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Cutting the cable

As AT&T's cable network sits quietly for sale, the scramble of potential buyers is shaping into a critical point in the battle for digital media supremacy.

 

Sale of AT&T Broadband could rock industry

By Corey Grice, John Borland and Jim Hu
Staff Writers, CNET News.com
August 17, 2001, 3:00 a.m. PT

As AT&T's cable network sits quietly for sale, the scramble of potential buyers is shaping into a critical point in the battle for digital media supremacy.

In the last several years, AT&T Chief Executive C. Michael Armstrong has


AT&T built the nation's largest cable network but now looks ready to sell.

June 1998
AT&T agrees to buy Tele-Communications Inc.

April 1999
AT&T bids $54 billion for MediaOne Group, beating Comcast's offer.

May 1999
Microsoft invests $5 billion in AT&T.

October 2000
AT&T announces a restructuring, including a spinoff of its cable division.

July 2001
Comcast bids $44.5 billion for AT&T Broadband.

AT&T rejects the bid but opens the door for other bidders.

cobbled together what is the largest cable network in the United States, able to reach more than 24 million households with TV programming or high-speed Internet connections.

Now, as Armstrong prepares to split that network off from AT&T, it has temporarily become a screen on which others in the industry can project their futures. For major cable players, led by Comcast, acquisition of the network would be a way to solidify a position in the industry's lucrative infrastructure business.

The interest of Disney, AOL Time Warner and even Microsoft added a new dimension to the situation, leading to speculation of a coalition rising from AT&T Broadband's network to rival the power of AOL Time Warner. Although nothing is certain, a source familiar with the talks has confirmed early discussions between Disney and Microsoft, raising the possibility of a new alliance that could shake several industries to their roots.

"I think there are a lot of agendas at play here, which is what makes it interesting," said Mike Paxton, a senior cable-industry analyst at Cahners In-Stat Group, a market research firm.

"Armstrong's ego is involved, but he believes his long-term strategy for AT&T Broadband is sound, and I agree with him," he said. "But his execution to get there is hurting him. He paid way too much for MediaOne and TCI and he got scalped."


If AT&T Broadband is spun off as an independent company or bought by Comcast, Cox Communications or Charter Communications, the cable industry's relationship with the broader media world would likely not change much. But a broader combination or alliance between AT&T Broadband and an outsider such as Disney or Microsoft could create a powerful new industry axis, combining content or software with high-speed Internet connections and multiple-channel video programming--and presenting a true challenge to AOL Time Warner.

The closed discussions, in which many of the major players in the technology and media industries appear to be having conversations with virtually everyone else, are a heady mix of money, ambition and naked ego. At the center of this contest is AT&T's Armstrong, whose decision at the end of the undeclared bidding war will decide how he is portrayed when the business histories are written.

"It's (Armstrong) trying to save his reputation and his career," one cable industry source said.

Two years ago, Armstrong was hailed as a visionary, a leader who had turned a languishing long-distance company into a communications empire able to compete with local phone carriers, video networks and Internet services all on their own turfs. With $110 billion invested, AT&T made cable technology central to that multifaceted strategy.

Many industry executives and analysts believed that Ma Bell was returning to its former glory. But the crash of AT&T's stock, and the inability of the company to make quick delivery on that empire's promises, has badly tarnished Armstrong's reputation.

Last October, he and the AT&T board of directors announced a plan to split the company into four pieces, spinning off the cable networks and mobile phone companies as independent entities. Widely viewed as a capitulation to Wall Street pressure, the decision did little to improve Armstrong's standing.

A sale of the cable unit could provide an opportunity to restore his reputation. But much of that legacy depends on the identity of the buyer.

Selling the cable unit to Comcast, the only company that has publicly announced a bid, would infuse AT&T with tens of billions of dollars that could be used as a platform for recovery. At the same time, it could be viewed as a defeat because Comcast could essentially get Tele-Communications Inc. and MediaOne--acquisitions that formed the core of AT&T Broadband--for about the same price the company was willing to pay for MediaOne alone just two years ago.

A deal with a coalition of media companies hoping to rival AOL Time Warner is a more compelling story. Creating a new giant from the ashes of AT&T's old strategy would be a final masterstroke, regardless of whether Armstrong is involved in running it.

The reluctance of any content company or coalition to step immediately forward highlights just how complicated any such endeavor might be, however. The merger of America Online with Time Warner has forced other giants to consider the same kind of structure, but not necessarily with pleasure, analysts say.

