plumbing here."

While Roberts is plenty collegial in the office, executives on the outside say he is easily the most competitive man they know. Several years ago at Allen's media conference in Sun Valley, Idaho, Roberts was desperate to persuade Warren E. Buffett to buy Comcast stock, but not desperate enough to pull back and let the Oracle of Omaha golf a better round. (Roberts is still trying to persuade Buffett to buy.) But Roberts seems comfortable sharing power with Burke; no doubt similar backgrounds make that easier. Brian grew up watching his father work hand-in-hand with Comcast co-founder Julian Brodsky, while Burke observed his father, Dan, president of the ABC Network, work closely with Capital Cities/ABC Chairman Tom Murphy.

Two years ago, Roberts saw the opportunity of a lifetime when AT&T announced it would split itself in three. The phone giant's cable unit, AT&T Broadband, had more than 13 million subscribers, several prized systems--and some of the worst numbers in the business. Its margins were as low as 18% in some cities, vs. industry averages of 35% or better. The systems had been neglected for years, first by ex-Tele-Communications Inc. Chairman John C. Malone, and then by Armstrong at AT&T, who bought the systems from Malone in 1998 but stayed largely focused on telephony. While Comcast's systems are 95% upgraded, only 65% of AT&T's are. Since the deal was announced last December, AT&T has lost nearly 500,000 subscribers.

Burke says his immediate goal is improving margins to at least Comcast's average of 40% within three years. He'll decentralize operations (AT&T customer service had been handled out of its Denver headquarters), cut costs (Comcast has already said it will pare 1,700 of 4,000 jobs in Denver), improve customer service, and sell more premium-priced services such as digital cable or high-speed data. "What is good is that we've done this before with other systems we've acquired," says Burke.

Central to AT&T Comcast's success is the complicated business of broadband. "That's our critical product of the future because we can add on other services," says Burke. Analysts predict that about 30% of AT&T Comcast's subscribers, or 6.7 million homes, will be paying for high-speed data by the end of 2006. If they are right, that revenue will go a long way toward meeting Burke's goal of boosting AT&T's yearly cash flow per subscriber from $175 to a figure closer to Comcast's $300 level. These services are also key to fending off the threat from satellite, which can't offer such interactive products. Burke also is counting on selling more advertising; he believes digital technology will make cable a more interesting proposition, since marketers will be able to target spots to individual subscribers or homes. Advertising revenue will be $1 billion next year, and Burke predicts that will double in five years.

Although AT&T is a much larger system to swallow than any Comcast has acquired in the past, few doubt that Roberts and Burke can manage the integration. But their talk about digital cable service, high-speed data, and video on demand as major sources of cash flow seems far too optimistic to many. Haven't cable executives been promising this for years? "I'd be shocked if you get 20% of homes on high-speed data," says Leo Hindery, an ex-president of AT&T Broadband and now CEO of the Yankees Entertainment & Sports Network LLC. Burke counters that Comcast now has an edge: A bonus from the TWE deal was a broadband-access pact it reached with AOL. Although the terms have not been disclosed, the arrangement is said to stipulate that AOL will pay Comcast about $38 a month per new subscriber (consumers will pay about $55 for AOL and Comcast broadband services combined), at the same time delivering to Comcast all those AOL customers.

Roberts made it clear early on that most of AT&T Broadband's senior executives would be better off elsewhere, and many already have left. One person who is staying, though, may be the most difficult--the former boss. Armstrong has been criticized for his role in running AT&T; he was pushed to sell the broadband unit by his board of directors. At AT&T Comcast, he finds himself in the undefined position of nonexecutive chairman, surrounded by Comcast veterans. It sounds like trouble already. One Comcast executive says: "This was a face-saving situation, and Mike knows that." At worst, he could be a disruptive force; at best, a distraction.

So far, the Roberts-Armstrong relationship has been "constructively awkward," says one executive. Armstrong and Roberts have talked over the past months, mostly by phone, but he has not been part of Roberts' inner circle planning for the new company. Armstrong hasn't been included in strategy sessions or the weekend conference calls Roberts holds from home. Nor has he been invited on the road trips to inspect AT&T cable systems. Clashes will likely arise over the telephony business: Roberts is uneasy about making a big push after so many others have tried and failed. "Mike is going to have to recognize this is a very different role for him," says AT&T Comcast director Felix Rohatyn, a former managing director at investment bank Lazard Frères. "He's going to have to accommodate himself to what Brian wants."

For his part, Armstrong says he sees his role as helping Roberts strengthen the company's financial position. But given the opportunity, Armstrong quickly shows why he may be more of a nuisance for Roberts. He still criticizes Brian and Ralph for taking 33% voting control in the new company (they had 86% voting control in Comcast, through a special class of stock). Armstrong says he urged them to take 20%, particularly given the growing concerns about the concentration of power in the hands of a few shareholders. "This is a new company and an opportunity to do it right," he says. "If we paid a full and fair premium for the company, why should we give up control?" counters Roberts. "[Family control] has been good so far for shareholders," who have seen the stock split 12 times since 1971.

Roberts is as confident as the next CEO when it comes to his company's performance. But he's reluctant to talk about lofty goals. In fact, he says he has pretty much junked the notion for now. As he puts it: "I don't get to relish this deal. I have to deliver." But his hesitancy to articulate what the company will look like in five years makes some people nervous. "Brian has to figure out, and fast, if he wants to be predominantly a distribution company or run a content company, enhanced by distribution, like supermen Rupert Murdoch and Mel Karmazin do," says Hindery. There is talk about Roberts buying Disney one day, though not a word from him. But who can blame Roberts for hanging back when so many media moguls with grand visions have been shown the door?

Of course, right now he simply doesn't have the money to do much of anything. A purchase the size of, say, a TV network is unaffordable; even something smaller would be unpalatable. Instead, Roberts will keep launching lower-profile cable channels, which he can count on breaking even almost immediately, given his 21 million subscribers. And he'll use his new influence to secure more favorable deals for the content he has to buy: Roberts expects to cut $500 million from programming costs. "No doubt there'll be new tensions in the relationships between distribution and programming companies," says AT&T Comcast board member Decker Anstrom, president of Landmark Communications Inc., which owns the Weather Channel.

These days, it's hard to say who has the toughest job in the business. But heading the country's largest cable company puts Roberts in the running, especially since he has placed the family business in a tough financial position at a time of skepticism about his industry. When Roberts said he doesn't have time to savor the AT&T deal, he wasn't just being modest. It's a good thing he didn't get into this for the glamour.

By Tom Lowry in Philadelphia, with Amy Barrett in Philadelphia and Ronald Grover in Los Angeles

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