Comcast’s AT&T move

Mar 26, 2001  •  Post A Comment

Despite a recent reprieve of sorts from the Federal Communications Commission, the fate of AT&T Broadband hangs in the balance between AT&T Chairman Michael Armstrong’s deepest desire for a public independent cable powerhouse and Comcast Corp.’s expansionist drive to become an aggressive suitor.

The dance between the two companies has already begun, sending ripples of speculation through a volatile market. Executives at AT&T Broadband, AT&T Corp. and Comcast declined comment.

However, industry sources close to the companies say Mr. Armstrong already has rebuffed a personal inquiry made by Comcast President Brian Roberts to acquire all or part of AT&T Broadband.

“Comcast is ready to buy, but AT&T has got to want to sell,” one high-level source said. “Comcast would prefer to acquire AT&T in a friendly way.”

But selling would be an admission of the failure of Mr. Armstrong’s $200 billion-plus cable acquisition strategy, which began when he bought John Malone’s TCI in 1998 for $36 billion, or $3,350 per subscriber. Sources who know Mr. Armstrong well say that isn’t going to happen-at least not right now.

Comcast calling

The FCC on March 16 indefinitely suspended AT&T’s MediaOne divestiture requirements, eliminating a May deadline for shedding a 251/2 percent stake in Time Warner Entertainment and some of its own cable systems. However, the complete spinoff of its Liberty Media tracking stock, which was already in motion, is expected any day, pending Internet Revenue Service approval of tax-free status for the transaction.

The selected cable system sales and swaps AT&T has made in recent months-which some industry observers have misconstrued as the start of a sell-off-were never part of the company’s core upgrade plan. They made sense as a means of raising funds to reduce what was AT&T’s $65 billion debt.

Comcast, the third-largest cable operator behind Time Warner and leader AT&T, acquired some of those AT&T systems and should be able to improve the cash flow on most of them by 25 percent within the first year of operation, sources say.

That is indicative of the upside that is possible at AT&T’s upgraded systems with Comcast’s seasoned management calling the operational shots, analysts say. That would translate into welcome new value for shareholders at a grim time.

AT&T cable systems have been operating at 23 percent margins. Comcast operates its cable systems at 43 percent margins. The difference in gradually increased revenues and profits alone would pay for Comcast’s acquisition of AT&T Broadband.

Analysts value AT&T’s cable systems at as much as $3,800 per subscriber, compared with Comcast’s valuation of about $4,300 per subscriber, and even higher per-subscriber valuations in some recent sales.

Comcast’s big opportunity will come right around the time AT&T files with the Securities and Exchange Commission to spin off AT&T Broadband as a publicly traded tracking stock as a first step toward a full-fledged public spinoff in 2002. The IPO filing still is expected by late summer.

There has been growing speculation that AT&T could back off plans to launch a cable IPO in this weak and uncertain market. However, well-placed sources say Mr. Armstrong is convinced the AT&T brand will help carry the IPO, although it may not command the pricing premium first hoped.

“Time will run out,” one industry expert said last week. “It is hard to do an IPO in this climate. From a tax standpoint, AT&T would need to sell the entire broadband unit-not sell systems off piecemeal.”

Main squeeze

Whether AT&T and Mr. Armstrong can hang on to AT&T’s cable systems and investments is primarily a question of how well the company executes on its plan for new bundled services and improved customer service in the coming months. Also, like other corporations, AT&T is being squeezed by deteriorating economics.

The clock is ticking on AT&T’s huge debt payments while it is spending another $4 billion this year on cable system upgrades. Standard & Poor’s last week said it maintains a negative credit watch on AT&T and its subsidiaries. The clock is ticking on AT&T Broadband’s ability to reach positive cash flow by 2003. However, in what was billed by some journalists as an “angry defense” of his company’s performance, AT&T Broadband CEO Dan Somers recently conceded the MSO will slow its aggressive rebuild program to better target capital spending on the most promising systems and boost cash flow, margins and customer service.

“We’ll end this year much stronger and much healthier financially,” Mr. Somers said at a Cable Television Laboratories press briefing in Colorado.

So far this year, AT&T has reduced its $65 billion debt by more than $20 billion through divestitures and could raise at least another $15 billion through additional asset sales.

Many analysts remain bullish on AT&T Broadband’s go-it-alone prospects. In a recent detailed report, Lara Warner of Lehman Brothers said, “While AT&T’s performance has not been without flaws, we believe its efforts have been underestimated.”

The pros and cons of which course AT&T takes later this year are dramatic for both AT&T and a potential suitor such as Comcast.

AT&T is nearing the moment of truth, having struggled through the pricey acquisition, upgrade and marketing of its patchwork of cable systems. The benefits of Mr. Armstrong’s labor and public angst will come gradually with the rollout of new services to the company’s 28 million subscribers as it aims for $6 billion in cumulative free cash flow by 2005.

Other beaus and bidders

Even if AT&T stumbles or fails to pull off its planned broadband IPO on schedule, there are few other obvious bidders for a company that size. It is possible that a well-funded, noncable player could emerge to take advantage of AT&T’s having completed all the heavy lifting on its upgraded systems. But the gap between heavy capital investments for upgrades and the return from new services could scare potential suitors away in an unstable economic climate when corporations of all size already have halted their merger and growth activity.

Comcast’s recently refinanced and realigned balance sheet gives it uncommon flexibility to acquire and grow when others cannot during the next 12 months.

The company will have $10 billion in cumulative free cash flow over the next five years, and it already has at least half of that in deal capacity. It recently filed a shelf registration to raise necessary funds. Comcast’s refinancing actually frees more than $500 million annually in new revenues to the company.

All that gives Comcast the ability to move quickly in pursuit of AT&T when it’s ready-and it will. Comcast put industry peers on notice more than a year ago when it aggressively bid for MediaOne Group, though it lost to AT&T.

Branded identity

An AT&T acquisition would give Comcast the highest, most powerful reach of any cable operator in the major metropolitan areas of the United States.

Still, the risks would come in other ways. Jeffrey Halpern at Bernstein Research points out that Comcast would be acquiring only the AT&T cable systems-not the AT&T branded service that would drive new consumer offerings.

As a result of a bundling study he conducted, Mr. Halpern concludes that AT&T Broadband has “a significant first-mover advantage” with its branded data and telephony services.” If AT&T can’t make the most of that, surely a company such as Comcast can.