Despite progress in rolling out new products, AT & T Corp.'s cable division is displaying some unexpected cracks as heavy spending continues to drag the unit down.
In addition to another significant drop in cash flow at its core systems, AT & T Broadband's sales of digital and modem customers took a slight but unexpected pause during the second quarter ended June 30. The unit sold fewer subscriptions during those three months than they had in the quarter that ended in March. Basic subscriber growth was negligible.
Certainly, Wall Street expected AT & T Broadband's results to be dampened by heavy spending to roll out digital cable, high-speed data and telephone services. But steep losses combined with a slowdown in growth is increasing anxiety over the company. AT & T Chairman C. Michael Armstrong may have to change some minds as he and AT & T Broadband Chief Dan Somers build their digital future.
"They're certainly spending a lot for each new customer," said Bear Stearns & Co. media analyst Ray Katz, who monitors AT & T Broadband but does not formally cover AT & T Corp. Another analyst was more blunt: "Their numbers were terrible."
AT & T Broadband CFO Michael Huseby minimized the snags, saying that, between its existing operations and the newly acqired MediaOne Group operations, the company is on track to hit its major targets of the year. For example, AT & T Broadband's existing systems added almost 100,000 telephone subscribers during the quarter, and the pace is accelerating to approach the unit's goal of 400,000 to 500,000 by year-end.
"We have annual targets, but we made no secret that the bulk of the target was going to be hit in third and fourth quarters," Huseby said.
He said the cash flow decline was also expected "because of the ramping of the new services."
Excluding the MediaOne systems AT & T owned for just a week of the second quarter, AT & T Broadband's revenues increased 10% to $1.5 billion, a tick up from the 8% growth the unit had generated during the first quarter.
However, the cable unit's cash flow took another sharp dive, falling 14% to $376 million.
During the second quarter of 1999, AT & T's cash flow dropped 28%. So even after adjusting for system acquisitions and sales, AT & T's cable cash flow now stands down a third from where the systems were under Tele-Communications Inc.
Looking only at the company's core video cash flow, AT & T Broadband showed some growth, about 7%. But that was more than wiped out by spending on new products.
Certainly, there was growth in new-product subscribers. The company added 152,000 digital-video customers during the quarter, hitting 2 million customers and putting AT & T Broadband's penetration at a substantial 18% of basic homes after just two years sales.
However, the connect rate was less than expected and less than the 188,000 digital subscribers added during the first quarter.
The same goes for high-speed data customers.
The company connected 71,000 new subscribers during the second quarter, hitting 365,000 units. That growth rate is much lower than the 91,000 new units sold in the first quarter and even the 78,000 units connected during the fourth quarter of 1999.
Huseby explained that even though digital and data are relatively new products, there is some seasonality in growth.
During April, southern markets suffer from snowbirds heading back to their homes in the north. In May, college students disconnect as they return home for the summer. That particularly affects high-speed Internet units.
"Digtial video will increase," Huesby said. "We need to pick it up in the third and fourth quarters."
But investors willing to accept declining cash flow from new-product spending want to be rewarded with strong momentum, and they're starting to revise their outlook for AT & T even further downward than they have over the past few months.
Morgan Stanley Dean Witter media analyst Richard Bilotti said that he was surprised that digital- and data-connect rates decreased even as new-product losses rose from $108 million during the first quarter to $128 million.
"Startup losses will continue to increase through 2000 into 2001," Bilotti said. "This would indicate slow overall cash flow growth over the next four to six quarters."