Santa Claus doesn't always deliver; wishes sometimes go unfulfilled. Michael Armstrong, CEO of AT&T (NYSE--T), dreamed of building a broadband communications giant that would rule the world. He intended to transform sleepy Ma Bell through acquisitions but is instead reluctantly watching the split-up of AT&T. The reported sale of AT&T Broadband, the company's crown jewel, is the climax of this process. How did AT&T end up in this awful situation?
Armstrong joined AT&T as CEO in 1999, when the company was facing severe competition and losing market share in its consumer long-distance, business long-distance, data, and international divisions. Only wireless was doing well. Armstrong's vision was to capitalize on the opportunities presented by broadband. The fat pipes from cable networks leading into customers' homes were supposed to provide much more than some boring channels. The whole network would be upgraded to provide hundreds of digital channels, two-way data, cable telephony, and, eventually, video on demand. AT&T would capture a significant portion of consumers' spending on communications services.
AT&T went on an acquisition spree on 1999 and early 2000. It acquired cable and telecommunications company TCI for $54 billion. Next up was the acquisition of MediaOne, which was to have been acquired by Comcast Corp. But AT&T outbid Comcast and spent around $55 billion on that acquisition. MediaOne and TCI were combined to form AT&T Broadband, with more than 12 million subscribers, the largest cable company in the United States. After these audacious moves, it was time to run the business. This required the expertise of experienced cable guys who knew the nitty-gritty details of running a cable operation. Leo Hindery, the initial CEO of AT&T Broadband, was the perfect fit, given his tenure as chief operating officer at TCI. However, Armstrong undermined his credibility and Hindery left AT&T Broadband, along with several other senior executives. Meanwhile, AT&T Broadband was spending almost $5 billion a year to upgrade its cable network, but profit margins remained well below industry averages and the rollout of some new services didn't go smoothly.
AT&T found its balance sheet heavily burdened by the debt it had taken on to complete these acquisitions. Its core businesses were collapsing faster than anyone had anticipated, and interest expenses were high. The solution was a restructuring that would split AT&T into four operating companies. Everything proceeded according to plan until Comcast offered to purchase AT&T Broadband for $40 billion. This sounds like a lot of money--except that it amounts to less than half of what AT&T paid for TCI and MediaOne.
In the end, Comcast paid about $72 billion for AT&T Broadband, beating out AOL TimeWarner and Cox Communications, which also had submitted bids. Brian Roberts, CEO of Comcast, will become the CEO, while Armstrong is slated to be the chairman of the combined company. It appears that Comcast paid about $4,500 per subscriber, which is a bit expensive, but that number will probably decline prior to the deal closing. However, Comcast will have to take on a substantial debt load and assume some unknown tax liabilities. The combined company will be a cable powerhouse in the United States, with about 22 million subscribers. It should enjoy substantial leverage when it negotiates with programming providers such as Disney. I expect the deal will clear regulatory hurdles, although it will come under close scrutiny.
Microsoft also will indirectly benefit from the transaction. It had tried to keep AOL TimeWarner from becoming too large, since an even bigger AOL would provide stiff competition for Microsoft's multimedia offerings.
AT&T's demise is due to acquisitions resulting in a highly levered balance sheet, rapidly deteriorating core businesses, and execution blunders from management. Maybe someone else in the cable business will now get a Christmas present. After all, 'tis the season of sharing.
William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at [email protected].