Is Armstrong right?

Not many think so, but Comcast still has to raise its bid

Can Mike do anything Brian can? That's perhaps the basic question in the fight between AT&T Corp. Chairman Mike Armstrong and Comcast Corp. President Brian Roberts, who is striving to buy AT&T's cable operation. If AT&T Broadband were to spin off and remain independent, can Armstrong and Broadband Chairman Dan Somers perk up the operations enough to give shareholders a better return than what Comcast is offering?

Comcast has so many fans on Wall Street—and AT&T so few—that the answer may seem obvious. But Armstrong and Somers do have some players who, if not actually supporters, at least concur that AT&T shareholders could be better off going it alone.

If this were a cash deal, the question would simply be: "How much?" But nobody can service the debt from a deal this big priced at a huge 30 times cash flow, or even a more conventional 15 times cash flow. So Roberts is offering Comcast stock, stock that would most likely get distributed to AT&T shareholders. So those investors will have a big continuing interest in what Comcast does with the AT&T systems.

The best arguments favoring Armstrong are ones grounded in common sense. Why sell with AT&T Broadband's cash flow at the bottom? Maybe Armstrong and Somers can't squeeze as much cash out of their 13.5 million cable subscribers as Brian Roberts and his management team can. But wait at least until performance is on the upswing and get a better price.

The CEO of one cable operator contends that Armstrong has taken the right approach with AT&T by aggressively marrying cable and telephone in the same wire, a move that Roberts would immediately slow to improve earnings.

"I think the strategy is right, even if the execution isn't," the executive said. "Don't blow up the company because you didn't execute. Manage it so you get it right."

Armstrong's support isn't overwhelming, except, of course, from people who collect a paycheck or retainer from AT&T. Call around to Wall Street, media and telcom circles, and lots of people will quibble about the price Comcast is offering. Everyone but the buyer always wants see a higher price, either because he holds stock in the seller or it supports the value of other systems or stocks he or she owns.

But there don't seem to be many people who disagree that Comcast could run AT&T Broadband's properties better than AT&T has.

Armstrong and Somers' problem is their credibility is pretty low. They bought systems generating about 40% cash-flow margins and cut them in half. Then they brag about restoring a mere three points this year. While new products have AT&T's cable systems generating the highest revenues per subscriber in the industry, $55 per subscriber monthly, the $10 per sub monthly cash flow is half that of the other operators.

Armstrong blames the cost of new product rollouts, particularly cable telephone services, which Comcast is not doing. He also blames the cost of reorganizing recently purchased systems and programming costs.

OK, but Cox is pushing telephone as aggressively as AT&T and faces the same other problems. And Cox's margins are hanging in around 38%, right where they've been for years. And Comcast, Cox, Charter and Mediacom have also absorbed tons of systems in the past couple of years without noticeable problems.

The drop in Comcast's stock price means that the value of Roberts' bid has fallen from the initial $58 billion, or $4,300 per subscriber. It's now more like $52 billion, or $3,950 per subscriber. Roberts likes to argue that AT&T only paid $3,300 to $3,500 per subscriber for Tele-Communications Inc. and MediaOne. However, AT&T has also spent an additional $800 to $900 per subscriber in system upgrades. (And only 56% rebuilt, AT&T disclosed last month. Why so little?)

I calculate that between the systems, upgrades and the after-tax cost of AT&T's almost laughable adventures with Excite@Home, AT&T has about $65 billion or $4,800 per subscriber tied up in the systems Comcast is trying to buy. Comcast may not have to pay that much, but Roberts is going to have to raise his offer, even without a bidding war.