The expected move links the world's largest software company with the industry's largest long-distance telephone service provider.
Under the agreement announced today, both companies said that AT&T will use Microsoft's software in its television set-top boxes. The firms will also work together to run market tests of new digital cable services in two U.S. cities, as yet undisclosed.
Under the deal, Ma Bell said it will increase its use of Microsoft's Windows CE operating system software in set-top devices from its current license of 5 million to cover an additional 2.5 million to 5 million set-top devices.
"We have a firm commitment for a set number of units, and depending on how the trials go and how things go in general, we have the option of taking additional units," said David Nagel, president of AT&T Labs.
AT&T said that the deal does not limit it to using Microsoft products.
"We will continue to use multiple vendors which means we have an open environment for procurement of hardware and software," said Armstrong during a conference call.
Armstrong stressed that the interactive TV arena will remain open to developers with the publishing of relevant Windows CE application programming interfaces (APIs).
"All the Windows CE API layers are quite rich but different from that of PC," said Henry Vigil, Microsoft's vice president of consumer strategy and partnerships, in an interview with CNET News.com. "So it's an open platform in every sense.
"Access for advanced TV enhancement specifications for content is an important piece because it extends the Internet to the broadcast space and allows content developers to develop for interactive TV," Vigil added.
The telephone giant and newly created cable titan said, however, that it was not interested in entering the content business.
"We will be pursuing content over TV and interactive TV as well as an open Internet environment," said Armstrong. "AT&T will not be investing in content and getting into the content business or being a content owner."
Microsoft said it will pay $5 billion for newly issued AT&T preferred securities and warrants. The preferred securities priced at $50 each will make a quarterly payment of 62.5 cents per security. The warrants will be exercisable in three years to buy 40 million AT&T common shares priced at $75 per share, the companies said.
Despite the sizable cable investment into AT&T from Microsoft, the software giant said it remains access agnostic, noting it has investment and partnerships in other technologies.
"Microsoft is a believer in the broadband and many bandwidth strategies," said Microsoft chief financial officer Greg Maffei during the conference call. "We have several investments in the cable area but also have partnerships and investments in DSL, wireless, [and] satellite."
Maffei noted that the revenue stream from this partnership will be largely non-material to the company's income statements in the near future.