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Sprint, MCI deal adds to AT&T troubles

Charged with reinvigorating AT&T, chief C. Michael Armstrong may be facing the toughest challenge yet in his ambitious strategy to reinvent Ma Bell: timing.

    Charged with reinvigorating AT&T amid massive change in the telecommunications industry two years ago, chief C. Michael Armstrong may be facing the toughest challenge yet in his ambitious strategy to reinvent Ma Bell: timing.

    AT&T, the No.1 provider of consumer long distance services, has launched a strategy to circumvent the dominance of regional phone companies through the use of cable-based networks normally used to provide television programming. But with long distance rates falling faster than most expected and formidable new foes like merger-happy WorldCom on the horizon, industry observers and analysts say the firm may be in a race against the clock to develop new sources of revenue using unproven technology.

    Events of the past week and ongoing issues have cast AT&T's strategy in stark relief. No. 2 long distance provider MCI WorldCom announced plans to merge with No. 3 player Sprint in the largest corporate merger ever while Leo Hindery, chief strategist for Ma Bell's cable foray, resigned. Questions also continue to dog AT&T's proposed use of cable networks to deliver local phone service, based on current technological limitations.

    In some respects, the proposed merger of MCI WorldCom and Sprint for $129 billion can be compared with AT&T's $110 billion cable bet on Tele-Communications Incorporated (TCI) and MediaOne Group. With such huge bets come high stakes. But while MCI WorldCom will gain a much-needed proven nationwide cellular phone network, among other valuable assets, AT&T is betting its billions on networks that were not created to handle the voice traffic Ma Bell aspires to deliver through them, forcing the company to invest billions in technology upgrades.

    "Cable telephony to date has been a money pit," said Scott Cleland, telecommunications analyst with Legg Mason Precursor Group. "They're trying to take a quirky [network] and squeeze out of it the same reliability that competitors have with [traditional networks]. That costs a lot."

    "AT&T has an enormous task. The whole cable venture is to buy back access to the customer," Cleland said. "They've spent more than $100 billion to get access to about a quarter of the country. That signals the magnitude of their strategic dilemma. They still have to reach the other three-quarters of the nation. Access to the customer is expensive."

    Stock in AT&T has traded significantly lower in the past six months with shares having traded in the low 60s as recently as May. Stock in the company finished nearly 2 percent lower today at 47.88. Shares have traded as high as 64.12 and as low as 38.06 in the past 52 weeks.

    A formidable foe
    Not only does AT&T face technical challenges and slumping long distance profits, but Ma Bell faces a bulked-up competitor in the recent $129 billion combination of Sprint and MCI WorldCom. The combined company will have the size and market value to compete with AT&T in a future dominated by megacommunications companies.

    "[Sprint-MCI is] an extra competitor with extra power that wasn't there before," said Peter Jarich, a broadband analyst at telecommunications market research firm Strategis Group. "The biggest problem in facing the local telephone market is going to be competition from MCI WorldCom and Sprint."

    Not only do Sprint and MCI have strong long distance offerings and new wireless cable technology that could compete with AT&T for local telephone and cable TV revenue, but some analysts say they're better positioned than Ma Bell for high-growth markets. The combined Sprint-MCI has a better Internet backbone business and has made stronger in-roads into the international business telephone markets than has AT&T, Legg Mason's Cleland said.

    In addition, price erosion in the long distance market may force AT&T's hand sooner than it expects. The combination of the No. 2 and No. 3 long distance providers, along with a slew of communications upstarts, may only add to the pitfalls of that business.

    "Consumer long distance still remains a big chunk of AT&T's business, and resellers are chipping away at it and pricing pressures are reducing their profits," Cleland said. "They've bet the farm that they can grow those new services at a very high rate. They can definitely do it, but it's a matter of time. I'm skeptical they can do it on their timetable."

    But AT&T, long a focus of regulators itself, may get a federal reprieve given the nature of the MCI WorldCom/Sprint combination. After all, completion of that merger--if it passes regulatory muster--is likely a year off. "By the time they get together, which could be well into next year, AT&T should have a pretty good leg up on them," Jarich said.

    Behind the times
    When AT&T bought TCI, one of the nation's largest cable operators, in a blockbuster deal last year it heralded the company's embrace of cable as an avenue for directly accessing local customers.

    Although the TCI purchase gave AT&T access to millions of American consumers, it also gave Ma Bell a major headache. After years of neglect, TCI's cable networks weren't as technologically advanced as many others in the industry. AT&T even had to relinquish some of its control over high-speed Net access service Excite@Home because it hadn't met certain goals for its network upgrades.

    The company revealed in March that its cable networks were only 26 percent upgraded for two-way transmissions, a prerequisite for telephony and high-speed Net access. Now, nearly seven months later, AT&T says it expects its upgrades to reach 50 percent by the end of the year.

    In addition, AT&T's cable systems will be 85 percent to 90 percent upgraded by the end of 2000, according to AT&T spokesman Mark Siegel.

    "That's probably the biggest problem AT&T faces. They lag by several years behind the other [cable operators] in terms of network upgrades. They're kind of paying the price for that now," said Mike Paxton, a cable industry analyst at Cahners In-Stat Group. "The problem with the strategy is that it got ahead of the reality. It's going to take much more time to upgrade the [cable] infrastructure than I think Armstrong thought."

    Ma Bell expects to spend an additional $5 billion on network upgrades. Analysts say AT&T's top priority must be to bolster the technical capabilities of its networks if the company hopes to meet its goals, which currently call for widespread commercial availability of local telephone service sometime in 2001.

    "It's definitely dependent on how quickly they can upgrade," said Jarich.

    But AT&T insists its network upgrades are on track and its cable-based phone tests have been successful so far. "The challenge is the scale of what we're trying to do," Siegel said.

    Take me to your leader
    Amid the feverish network upgrades and multibillion dollar mergers, AT&T's top cable executive has decided to leave the company.

    Hindery, chief executive of AT&T Broadband & Internet Services, Ma Bell's cable division, will stay with AT&T long enough to complete a handful of outstanding deals. But he said in the aftermath of the merger news that he realized that he would not be with AT&T long term. Hindery is a well-liked cable industry power broker, and his absence raises questions about the future of AT&T's cable leadership, and--after a string of other high-profile executive defections--its corporate culture.

    In recent years Ma Bell has lost talent such as now-Qwest Communications International chief executive Joseph Nacchio; Global Crossing chief Robert Annunziata; Jeffrey Weitzen, now at Gateway; former AT&T WorldNet executive Daniel Schulman to Priceline.com; and Gail McGovern, currently an executive at Fidelity Investments.

    Although the loss of Hindery--who one analyst described as the cable industry's "demigod"--is a blow, analysts expect AT&T to continue moving forward with its cable strategy. "I don't think long term it's going to hurt, but short term it is," Cahners's Paxton said. "It's going to hurt their short-term vision. Once again, it could be a factor in slowing things down in terms of rolling out services."