The deal also gives AT&T a way out of its partnership in Time Warner Entertainment.
The new company, to be called Time Warner Cable, will be formed from Time Warner Entertainment's existing cable properties and from additional cable properties to be contributed by AOL Time Warner. AOL Time Warner will continue to control Home Box Office and Warner Bros., and maintain stakes in Comedy Central, Court TV and the WB Network.
The broadband deal is something that AOL Time Warner hasfor a while. Investors have criticized the media conglomerate's America Online division for not signing up new customers fast enough for high-speed Internet service. The three-year deal will give AOL access to about 10 million homes, in markets that include Boston, Seattle, Indianapolis and Nashville, within two years. AOL High Speed Broadband could also be offered to an additional 9 million homes in other markets.
Financial details of that deal were not released. Published reports say that AOL Time Warner will pay AT&T Comcast $35 to $40 a month per subscriber, along with a cut of advertising, e-commerce and other revenue."AOL has had an incredibly difficult time getting any cable operators to offer it as a broadband option. And given that last year marked the high-water mark for dial-up Internet use in the U.S., that's a problem," said Josh Bernoff, principal at Forrester Research.
Although the AT&T deal gives AOL access to a huge percentage of the U.S. cable market, it doesn't mean that customers will automatically sign up, Bernoff said. "They still have to get consumers to actually choose AOL as their main broadband (service) , and it's not been shown in any significant way that given the option to get AOL, consumers will sign up."
The arrangement gives AOL Time Warner a "critical opportunity to partner with a key player in the cable industry," CEO Richard Parsons said in a release. "Our task is to develop broadband products and services that become embedded in consumers' lives, just as AOL has done in the narrowband world, and HBO has done in cable television. We are confident that AOL members and other cable customers will increasingly take advantage of this upgrade to AOL High Speed Broadband access on AT&T Comcast systems, as they have on Time Warner Cable systems."
Some analysts seemed to agree with that assessment. The new deal "removes uncertainty" and simplifies the company's capital structure, wrote J.P. Morgan analyst Jason Bazinet.
The new cable company should have around 10.7 million subscribers, making it the second-largest cable company after AT&T Comcast, Bazinet said.
Not every one was pleased with the deal, however. Mandana Hormozi, an analyst at Lazard Freres, noted that the terms of the arrangement seem "onerous."
"While we are relieved a deal has been struck and it's not all cash for TWE, we believe the shares should trade down on this announcement since the deal...leaves both minimum upside potential for AOL Broadband and another overhang in the Comcast shares," Hormozi wrote in a research note.
The terms of the deal call for AT&T to get $2.1 billion in cash and $1.5 billion in AOL Time Warner stock in exchange for its 27.6 percent stake in Time Warner Entertainment. AT&T also will get a 21 percent stake in the new company. AT&T acquired its stake in TWE as part of its June 2000 acquisition of the MediaOne Group, but has been looking for a way out of the deal for years, culminating in a 2001 request to put the assets for sale in a public offering.
Standard & Poor's Ratings Service announced that it was reviewing its long-term rating of AOL Time Warner for a possible downgrade, based on the additional $2.1 billion in debt that the company will incur as a result of the restructuring.
The deal could prove a more positive one for AT&T.
"This agreement will turn a nonstrategic investment into cash that we can use to pay down debt," AT&T Chief Executive Officer C. Michael Armstrong said in a release. "That has been the goal since we acquired our stake in Time Warner Entertainment, and I'm delighted we were able to accomplish it on favorable terms for everyone involved."
AOL CFO Wayne Pace said that the entire deal would take about four cents off of the company's earnings per share next year, due in part to the tax implications of the added debt.
He stressed that AOL still has over $7 billion in available liquidity to cover this transaction and future funding needs.