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Comcast's big pitch

Roberts' bear-hug ploy for AT&T Broadband will prompt other players to look, too 7/15/2001 08:00:00 PM Eastern

Can Armstrong save face?

Can Armstrong save face?

At first glance, Comcast Corp.'s $58 billion bid for AT&T Broadband makes AT&T Chairman Mike Armstrong's three-year waltz through the cable industry look like a fire sale.

After all, Armstrong used to brag to Wall Street and regulators about the $120 billion he spent in cable: $62 billion in its 1999 bid for MSO MediaOne Group, $48 billion for his 1998 bid for Tele-Communications Inc., plus billions more for system upgrades.

After a careful look, however, even if AT&T's cable systems are worth Comcast's bid, the math isn't as terrible for Armstrong as it looks. Armstrong can argue with a straight face that his stab in the cable business cost him around $67.5 billion.

First, AT&T bought the two companies for a combination of cash, assumed debt and its own stock. The spending is really pegged to the price of AT&T's stock when the deals actually closed.

SEC filings show the deals were really worth $97 billion when they closed.

Capital spending so far has hit Armstrong's initial expectations, running about $10.1 billion though June. Put AT&T Broadband's outlay at $107 billion.

But those acquisitions, particularly MediaOne, came with all sorts of odds and ends in the attic that AT&T has sold or aren't covered by the Comcast offer. Some fetched fat prices.

Microsoft paid $3 billion for a 30% stake in UK cable operator Telewest. Shares in UK cellular operator Vodafone were "monetized"—used to collateralize a $3.4 billion convertible bond offering. (This can be tax-free cash and is what CEOs usually mean when they say "monetize" these days.) Stock in UK cellular operator One-2-One fetched $5.7 billion (that's pre-tax) when Deutsche Telcom took over interests in overseas cellular ventures. Cellular Telecommunications brought another $2 billion. Total after-tax proceeds: $26 billion.

That takes AT&T's outlay down to $81 billion. The big items left include TCI's 48.9 million shares in Cablevision Systems Corp. ($2.8 billion market value), which spawned a 25 million share stake in tracking stock Rainbow Media Group ($660 million).

Then there's the big problem child, a 26% stake in Time Warner Entertainment. That stake is worth as much as $15 billion. But 74%-owner AOL Time Warner has for years been playing hardball in attempts to cash it in or trade it for assets. Figure its value at $11 billion. AT&T Broadband is also expecting about $4.5 billion from the sale of rural cable systems.

That takes AT&T's outlay for the cable systems down to $65.5 billion. The last big piece is AT&T's embarrassing acquisition of Excite@Home.

After all its maneuvers and the Internet crash, a person familiar with the transactions said the investment is worth only about $200 million, but AT&T's damage, after nifty tax footwork, was held to about $2 billion.

That would put AT&T's cable business outlay up to around $67.5 billion,16% more than Comcast's $58 billion offer.

So can Mike Armstrong squeeze another $9.5 billion out of a bidder and save face?

J.H.

Media moguls can be like kings. They sit at the top of their world constantly pursued by supplicants, from programmers, technology vendors, lenders, investment bankers and miscellaneous entrepreneurs wanting a piece of their lives. Carry our network. Buy our box. And the ever ironic, pay us to raise money for you.

The roles, however, do reverse. Every so often, it's the turn of even the mightiest, most successful media don to bow and scrape. For Brian Roberts, this is one of those times.

The president of Comcast Corp. spent last week jetting around the country to convince some of the largest shareholders to support him on the biggest quest of his lifetime in cable, a $58 billion bid for AT&T Corp.'s cable systems. Unable to coax AT&T chairman Mike Armstrong into selling, Roberts is campaigning among AT&T's largest shareholders to put the heat on. The trouble for Roberts is, if he is successful, he risks sending AT&T Broadband into the arms of a different owner, not necessarily Comcast.

Shortly after explaining their proposal in New York, where the deal-makers live, Roberts, Comcast Cable Division President Steve Burke and others from the Comcast crew headed off for places where the money lives and plays—Boston, Denver and Sun Valley—where, for a week each year, Allen & Co. sponsors a media-investment conference cum
summer camp for the media elite.

"I think people find the offer to be very compelling," Burke said, while jetting to the retreat. "Of the top-50 AT&T shareholders, 38 of them have Comcast [shares]. They understand what we're talking about."

Since Comcast wants to pay stock, not cash, it's not simply an auction. Roberts has to convince AT&T shareholders he can run the systems vastly better even than a spun-off, independent AT&T Broadband.

