April 26, 1999

NEWS ANALYSIS

Tasty Morsels and Digestive Challenges for AT&T

By SETH SCHIESEL

ollowing the AT&T Corp. under C. Michael Armstrong has become an experience akin to watching one film sequel after another in the "Jaws" series.

Just when you thought that Armstrong, AT&T's chairman of 18 months, could not possibly bite off another big deal, he does just that, and the masses in the communications industry are sent fleeing to find ways to cope.

Last week's casualty may have been the Comcast Corp., the big cable television operator. Just when it looked as if AT&T had settled down to manage its own $31.8 billion acquisition of Tele-Communications Inc., the No. 2 cable carrier, Armstrong swam into the middle of Comcast's pending $53 billion deal for the Mediaone Group and roiled the waters with an unsolicited bid for AT&T to buy Mediaone for $58 billion.

Mediaone executives have not yet publicly responded, but many analysts say that AT&T, with its superior financial power, will scare off Comcast and win Mediaone -- if regulators allow it. That would make AT&T the nation's No. 1 cable television company, in addition to the nation's No. 1 long-distance telephone carrier.

But like a voracious shark that ends up with a bunch of old license plates in its belly, AT&T may have a tough time digesting everything it has tried to swallow. The main question for AT&T now is whether its appetite has exceeded its ability to integrate its businesses into the lean yet powerful communications machine that Armstrong wants AT&T to become.

As Armstrong propels AT&T headlong into the future he has envisioned, the company faces mounting challenges -- not only of management and strategy, but also of regulation and technology.

Perhaps the most daunting management challenge for AT&T is the sheer breadth of Armstrong's strategic ambition. After John Zeglis, AT&T's president, was conspicuously absent during the company's Mediaone announcement last Thursday, several analysts wondered where he was.

It turned out he was in Japan. There, over the weekend, AT&T and British Telecommunications, AT&T's new international partner, announced a joint investment of more than $1.8 billion to acquire a 30 percent stake in Japan Telecom, a communications carrier backed by the main Japanese railroad company.

AT&T and British Telecommunications will also fold into Japan Telecom two of their existing Japanese ventures, with combined annual revenue of just more than $200 million.

The announcement's near simultaneity with the Mediaone bid was either impressive or unnerving, because it demonstrated Armstrong's comfort with juggling multiple deals. In fact, the Japan Telecom and Mediaone deals "are part of the same strategy," Zeglis said over the weekend. "We want to go end-to-end delivering services for our customers on our own architecture."

Despite AT&T's common goal of controlling its own architecture, or electronic infrastructure, there is a big difference between these two deals. AT&T's overseas ventures are aimed at serving big-ticket multinational corporate clients, while the company's cable television expansion is aimed at serving everyday residential consumers. It is the company's hunger for residential customers that best explains AT&T's seeming feeding frenzy.

It is clear by now that AT&T is terrified of the prospect of at least one of the local Bell phone companies, probably Bell Atlantic, being poised to win regulatory approval to enter AT&T's core long-distance business this year.

By way of a harbinger, AT&T is well aware of what happened in Connecticut after the Southern New England Telecommunications Corp., which did not need special approval, began offering long-distance service to Southern New England's local phone customers. Large numbers of Connecticut customers dropped long-distance service from AT&T, among others, to take a single package of local and long distance from SNET.

AT&T's strategic planners hate to contemplate the millions of local phone customers who might drop AT&T phone service once Bell Atlantic is freed to offer long-distance service to customers along the Eastern Seaboard, or even just in New York. It is a much bigger worry for AT&T than for its principal long-distance rivals, MCI Worldcom and Sprint, because AT&T derives a much higher proportion of its long-distance revenue from residential consumers than do MCI and Sprint.

Armstrong has decided that the solution is to counterattack the Bells by taking the war to a new front -- off the conventional local telephone network and onto cable TV systems. Through those cable lines, AT&T intends to offer local and long-distance calling, as well as Internet service.

It will probably take a few years to determine whether that strategy is visionary or foolhardy. AT&T would like to offer its cable-based services using a variant of Internet technology. Because this is a largely experimental approach, it poses large technical challenges. It may, however, prove easier in Mediaone territories than in TCI areas, because Mediaone's network is generally more technically advanced. That is why AT&T is willing to pay more for Mediaone than it did for TCI, even though TCI has more customers.

The cable strategy also raises management questions. AT&T is well practiced in telephone-network technology, but linking so much of its future to cable television networks means the company needs to rely on experts from outside the AT&T tradition. Foremost among them is Leo Hindery, the former No. 2 executive at TCI who now runs AT&T's cable operation -- but who is still largely unfamiliar with AT&T and its culture in offering telephone service. The same could be said for the highly respected Amos B. Hostetter, Mediaone's largest shareholder, who AT&T has said will become chairman of its cable and Internet unit if its Mediaone bid succeeds.

But before Hostetter can come aboard, AT&T must not only fend off Comcast, but also convince Federal regulators that a combined AT&T-TCI-Mediaone would not wield disproportionate power in the cable television industry. Under Federal Communications Commission ownership rules, no single entity can control cable systems that together are available to more than 35 percent of the nation's households. But those rules have been suspended pending a review by the FCC.

There are financial imponderables. AT&T -- with backing from Chase Manhattan Bank and Goldman, Sachs & Co. -- seems set to raise $30 billion in cash to support its Mediaone bid. But Standard & Poor's, the credit-rating agency, said on Friday that it was considering downgrading AT&T's debt to reflect the big financial burden the company will take on if it acquires Mediaone.

The stakes for Armstrong, not to mention AT&T, are high. They keep escalating. If the cable strategy works well, he will become known as one of the most visionary and dynamic executives of his day. If it does not, business history might one day recall him as a former IBM executive who was passed over for the top job at that company and who, later, when given the chance to run AT&T, tried to prove too much.

For now, at least, dynamic seems to be winning. Armstrong, presumably, is looking for his next "Jaws" sequel.

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Related Sites
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• AT&T Corp.

• Comcast Corp.

• Tele-Communications Inc.

• Mediaone Group

• British Telecommunications

• Japan Telecom