"The existence of AOL Time Warner and its power forces the issue for people," said Dylan Brooks, an analyst with Jupiter Research. "But even when a company owns its own delivery network and programming divisions, they often treat each other with the same hostility as if they were separate. It's not a slam dunk."

AT&T, Comcast, AOL Time Warner, Microsoft, Disney, Cox and Charter declined to comment on any negotiations.


From the first moment Ma Bell announced its four-way split, AT&T Broadband's fate as a separate company appeared sealed. Although a stunning admission of the failure of more than $100 billion in cable networks purchases, the breakup appeared to make sense to a board and investors horrified by the company's plummeting stock price.

The company's cable networks, its video programming and its interest in the Excite@Home cable modem service would all be transferred to the division named AT&T Broadband and be released in a separate tracking stock, the company said. The tracking stock's summer debut was delayed but is still planned for this year, "depending on market conditions."

Originally, the cable division was to become its own independent company a year after that initial public offering, executives said, and the tracking stock was to be turned into shares of this new entity. The Comcast bid, and management's decision to see if a better deal could be found, put those plans on ice.

AT&T Broadband has inherited many of the problems of the old TCI, the cable operator purchased in 1998. Its scale gives AT&T enormous potential, but TCI's network is not as technologically advanced as other cable companies, and AT&T trails rivals in basic TV subscriber rates. Expenses stemming from building high-speed data, digital video and cable telephony features into the network have kept the unit in the red through recent quarters, and considerably more investment is needed.

Nevertheless, an independent AT&T Broadband company would remain a cable powerhouse, with majority ownership in Excite@Home, the largest high-speed Net service in the United States. It would retain the ability to cut separate programming and content deals with the likes of Disney or Microsoft or even to merge with some other company.


A sale to Comcast and its executives--prototypical cable industry insiders--would be a very different story. Where AT&T has stumbled as a newcomer to the business, Comcast could boost AT&T's below-average profit margins through its knowledge of the marketplace.

Comcast owns many cable systems and some sports franchises, giving it access to both distribution and programming. The company is focused specifically on cable, unlike other potential suitors with ambitions that include dial-up Internet service, software or movie studios--all major industries in their own right that could serve as distractions from the cable business.

Analysts say Comcast must be considered a front-runner because of its solid track record as a cable operator, its relatively stable stock price, and its ability to sell higher-priced offerings such as cable modem Net service, digital TV and local phone service to customers already subscribing to its network.


On the other end of the spectrum is AOL Time Warner, which would love nothing more than to absorb AT&T Broadband into its vastly expanding empire. Already the nation's No. 2 cable operator, AOL Time Warner would be the largest U.S. cable company by far with the addition of AT&T Broadband's networks.

The companies already share a stake in cable modem service Road Runner, and AT&T Broadband owns a stake in Time Warner Entertainment. AT&T and Time Warner had hoped to work together to offer cable-based local and long-distance phone service, though a deal was never consummated.

But the two companies also have a long history that has included some bad blood. Years ago, America Online rejected a reported buyout offer from AT&T. More recently, AOL lobbied fiercely against AT&T Broadband in an effort to deliver its Internet service over AT&T's cable networks.

Yet the biggest hurdle to any deal between AT&T Broadband and AOL Time Warner is regulation. In an effort to avoid an industry monopoly, the Federal Communications Commission has mandated that no cable operator can serve more than about a third of the nation's homes. And AOL Time Warner already faces a variety of antitrust regulations involving its historic merger.

Sources say AOL Time Warner has already gotten regulatory advice against pursuing a purchase. "All they want is a low price for the (Time Warner Entertainment) interest and then they'll go away," one cable industry source speculated.


Outside the communications industry, Microsoft has become a more recent entrant into the fray, believed to have held talks with AT&T regarding the future of the broadband unit.

Microsoft has a distinct interest in the adoption of broadband Internet technologies. High-speed Net access is critical to the future of its Windows XP operating system, Xbox gaming console and Internet strategies.

To that end, the company has invested in cable networks and telephone carriers that provide DSL high-speed Internet connections.

The software powerhouse is doing its best to build bridges with Hollywood studios and other companies, in hopes of seeing its media technology used in movie and music distribution, as well as carrying those subscription services on its MSN Internet service. A new relationship with Disney or other partners in an alliance to buy or invest in AT&T Broadband could substantially advance that goal.

