Reversal of fortune - Broadcasting & Cable

Reversal of fortune

Frustration again drives AT&T's Armstrong to drastic moves
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Mike Armstrong is shedding the cable business the way he plunged into it: consumed by desperation.

When he embarked on a $120 billion cable shopping spree just two years ago, Armstrong, chairman of AT&T, was openly hungry for a direct connection to consumers' homes, the critical element in getting into the local phone business to offset AT&T's crumbling core long-distance phone business. Thwarted in his attempts to merely partner with cable operators, he stepped up to buy cable giant Tele-Communications Inc.

The despair sparking this second breakup of AT&T comes from the retreat of Armstrong's supporters on Wall Street, who have ceased believing that he can execute his ambitious plans to save AT&T from itself. It did not help that he was the target of a very public campaign by his largest individual shareholder and an AT&T director, Liberty Media Corp. Chairman John Malone, who wanted an immediate fix.

That fix is to spin off units that had been operating under one umbrella: cable, consumer services, business services and cellular. There are certain operating advantages, but Wall Street executives see the primary benefit as attracting investors who like AT&T's potentially high-growth wireless and cable assets but are repelled by the ailing long-distance business.

The big, currently unanswerable question is how much good the breakup will do. The previous one, ordered by late Federal Judge Harold Greene over antitrust issues in 1984, proved a boon for AT&T's spawn, the Baby Bells.

This time, AT&T and industry executives expect the separation of the relatively unrelated units to invigorate management, cut through internal politics and halt competition for capital. It certainly worked, until recently, for the company's 1996 spin-off, Lucent Technologies.

However, a company already plagued by operating misfires and simple adjustment to rounds of layoffs has an all-new distraction, immersing its employees in many more months of uncertainty.

AT&T executives maintained straight faces as they proclaimed that the breakup was simply another step in their 3-year-old master plan for transforming AT&T from merely a long-distance company with some cell-phone licenses.

"It's a lot of fun to write that this is a reversal or a repudiation of our strategy," Armstrong said in announcing the breakup plan last Wednesday. "I find that not only wrong but offensive."

He insisted that the split-up is a "logical and necessary next step. These companies will be leaders and are leaders today in the industries they serve."

Hardly anyone outside the company accepts Armstrong's spin. Although some favor the breakup as a way to boost the company's stock price, he is widely seen as buckling to pressure from investors-more specifically, to Malone. With AT&T's stock sliding 65% in recent months, Malone has openly pressed for some sort of restructuring to spark a revival.

"[Armstrong] is not doing this because he wants to. His hand is being forced this way. He has sold his soul to the financial community," said Howard Anderson, founder of research firm The Yankee Group and currently a venture capitalist.

"It's a complete invalidation of the strategy," said one cable company CEO, who has spent much time discussing cable and telephone with Armstrong over the past two years. "He's surrendered."

Another cable executive agrees: "The fundamental strategy they launched two years ago was dead on. Now he's caved to expectations of the market, sometimes unrealistic expectations."

Armstrong's plan calls for separating the companies through a mix of spin-offs and tracking stocks. At the end of the day. there will be five pieces: the four pieces AT&T executives keep talking about, plus Liberty Media, which they neglect.

The mechanics call for the century-old corporation known as AT&T Corp. to spit out everything but its cable assets, which can't be readily spun off without severe tax complications.

The core unit that Armstrong plans to continue running will be AT&T Business, which targets large and small businesses with long-distance and competitive local-exchange-carrier (CLEC) services. It will inherit the AT&T brand and its New York Stock Exchange symbol, "T".

The assets of the sagging AT&T Consumer long-distance business will go along with AT&T Business but will then get tied to a tracking stock.

AT&T Wireless is already a tracking-stock subsidiary of which AT&T owns 15%. That will be converted into conventional stock and completely spun off.

Nobody's saying what happens to Liberty, including Liberty itself. But Wall Street and industry executives expect AT&T to strip it of its tracking-stock status and spin Liberty away.

It's impossible to value the individual pieces. AT&T has not settled on critical elements like how corporate debt will be allocated among the spawn and what continuing relationships the companies will have. Will AT&T Broadband, for example, be forced to deliver AT&T Consumer long-distance service to its local phone customers, or can it cut a sweeter deal with Sprint?

This is not the first time Armstrong's hand was forced. His decision to buy TCI can be traced to a pivotal 1998 meeting at a National Cable Television Association convention in Atlanta. Armstrong went to the show to continue AT&T's years-long series of discussions on finding a way to work with operators to start a local phone business that would allow AT&T to bypass the Baby Bells' lock on direct access into the home.

But Armstrong put himself at a tremendous disadvantage by signaling both privately and publicly how badly he needed the cable operators. He had lots of capital to offer as incentive but no real leverage.

The meeting did not go well. Cox Communications Chairman James Robbins, Time Warner Cable Chairman Joseph Collins and Comcast Chairman Brian Roberts signaled that they wanted big upfront payments to even begin a joint venture. MediaOne Group Chairman Charles Lillis proposed that the operators would handle phone transport but for "a number that would choke a mule," says one executive: a commitment of $5 billion.

Put in context, AT&T had invested $4 billion in switching facilities around the country to simply resell services from the Baby Bells. But reselling proved to be such a money loser that Armstrong was in the process of shelving the venture, despite tying up so much cash.

Armstrong associates said he stalked out of the meeting so angry and frustrated that he reversed another public proclamation: that AT&T would not buy a cable company. Believing he would increase his leverage with MSOs if he himself were a major operator, he took less than six weeks to sew up a deal for TCI.

But AT&T's committing $50 billion to buy TCI only emboldened other operators, cable executives said. "He had no advantage left at all," said the chief executive of one MSO. Though spending even more money to buy MediaOne Group Inc., Armstrong still has no telephone deal with any operator in which AT&T has no substantial financial interest.

For AT&T Broadband, the goal is to stay on course. Division Chairman Dan Somers said it will take nine months or more to create the tracking stock and until 2002 to totally finish the restructuring plan.

Somers, who disputes that AT&T's hand is being forced, said the division will continue rolling out telephone, data and digital services and should post another double-digit gain in revenues next years. "My job right now is to do exactly what we've been doing, which is kick butt," he said, adding that he plans to stay in his job. "I'm happy, I'm ready to go."

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