How would Comcast-AT&T fare?

Jul 16, 2001  •  Post A Comment

Lost in the shuffle of the high-powered speculation and maneuvering in the wake of Comcast Corp.’s $54 billion bid for AT&T Broadband is a closer look at some of the financial implications for the merged company.
This isn’t just about the No. 3 cable player lusting to be the biggest operator in the United States and the world.
Comcast President Brian Roberts is still smarting from losing MediaOne Group to AT&T more than a year ago in a spunky effort to morph his company, even though he walked away with a $1.5 billion spoiler fee. He does want to be on top of the heap.
Wisely, Comcast management remains squarely focused on its stellar acquisition, execution and financial track records.
Mr. Roberts last week argued that mere scale in the right places would give Comcast the rare opportunity to accelerate the rollout of new digital content and services, which he says will meet consumer demand and aid the entire cable industry.
But Comcast officials have not been able to put a price on such a process-or on bringing AT&T’s systems technically and financially up to snuff.
“[The merger] allows us to take the fastest-growing part of our company, which is our content division, and turbocharge it with 22 million customers as a platform,” Mr. Roberts said, pointing to Comcast’s success with QVC, E! Entertainment and Sportsnet.
Getting it right
The company could leverage its more potent national footprint to build new strategic equity partnerships, working alliances and off-balance sheet investments that can fill voids in its content, service and distribution without having to resort to more costly acquisitions, he said.
“If you can do it just right, you can create future value and future growth for your shareholders that otherwise would not be there without that acquisition,” Mr. Roberts said.
To be sure, Comcast’s proposal is all about exploiting scale in a way that AT&T Broadband hasn’t been able to do, in part because the latter has been mired in $2 billion-plus in annual upgrades of the deficient systems it acquired from John Malone two years ago.
However, a merged company-over which Comcast would have management control-also would have to finance the remaining upgrades to about 35 percent of AT&T’s cable systems. Sources say the merged company would likely spend at least $2.5 billion during the next several years to complete the process, which would include the distribution of digital cable set-top boxes and modems to subscribers wanting new services. Half of that amount would be financed from Comcast’s positive cash flow and the other half from a bank loan, well-placed sources said.
That would be the main reason the merged cable company would have to wait until at least 2003 to turn cash-flow-positive, analysts say. Although Comcast has projected that its existing structure will generate between $600 million and $800 million in free cash flow in 2002, it will be years before AT&T Broadband turns cash-flow-positive.
At the same time next year, Comcast will still have about $200 million in costs to complete upgrades in only 10 percent of its remaining systems and will continue to provide an estimated $250 million in digital cable boxes and modems to subscribers who wanted new services at an estimated average cost of about $300 per unit.
Although Comcast executives say upgrading AT&T’s systems and equipping subscribers will likely be the biggest new cost after the merger, there will be other expenses that they and Wall Street haven’t yet analyzed as they integrate, operate and grow their new company.
Comcast officials say those added costs will not be onerous. “In a lot of ways, operating the merged company will have more to do with savings rather than with increased costs,” a top-ranked Comcast executive said.
While an estimated $3.5 billion in annual programming-related costs will be one of the merged company’s largest expenses, it is an area where the company’s unparalleled scale could be used to realize new savings and minimize increases.
After all, what content and service provider won’t want to do business with the largest cable operator? A merged Comcast-AT&T Broadband would use its clout to negotiate favorable rates and launch new services with new program allies. At the very least, it would realize an estimated $50 million in savings by moving some Comcast systems to the AT&T rate card.
Windfall of returns
On the other hand, it would behoove a merged Comcast-AT&T to have an advantage similar to that of AOL Time Warner. The nation’s second-largest cable operator can simply dip into Warner Bros. and its other vast content reserves at minimal or no cost to meet subscribers’ content demands.
Ultimately it would cost a merged Comcast-AT&T to acquire or align with more influential content and service providers.
Comcast officials say they still are analyzing such potential scenarios and what it will cost to bring AT&T’s 18 percent margins up to Comcast’s 41 percent margin standards at a time when they-like the rest of the cable industry-are waiting to realize a windfall of returns on their hefty digital investments.
Comcast management said last week that bringing AT&T cable to parity with its own systems is the key to making a merger work.
For now it’s fair to say the $2.3 billion in savings in margin improvement, and an additional $300 million to $500 million in annual savings from synergies and overlap, would help offset the cost of integrating and upgrading the merged company and developing and maintaining competitive digital content and services.
Whether or not telephony-the very reason AT&T got into the cable business-is part of the merged company’s digital game plan is a big unknown and a potentially large cost item. AT&T already has incurred an estimated $500 million in telephony-related losses, sources say.
Mating dance
Comcast has been cautious about telephony, largely because it represents a losing gamble until Internet-protocol telephony becomes a full-blown option.
Telephony is one of the wild cards in the mating dance between Comcast and AT&T. If Comcast executives find themselves having to agree to use AT&T for telephony services in its merged systems, they would be making a new service commitment that over time could cost lots of money before it generates profits. That would have to be factored into the combined company’s long-term financial picture.
Telephony would cost far more over a longer period of time to roll out and take hold than video on demand, which many consider to be digital cable’s more immediate killer app.
Industry analysts expect cable operators to roll out VOD to more than 85 percent of their digital customers by 2006, generally spending an average of $60 per subscriber. Within five years, they can expect to realize a 58 percent return on their investment.
That is an unfounded projection that represents the best-case scenario of any new cable services, including digital video, high-speed data and telephony.
Some experts contend the economies of scale that a merged Comcast-AT&T represents would more than offset the potential costs, variables and risks, which have not yet been fully analyzed.
But many on Wall Street are beginning to realize that scale alone is no guarantee of success.
In a coincidentally timed report titled “Does It Pay to Be First?” Richard Bilotti, a leading analyst at Morgan Stanley Dean Witter, which is advising Comcast in the AT&T deal, writes that the economies of scale can “be fragile and fleeting” even for the most astute operator.
“The growth benefits from domestic scale are fading,” Mr. Bilotti writes. “Viacom, Disney and AOL Time Warner need other sources of growth,” primarily in international and Internet venues, “or [they] run the risk of becoming value investments.”
“While scale economics provides some operating cost leverage, operating margins within developed cable networks are primarily a product of programming costs,” Mr. Bilotti said.
As we all know, programming costs are one of cable’s biggest line items and the runaway train that keeps all major d
istributors hopping.
While there is no doubt Comcast could more cost-effectively and efficiently operate AT&T’s cable systems, it’s still not clear at what price.
That’s a question that’s even more formidable than the deal’s lofty price tag.