But running a cable company is far different from building software, and Microsoft has repeatedly said it does not intend to become a communications service provider--in no small part because of the prospect of more federal scrutiny, something the company is loath to take on. Still, an AT&T Broadband deal would provide Microsoft with direct access to the interactive television market that it so desires.


Media and entertainment giant Disney also is monitoring the situation closely and may consider a bid--possibly in conjunction with a partner company. Charter, a cable operator backed by billionaire Paul Allen, has been linked with Disney.

"It's a big priority. Disney is burning the midnight oil" over a possible deal, according to one source close to the discussions.

From a strategic standpoint, analysts say, a combination of Disney's content and AT&T's cable distribution would be a smart move. But Disney's failures on the Internet, exemplified by Starwave and Go.com, raise questions about the company's adeptness in overseeing distribution. In particular, Disney knows nothing of managing and operating a cable operator--a situation that, according to one source, Armstrong would see as an opportunity for a new management role.

Disney's interest in a possible deal may be as much a defensive play as anything else. Even if it has only lukewarm enthusiasm, Disney will do anything it can to prevent AOL Time Warner from getting its hands on AT&T Broadband, whether by leading an antitrust fight in Washington or purchasing the cable division itself. As underscored in public opposition to the America Online-Time Warner merger, Disney clearly sees the media conglomerate as its strongest competitor.


Other companies are considering their chances, including rival cable operators Cox Communications and Cablevision Systems, which declined comment, but their prospects are not seen as particularly bright at this point in the courtship.

Cox's networks are among the most technologically advanced in the industry, and the company is known for its success in selling advanced services such as high-speed Net access, local voice and digital TV to its subscribers. But some have suggested that the family-owned company might balk at making a bid for fear of significantly diluting the family's stake in the company.

Analysts and industry insiders have begun to speculate that the longer Comcast's offer is the only one on the table, the more likely it is that the cable operator will win the prize. Some insiders suggest that AT&T investors will begin to pressure the company for a decision with the approach of Labor Day, which traditionally signals the end of the summer and its slower business period.

Even if AT&T opts not to sell, or if Comcast walks away the winner, industry watchers speculate that the talk of a coalition or broader partnership aimed at AOL Time Warner could resurface in a year or so.

But for now it appears AT&T and Armstrong will spend the rest of the summer mulling their options.

"I think clearly Mr. Armstrong is trying to ensure that he maximizes the value for his shareholders," said Michael Harris, president of Kinetic Strategies, a broadband market research and publishing firm. "And part of that is negotiating, or posturing that you're negotiating, with several players to get the best price." 


 


From Comcast to Disney, these companies have reason to partner with--and avoid--AT&T Broadband.

Comcast
Major cable operator
President: Brian Roberts
Pros: Hopes to expand its reach with acquisition. $40 billion offer already on the table.
Cons: AT&T has rejected bid as inadequate.
Wild card: Roberts family, which controls Comcast, is notoriously persistent.

Microsoft
World's largest software maker
CEO: Steve Ballmer
Pros: Would provide cable distribution for software, interactive TV and Net services. Already has investments in cable industry and AT&T. Could make for a blockbuster deal.
Cons: Has no desire to operate a communications network. Would open company to new regulations.
Wild card: Gates and Armstrong egos.

Disney
Entertainment and media juggernaut
CEO: Michael Eisner
Pros: Provides avenue for distribution of content such as TV programs and movies. Already knows the cable industry.
Cons: Existing customers would become competitors. Prior experience with the Internet ended badly.
Wild card: Behind-the-scenes politicking and willingness to partner.

AOL Time Warner
Massive Internet, cable and media company
CEO: Gerald Levin
Pros: Would extend Time Warner Cable reach.
Cons: Major regulatory hurdles.
Wildcard: AT&T's 25 percent stake in Time Warner Entertainment.



Yankee Group analyst Mike Goodman explains why Microsoft and Disney are holding talks with AT&T. (8/13/01, 6 minutes)

• Windows Media Player
• Real Audio



AT&T talks up cable

AT&T rejects Comcast takeover bid

Malone leaves AT&T board; shares take flight

Comcast makes bid for AT&T Broadband

AT&T makes its four-part breakup official

AT&T wins the bidding war for MediaOne
 



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Editors: Mike Yamamoto, Lara Wright, Jennifer Balderama
Design: Melissa Parker
Production: Mike Markovich