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Breaking up may not be AT&T's lifeline

Now that it's breaking into four pieces, Ma Bell may have a chance at survival, but not until it knows what hit it.

Now that it's breaking into four pieces, Ma Bell might have a chance at survival, but not until it knows what hit it.

AT&T has sailed during the past few years into a disruptive storm of innovation and converging market pressures. Its bulk made it ill-fitted for the journey, and even its enviable marketing power was ineffectual against the currents. That, more than anything else, prompted the company's announcement two weeks ago that it will break up into four companies by 2002.

The four separate units will offer consumers long distance, cable, wireless and business services. And yet, on the eve of this breakup--its third in 16 years--experts and investors alike remain skeptical that the century-old phone company can sort out the right pieces and move forward.

The breakup plan isn't all. On November 8, the Wall Street Journal reported that AT&T, "facing intense scrutiny from credit rating agencies because of its $62 billion debt load, is planning major, nonstrategic asset sales" in the next few months. This so-called deleveraging is aimed at addressing the credit rating agencies' concerns about how the new AT&T companies will allocate capital and debt among themselves. The most significant divestments may include AT&T's 25 percent stake in Time Warner Entertainment and its 30 percent stake in Cablevision Systems.

The responsibility for these moves, and especially the breakup plan, lies with AT&T CEO C. Michael Armstrong. Someone who will never be remembered as a man of little action, Armstrong capitulated to the investment community by giving it what he thought it wanted. Now, his biggest challenge is to somehow convince the world that there is a method to his merger/demerger madness. And if that's not hard enough, he must also show that a menu of AT&T business investments will succeed on Wall Street, despite the fact that a laundry list of communications services has been a costly dud with consumers.

Armstrong brought his vision to the adrift long-distance giant in 1997, following the departure of CEO Robert Allen, who had initiated his own merger/demerger flip-flop. After spending billions of dollars on acquiring companies such as NCR and McCaw Communications, Allen oversaw the breakup of AT&T into the present AT&T, Lucent Technologies and NCR.

Armstrong's charter for AT&T, however, initially seemed more clear-sighted. He wanted the company to be the first company to offer people a one-stop shop for all their communications services, or die trying. This was based upon a so-called bundling strategy that many people bought implicitly at that time. The argument was that companies that offered the best combination of services--from local and long-distance phone services to wireless services as well as broadband Internet access--would win the battle for the consumers' minds and wallets.

Forging ahead
Armstrong's "no guts, no glory" message certainly packed a punch. With the troops at attention, Armstrong roared into a merger spree and corporate reinvention unmatched in price and scope. The goal of putting TV, Internet, wireless and conventional phone service on one bill seemed attainable.

Meanwhile, a once-in-a-century collision of tech and talent and economic forces was coming together like a powder keg under what observers term an outdated, overmanaged corporate relic.

"It was a perfect stormlike convergence of so many things," said David Isenberg, a former AT&T scientist, who is now an independent strategist with The emergence of the Internet, deregulation, the abhorrence of traditional management structure, gobs of start-up capital, advances in fiber optics, and a surge of talent with the gumption to chase ideas? "All these things happened at once," said Isenberg. "It's amazing AT&T can still chew gum and walk at the same time."

Armstrong's bundled-service strategy is now in a shambles. We'll never know if the original vision would have worked, but the early indicators were not positive. Wall Street, with its ultimate jurisdiction on the matter, had already rendered its verdict. AT&T shares dropped to $21.25 during regular trading on Oct. 18, a three-year low. In other words, investors knocked the company's value back to the pre-Armstrong Bob Allen days, essentially saying Armstrong's tenure amounted to nothing.

AT&T is not alone either. The No. 2 and No. 3 long-distance companies, WorldCom and Sprint, have been rocked by the same turmoil, or more simply, competition. Newer networks with better technology and lower costs took away customers and cut into profits faster than the accountants at the old-line telcos could calculate the numbers.

Bundling bungle
By attempting to bundle services, AT&T presumed it could hold its ground during this pricing free fall. It was a compelling theory that was never really put to practice, said Willis Emmons, who teaches at Georgetown University's McDonough School of Business, and author of The Evolving Bargain: Strategic Implications of Deregulation and Privatization.

"You could either create cost synergies on the supply side or pricing synergies on the demand side by putting these pieces together. And that's really where the rubber never hit the road for AT&T," Emmons said. "There is still a question that he (Armstrong) may have pulled the plug too early on that strategy. Splitting this up now kind of puts you back where you started."

Among Armstrong's problems is the difficulty of serving two masters, said Wharton telecommunications management professor G. Anandalingam.

"In breaking it up, AT&T wanted to increase its share value, which may work in the short run, but the company has set itself up for more trouble in the long run by separating the operations," Anandalingam said. "AT&T never really worked out a way to be a vertically integrated company."

Armstrong, however, his game face on, told a see roundup: AT&T breaks upballroom full of investors at a Bear Stearns communications conference on Nov. 1 in New York, that the breakup was all a part of the big plan. Each separate division will be able to focus on its own business model and offer a bundle of services unique to its operations, he said.

So does that mean the expensive merger quest for scale was all for naught? Hardly, said Armstrong in an interview after the presentation. "Scale is still important; we've lost no scale," Armstrong said. Each division will "provide service from common pools. We gain from that." Clearly, Armstrong would like to have it both ways: separate companies, yes, but still serving the common AT&T cause. Plus, whether he is talking about four parts or a whole, Armstrong's not really about to say his original vision was wrong.

Isenberg points out that Armstrong may be just rearranging the deck chairs at this point. He believes AT&T's problems might not be fixable. Three years ago, Isenberg wrote a now widely distributed essay, "Rise of the Stupid Network," which outlined the disruption that emerging bandwidth abundance and the ubiquity of the Internet would cause to the business of running traditional networks. At that time, he said, AT&T shooed him out the door.

The competition, riding the wave of that disruption, swamped the AT&T mothership. And while Armstrong may not be letting go of his vision for the company, he is letting go of the divisions by 2002. Now they'll have a shot at their own destiny.

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All materials copyright © 2000 of the Wharton School of the University of Pennsylvania.