May 6, 1999

AT&T Is in Talks With Microsoft on a Wide-Ranging Alliance

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Actions by Phone Giant Could Redraw Communications

By SETH SCHIESEL

whirlwind of deals surrounding the AT&T Corporation's cable television ambitions raised concerns in Washington and in many high-technology quarters Wednesday about the prospects for competition in the fast-growing communications industry.

	Associated Press
	Amos B. Hostetter Jr., chief executive of Mediaone Group, took questions about its acquisition by AT&T at a news briefing Wednesday. AT&T's unsolicited bid beat one by the Comcast Corporation.

Having cleared the way to become the nation's biggest cable television company by acquiring Mediaone Group Inc., AT&T Wednesday also moved to the brink of a partnership with the Microsoft Corporation, the software giant, to increase Microsoft's role as a supplier to AT&T's cable systems.

With its cable and possible Microsoft deals, AT&T -- which two years ago seemed a crippled giant losing ground to smaller, more nimble competitors -- is poised to once again stand astride the communications world. For Microsoft, a strong relationship with AT&T could become the company's most important vehicle for expanding beyond desktop computers into a new world in which millions of consumers use seamless bundles of phone, TV and high-speed Internet services.

But for regulators and competitors in industries ranging from computers to telephones to Internet access, a partnership between AT&T and Microsoft, which is still being negotiated, could appear as frightening as it is formidable.

AT&T's expansion into cable television so quickly and broadly -- starting with its deal last year to acquire Tele-Communications Inc., then the No. 2 cable company behind Time Warner Inc. -- raised concerns on its own.

On Tuesday, AT&T opened a path to acquire Mediaone, the No. 4 cable company, for $58 billion by persuading the Comcast Corporation to withdraw its earlier bid for Mediaone. Comcast also agreed to offer local telephone service over its cable lines in league with AT&T, the nation's biggest long-distance carrier.

Microsoft had earlier considered joining Comcast to fight against AT&T, but decided instead to seek a partnership with AT&T to use Microsoft's Windows operating system in some of AT&T's cable-based communications systems.

The Senate antitrust subcommittee said yesterday that it would hold hearings into the competitive impact of AT&T's looming acquisition of Mediaone. AT&T wants to use cable systems to offer integrated bundles of telephone, television and high-speed Internet service to millions of consumers. The subcommittee's leadership said that AT&T's expansion into the cable business could speed the advent of local telephone competition, but added that AT&T's dealmaking might slow competition in video services.

"This deal will likely increase AT&T's ability to provide competitive local phone service to residential customers, which we certainly support," Senator Michael DeWine, Republican of Ohio, the subcommittee's chairman, and Senator Herb Kohl, Democrat of Wisconsin, the ranking minority member, said in a statement. "But the jury is still out on how it will affect the cable/video market and we need to closely examine all of the competitive aspects of the deal."

What clearly emerges from the blur of billion-dollar dealings is a sense that AT&T is assembling the pieces to create a profile of dominance in the communications landscape unmatched by any company since the old American Telephone and Telegraph broke up under Government pressure in 1984.

In two swift moves, AT&T recasts itself as a leading player in several industries.

Many analysts described AT&T's flurry of deals as good for all the companies involved, and the market supported that notion. AT&T's shares rose $5.375 yesterday, to $56.9375; Comcast shares gained $9.1875, to $73.3125; and Microsoft shares rose $1.0625, to $79.125. Mediaone's shares fell by 75 cents, to $76.875, perhaps on disappointment that an extended bidding war for the company now seems highly unlikely.

In some ways, a resurgent AT&T could become a major force in promoting competition. With its cable lines into millions of homes, AT&T has now become the biggest threat to the regional Bells' dominance in local consumer phone service. In fact, AT&T's deal with Comcast, like an existing deal with Time Warner, is focused solely on telephone service.

No other long-distance giants has assembled a full-fledged plan to offer local phone service to residential consumers nationwide, but AT&T has made offering local service in competition with the Bells a cornerstone of its strategy.

But because AT&T is moving so fast to gain links to United States homes, and because of its legacy as the nation's telephone monopoly, any strategic relationship it forges with Microsoft is bound to raise eyebrows.

"AT&T is putting together a cable monopoly that is beyond the wildest dreams of John Malone," said Gregory C. Simon, co-director of the Open Net Coalition, a lobbying group that includes many of AT&T's competitors -- including America Online and Mindspring in Internet service and MCI Worldcom in long distance. Malone was the freewheeling chairman of TCI before its sale to AT&T.