As an independent company, AT&T Broadband would get 100% of whatever upside Armstrong and AT&T Broadband Chairman Dan Somers can squeeze out of the largest portfolio of cable systems in the country.

Roberts has to convince AT&T shareholders that Comcast's performance would be so good that AT&T shareholders would make out even if they had to split that upside with Comcast's shareholders.

DO IT NOW, ROBERTS SAYS

To investors in New York, Roberts said his plan steps up Armstrong's multiyear plan to first create a tracking stock around AT&T Broadband this fall, then, in another year or two, completely separate the cable unit from AT&T's core phone operation.

Separate those assets today, he argued. "What this would allow is a rapid acceleration and a significantly better outcome, I believe, for the AT&T shareholders than the deal that they're currently preparing to do," Roberts said.

So while pressuring shareholders to pressure Armstrong, Roberts also has to worry about triggering a bidding war. This, of course, is how he lost his deal to buy MSO MediaOne Group in 1999. Roberts thought he had a deal, but instead simply put MediaOne in play and got outbid.

The winner: Armstrong.

AT&T executives, unsurprisingly, are not thrilled. Armstrong, too, is accustomed to being courted into deals and, indeed, was being wooed by Roberts for a while. But Armstrong is testy about Comcast's rare and risky "bear-hug" tactic.

For all of Roberts' contention last week that AT&T rejected his approaches, AT&T Chairman Mike Armstrong said he never got a detailed bid for the telco's cable division until everyone else did. "Comcast never gave us a concrete proposal," Armstrong said in a speech to the Boston Chamber of Commerce Wednesday, "at least not until a two-page letter showed up on my home fax machine Sunday evening—about the same time that it appeared on fax machines of newspapers around the country."

Armstrong said the company is giving "serious consideration" to Comcast's offer to buy its cable systems. But he added that one of his best options is focusing on "the value we will create by growing our business and improving our margins."

Comcast executives have been lusting for AT&T for months. Almost as soon as Armstrong announced he would splinter AT&T into five parts last October, they began studying how to pry the cable systems out early. "If it becomes a tracking stock, there's nothing you can do with it," a Comcast executive said last December.

BAD FINANCIALS, GOOD AMMO

In the end, it was Armstrong and Somers who gave Comcast its best ammunition by turning in an abysmal performance during the first quarter ended March. While new digital cable, Internet and telephone products drove the cable unit's monthly revenues to a strong $50 per subscriber, cash flow was horrible.

Cash flow per subscriber was just $8 per subscriber, far lower than the $20-plus other operators generate. AT&T Broadband's cash-flow margin was just 16%, while other operators run 40% to 50%. "It was startling," said the CEO of another MSO. "I'm not sure I could get cash flow that low if I tried."

Comcast is seizing upon that as its biggest weapon. "The best place to start would be an examination of our margins vs. the AT&T margins, over the last five quarters," Burke said. "What you will find is a pretty consistent 20%-plus gap."

Burke contends that, even if Comcast only closes half that gap in the next two years, it would squeeze $1.2 billion in new cash flow out. "That is about $20 billion of value creation that would be mostly going to the AT&T shareholders."

And how does Comcast run things differently? While trying not to bash AT&T hard, Burke contends that AT&T is simply bloated. He sees $500 million in overhead "We don't see a reason we can't take this overhead below $50 million." AT&T's sales and marketing expenses run double Comcast's, 5% to 6% of revenues.

PHONE HANG-UPS

Cable telephone service is a big drain, $500 million a year, or $60-70 per telephone customer. When Comcast acquired old MediaOne systems from AT&T last year, they came with 150,000 cable telephone subscribers. "We have kept those operations going and during the last six months have taken those operations from a significant money loser to break even." Burke contends he can do the same to AT&T's operation in 12 to 24 months by halting phone expansion, marketing more efficiently and milking the operation for cash.

An AT&T executive scoffed. "We already know how to shut down marketing cut to the bone, but we're trying to build a long-term business here." The executive noted that Comcast has kept margins up in part by scrimping on system upgrades and product development, being forced to play catch-up later.

No one really expects Comcast's bid to be the last one. First off, Comcast specifically excluded AT&T Broadband's stakes in Time Warner Entertainment, Cablevision Systems Corp. and Rainbow Media Group; all of them problem children that AT&T is in the process of somehow "monetizing".

Roberts pretty much acknowledges' he'll have to make some sort of commitment on those. Wall Street and media executives widely expect Comcast to boost his price, as well.

