Armstrong Cable's Master Dealmaker

K.C. Neel

AT&T Corp. chairman C. Michael Armstrong solidified his position as king of the telecommunications world last week with a series of bold transactions giving the company 3 million MediaOne Group subscribers, a coveted telephony deal with Comcast Corp., and a deep-pocketed partner in Microsoft Corp.

First, AT&T averted a costly and drawn-out bidding war for MediaOne by crafting a multi-faceted agreement that gives Comcast an additional 2 million customers and AT&T access to Comcast's 8 million homes to deliver phone services.

The next day, AT&T announced it's teaming with Microsoft to develop new interactive services in a deal that will net Microsoft a 3% stake in AT&T and give AT&T $5 billion to fund the projects (see story, page 42).

MediaOne will be AT&T's last big acquisition, Armstrong said last week, but don't expect the telco to sit still. AT&T has been talking to foe America Online Inc. about some kind of arrangement that would give the Internet access provider access to AT&T's cable lines on favorable terms. Such an agreement could be pivotal to getting the MediaOne acquisition completed. AOL has been urging regulators to take a critical look at AT&T's burgeoning power.

The company also will continue its quest for cable operator telephony deals and to swap systems to better cluster its operations, said AT&T Broadband & Internet Services president Leo Hindery.

Although AT&T came away with MediaOne, Comcast didn't walk away a loser last week, analysts said. The Philadelphia-based MSO will get a $1.5 billion breakup fee and will own systems that count 750,000 customers via several trades and purchases. Comcast also will buy AT&T properties counting another 1.25 million customers over the next three years for $5.7 billion, a $4,600 per subscriber fee that mirrors AT&T's per subscriber cost for MediaOne.

Some analysts believe the world of bundled digital communications services will be even more of a boon than many Wall Street analysts currently expect. "They're going to need a bucket to take away all the money" companies will make, said State Street Research SVP Larry Haverty, during a Paul Kagan Associates Inc. seminar in New York last week.

AT&T must now get down to the nitty gritty work of obtaining regulatory approval for its MediaOne deal. Armstrong was confident last week that AT&T would get the necessary OKs.

But the MediaOne deal may be the impetus that determines how the FCC rewrites its long-anticipated cable ownership rules. The regulations, which were stayed by a federal court ruling four years ago, limit MSOs to more than 30% of homes of U.S. homes passed. AT&T will pass 35% of U.S. homes with the MediaOne deal. At the same time, AT&T could also have problems with "attributable interest" rules that restrict MSOs' ownership in other cable systems.

The FCC defines an attributable interest as 5% voting stock or more. AT&T's proposed structure means it would control three of the top five U.S. MSOs. The TCI acquisition gave AT&T a 37% stake in Cablevision Systems Corp. and the MediaOne deal would give the long-distance giant a 25% de facto stake in Time Warner Cable, which MediaOne bought years ago.

Some Beltway attorneys believe AT&T will be able to skirt these problems pointing out there aren't subscriber and ownership limits on local telcos. Still, Roy Neel, president-CEO of the U.S. Telephone Association, outlined his concerns about the deal in a seven-page letter to FCC Chairman William Kennard last week and suggested the commission lighten telcos' regulatory load so "they can compete effectively for voice and data customers against AT&T and other broadband companies."

The Senate Antitrust Subcommittee will hold hearings in June on AT&T's proposed acquisition of MediaOne. And Rep. Billy Tauzin (R-La.) urged Kennard last week to veto the merger saying the deal would be "anti-competitive."

The peace treaty between AT&T and Comcast ends what was shaping up to be one of the most expensive bidding wars in U.S. history. Comcast, which had agreed to buy MediaOne in March for $58 billion, was usurped after AT&T's surprise $62-billion offer in April. Comcast talked to several potential white knights about putting together a counter offer. But in the end, the company chose to work with AT&T rather than against it.

"Comcast could've raised the money to increase their offer," said one source close to the company. "But they just couldn't rationalize the cost. The economics just didn't work."

Comcast will trade its operations in Georgia; Richmond, Va.; Sacramento; Calif.; Broward County, Fla.; Chicago; Colorado, and suburban Pittsburgh for AT&T systems in Michigan; Naples, Fla.; Pennsylvania; New Jersey; New Mexico, and Baltimore/Washington, D.C. Because it's getting more systems than it's trading, Comcast will pay AT&T $3 billion for the properties. Comcast has several payment options: the $1.5 billion breakup fee, AT&T stock Comcast owns via its Teleport sale and stock.

The company also will manage the Lenfest Communications Inc. properties that count 1.2 million customers in New Jersey, Pennsylvania and Delaware. AT&T is buying the 50% of Lenfest it doesn't already own - it inherited the Lenfest stake when it bought TCI - for $2.2 billion in stock.

To be sure, Comcast will now have one of the largest concentrated clusters in the U.S. operating a corridor that runs from northern New Jersey to Baltimore according to Comcast president Brian Roberts. It's unclear what properties Comcast will acquire next but most analysts believe the MSO would surely try to get its hands on the Lenfest systems, largely contiguous to Comcast's Philadelphia operations.

Comcast also agreed to offer AT&T-branded telephony services in all its markets as soon as AT&T cuts two other MSO agreements. AT&T must give Comcast its best terms as part of the deal. That surprised some analysts given AT&T's previous assertion that only Time Warner Inc. would get its best offer.

"This is a different outcome than our MediaOne proposal," Roberts said. "But it is an elegant win-win result."

Most industry watchers agreed, but some said the outcome had to be bittersweet for Comcast. "I wouldn't necessarily call it a win-win," said KPMG Peat Marwick partner Mark Carleton, "because Comcast wanted those MediaOne properties. But it was a prudent move on Comcast's part given the per subscriber prices it would've had to pay compared to the revenues they'd get from them."

Things couldn't have worked out better for AT&T, observers said last week. Even though it'll lose about 2 million customers over the next three years, AT&T comes away with a critical telephony partner in Comcast.

Talks with Time Warner will likely change in the wake of AT&T's agreement to buy MediaOne, Hindery said, noting that the existing agreement "would be modified to reflect our [new] status" as 25% shareholder in TWE. "We will begin conversations from a different vantage point," he said.