Related Articles (May 6, 1999) AT&T Is Seen Forging Link to Microsoft (May 5, 1999) MCI Is Said to Weigh Bid for Mediaone (May 4, 1999) Two May Aid Comcast Bid for Mediaone (May 1, 1999) Tasty Morsels and Digestive Challenges for AT&T (April 26, 1999)

"And now that they have cornered the network," Simon, a former domestic policy adviser to Vice President Gore, said, "they are putting the network under lock and key by putting Microsoft technology inside the set-top box."

Microsoft dominates the market for personal computer operating software. But its main objective in dealing with AT&T was to obtain assured access for its software and Internet commerce businesses -- preferred access, if possible -- to the fast-growing high-speed data network that AT&T is assembling.

Under the terms of the deal being negotiated between AT&T and Microsoft, Microsoft is to invest about $5 billion in AT&T, perhaps in exchange for some sort of preferred stock in AT&T, according to executives close to the talks. AT&T would also agree to use Microsoft's software in its integrated packages of voice, video and data service.

AT&T is adamant that Microsoft will not get an exclusive arrangement to supply its Windows CE software on the set-top boxes of AT&T's expanded network. But Microsoft is negotiating hard to get AT&T to allow Windows CE to be intrduced in at least one large cable market as an early proving ground for Microsoft's set-top box technology, according to the people close to the talks. For Microsoft, a $5 billion investment is a fairly conservative hedge against the uncertain future represented by "broadband networks," in which households are continuously connected to high-speed data lines.

These broadband networks -- whether built by cable companies, regional phone companies or wireless operators -- are expected to stream video, audio and text into people's homes, everything from movies-on-demand to electronic mail. And users are expected to tap into this rich flow of information and entertainment using various equipment, from Internet-enabled televisions to handheld devices. The vision is of a world of many diverse information appliances -- and all of them will need software.

Microsoft wants to compete in that market against traditional makers of cable television equipment, including the General Instrument Corporation and Scientific-Atlanta Inc. Before being acquired by AT&T, TCI had agreed to use Java software from Sun Microsystems Inc. in its advanced set-top boxes. Executives close to the negotiations said that agreement would not be affected by any AT&T deal with Microsoft.

To bring the nation to this broadband future, the cable industry -- including AT&T -- is locked in battle against the Baby Bells, the GTE Corporation and the rest of the local phone industry. As that inter-industry fight intensifies, and as AT&T becomes a unifying force in the cable business, some of the rivalries that had traditionally divided cable operators may soon disappear.

In acquiring Mediaone, AT&T will also get Mediaone's 25.5 percent stake in some of Time Warner's cable systems, its HBO network and its Warner Brothers film studio.

Time Warner, which has bickered incessantly with Mediaone on a number of issues involving those businesses, sat on the sidelines as Comcast and AT&T jockeyed for Mediaone, rooting simply for a deal to occur.

Even though AT&T would supplant Time Warner as the biggest cable system, Time Warner benefits by eliminating Mediaone's influence over its cable and movie units.

"I am pleased with the outcome and pleased with the role Brian Roberts played in bringing the companies together with a solution that benefits the cable industry," Gerald Levin, Time Warner's chairman, said in a statement, referring to Comcast's president.

Indeed, Time Warner is likely to look to create accords with AT&T on several fronts, media executives said. It hopes to to buy complete control back of HBO and Warner Brothers. In return, it will likely look for ways for Road Runner -- a high-speed Internet service in which it holds an 36 percent stake -- to cooperate with At Home, a comparable service in which AT&T is the leading shareholder.

The services could be merged outright. Or they could be linked more closely using compatible technology. Toward this end, Time Warner is likely to complete an already planned venture to offer local phone service through its cable systems in cooperation with AT&T. Enactment of that deal, first announced in February, had been delayed by Mediaone, executives said.

As AT&T moves into the high-speed Internet business through its cable acquisitions, the biggest player in the Internet market today -- America Online -- is not part of AT&T's party.

Instead, America Online plans to offer high-speed services employing a technology that uses phone lines rather than cable wires. It already has pacts with Bell Atlantic and SBC Communications and is courting other local phone companies.

America Online is eager to have access to cable systems as well, and considered backing Comcast in an effort to outbid AT&T for Mediaone. Ultimately, though, it decided the prospect was an expensive way to get into a business that is growing much more slowly than its own. "At the end of the day, we are a pure Internet company," said Robert Pittman, America Online's president.