And of course, convincing Armstrong to sell doesn't mean he'll sell to Roberts. Fee-hungry investment bankers are busily trying to convince other companies to get in the game, with the most obvious suspects being other cable operators like Cox or Charter or programmers who would like AT&T's remaining 13.5 million subscriber- distribution base to leverage their programming assets, like The Walt Disney Co. or Vivendi Universal. One company, AOL Time Warner, is in both camps.

Despite quitting AT&T's board in a huff last week after being shut out of discussions about Comcast, Liberty Media Chairman John Malone is still a major shareholder and would love to see a bidding contest.

"I expect that AT&T will be seeing alternative proposals and improved proposals," Malone told Bloomberg News Friday in Sun Valley. "AOL is not going to sit on its hands. There are a number of others that won't. So I think we're early in the game."

Coming up short
AT&T Broadband stunned other cable operators when its cash-flow margin sank to 16% during the first quarter, well below that of its peers. The cable unit has no problem generating revenues, but it also spends heavily. It has, for example, twice the employees per subscriber as other MSOs. Before AT&T bought them, its cable properties posted margins around 40%. Here's how the major operators fared in the first quarter of 2001.
Monthly rev/sub Cash-flow margin Monthly cash flow/sub
Source: Bank of America Securities
Cablevision $54.33 AOL Time Warner 47.3% Cablevision $24.85
AT&T $52.96 Adelphia 45.8% Comcast $22.27
Cox $51.84 Cablevision 45.7% Charter $20.74
Comcast $50.84 Charter 45.2% AOL Time Warner $20.16
Charter $45.91 Insight 44.4% Adelphia $19.92
Insight $43.73 Comcast 43.8% Insight $19.40
Adelphia $43.49 Mediacom 43.1% Cox $19.12
Mediacom $42.82 Cox 36.9% Mediacom $18.47
AOL Time Warner $42.66 AT&T 16.0% AT&T $8.47

Can Armstrong save face?

Can Armstrong save face?

At first glance, Comcast Corp.'s $58 billion bid for AT&T Broadband makes AT&T Chairman Mike Armstrong's three-year waltz through the cable industry look like a fire sale.

After all, Armstrong used to brag to Wall Street and regulators about the $120 billion he spent in cable: $62 billion in its 1999 bid for MSO MediaOne Group, $48 billion for his 1998 bid for Tele-Communications Inc., plus billions more for system upgrades.

After a careful look, however, even if AT&T's cable systems are worth Comcast's bid, the math isn't as terrible for Armstrong as it looks. Armstrong can argue with a straight face that his stab in the cable business cost him around $67.5 billion.

First, AT&T bought the two companies for a combination of cash, assumed debt and its own stock. The spending is really pegged to the price of AT&T's stock when the deals actually closed.

SEC filings show the deals were really worth $97 billion when they closed.

Capital spending so far has hit Armstrong's initial expectations, running about $10.1 billion though June. Put AT&T Broadband's outlay at $107 billion.

But those acquisitions, particularly MediaOne, came with all sorts of odds and ends in the attic that AT&T has sold or aren't covered by the Comcast offer. Some fetched fat prices.

Microsoft paid $3 billion for a 30% stake in UK cable operator Telewest. Shares in UK cellular operator Vodafone were "monetized"—used to collateralize a $3.4 billion convertible bond offering. (This can be tax-free cash and is what CEOs usually mean when they say "monetize" these days.) Stock in UK cellular operator One-2-One fetched $5.7 billion (that's pre-tax) when Deutsche Telcom took over interests in overseas cellular ventures. Cellular Telecommunications brought another $2 billion. Total after-tax proceeds: $26 billion.

That takes AT&T's outlay down to $81 billion. The big items left include TCI's 48.9 million shares in Cablevision Systems Corp. ($2.8 billion market value), which spawned a 25 million share stake in tracking stock Rainbow Media Group ($660 million).

Then there's the big problem child, a 26% stake in Time Warner Entertainment. That stake is worth as much as $15 billion. But 74%-owner AOL Time Warner has for years been playing hardball in attempts to cash it in or trade it for assets. Figure its value at $11 billion. AT&T Broadband is also expecting about $4.5 billion from the sale of rural cable systems.

That takes AT&T's outlay for the cable systems down to $65.5 billion. The last big piece is AT&T's embarrassing acquisition of Excite@Home.

After all its maneuvers and the Internet crash, a person familiar with the transactions said the investment is worth only about $200 million, but AT&T's damage, after nifty tax footwork, was held to about $2 billion.

That would put AT&T's cable business outlay up to around $67.5 billion,16% more than Comcast's $58 billion offer.

So can Mike Armstrong squeeze another $9.5 billion out of a bidder and save face?

J.H.

 

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