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THE BIG BUST-UP

10/29/2000 7:00 PM Eastern

No. 1 cable MSO AT&T Corp., which spent two years trying to reclaim the local telephone market it had shed in a court-ordered divestiture, last week unveiled a plan that would essentially break the company into four pieces.

Starting next year, AT&T will carve itself into wireless, broadband cable, consumer long-distance and business services units, with tracking stocks issued for the consumer long-distance and AT&T Broadband cable units.

The company also plans to eventually spin off its current AT&T Wireless Group tracker to shareholders. Business services and the long-distance tracker will be the vestiges of what is today known as AT&T Corp. However, AT&T Broadband would actually have the legal charter.

Because AT&T assembled the cable operations largely through tax-free exchanges for big MSOs such as Tele-Communications Inc. and MediaOne Group Inc., spinning off Broadband before a two-year moratorium on such deals expires would mean a huge tax hit.

AT&T plans an initial public offering for Broadband sometime in the summer of 2001. At that time, current AT&T shareholders also will be allowed to exchange some stock for Broadband shares.

The company expects to recapitalize AT&T Broadband about 12 months after the IPO, making it a separate, independent and publicly traded company.

The trackers could unlock the value of AT&T's growth businesses-some analysts have hung a $30 to $40 per-share price tag on the cable unit last week.

"The underpinning of these changes is to lay the foundation for shareholder value," chairman C. Michael Armstrong said at a New York press conference. "We are changing the structure; this is not a change in strategy. The structure is now serving that strategy."

Also included in the broadband tracker will be AT&T's 25 percent equity interest (and 74 percent voting control) of data-over-cable service provider Excite@Home Corp.

The restructuring is a sea change for AT&T. Many saw it as repudiating Armstrong's strategy of spending billions on cable as a last-mile complement to existing long-distance and data services.

But it could be the shot in the arm the broadband division needs-allowing financial and operational flexibility by removing it from the shackles of AT&T's underperforming businesses.

"The particular advantage is that [the new structure] will allow management to be receptive to the rigors of the capital markets," AT&T chief financial officer Chuck Noski said in a conference call with analysts. "They will focus on business, not on the ebbs and flows of a $70 billion telephone conglomerate."

FREE AT LAST

"Finally [AT&T Broadband] can operate as a cable company," The Yankee Group analyst Brian Adamik said. "When it completes its IPO, it can use the proceeds to continue to invest in itself and pursue its top three initiatives-digital TV, high-speed Internet and, to a lesser extent, telephony."

AT&T Broadband has struggled to meet projected telephony targets. The division has successfully added digital cable and high-speed data customers, and is on track to end 2000 with 2.8 million digital subscribers and 1.1 million high-speed data customers. But it has had to adjust its cable telephony targets at least twice this year.

The MSO is likely to meet its stated goal of between 500,000 and 650,000 cable telephone customers by year-end, noting last Thursday that it had passed the 400,000 mark.

But the pressure to deliver telephony may be lessened under the new structure.

"The driver has changed," Adamik said. "There won't be as big a push. I think they'll hit the target, but after that their priorities might change. Who cares if they're doing telephony?"

PaineWebber Inc. vice president of research Thomas Eagan said the new structure will also allow AT&T Broadband to place less emphasis on striking affiliation deals with other cable operators-once a key part of Armstrong's strategy to wire the country-and more on high-growth video and data businesses.

"What does happen is it pushes back the time for them to need to do deals," Eagan said.

Armstrong said the strategy to offer a bundle of video and telecom services will remain a top priority at the newly structured companies.

Although Broadband has also had its problems-operating margins and video cash-flow growth were below industry averages-it, like other AT&T divisions, has been hamstrung by rapid declines in consumer long-distance.

For example, the broadband and wireless units have grown at a 20 percent revenue clip during the last three quarters, Armstrong said. But a 15 percent decline in consumer long-distance revenue erased most of that gain.

Armstrong has been under intense pressure to bring AT&T Corp.'s sagging stock back to life. It stands at less than half the price it commanded last December.

But Armstrong said it was all part of a long-term plan.

"I hope to dispel the myth that this was done for any short-term purpose or lack of operational execution," Armstrong said. "This is done fundamentally as not only the next logical step, but the next necessary step in the transformation of this company."

If the idea was to boost the stock, the immediate returns were not encouraging.

AT&T dipped by 18 percent, or $3.50 per share, to $24.50 after the announcement last Wednesday. It slid to $21.81, down another 6 percent, the next day. But AT&T also released sluggish third-quarter results and warned that revenue and cash flow growth would be lower in 2001.

At least two analysts downgraded the stock. Anna-Maria Kovacs of Janney Montgomery Scott even issued a rare "sell" rating, citing the operational and management chaos that normally surrounds such changes. Salomon Smith Barney Inc. analyst Jack Grubman downgraded AT&T for the second time this month, this time to "neutral" from "outperform."

Grubman characterized the breakup as a reversal of AT&T's strategy. "The fact is AT&T made a big deal about creating an integrated communications company selling bundled services to consumers and business across various distribution channels," he wrote. "That is being abandoned after less than two years of trying."

WELCOME TO GROUP

The AT&T Broadband tracker could bode well for other cable stocks, according to some analysts who were happy to see it join the beleaguered MSO group.

"This could open up the investor base," Morgan Stanley Dean Witter analyst Rich Bilotti said. "Depending on the size of this IPO, it could mean more invested capital in the sector."

Eagan said the Broadband tracker would further diversify the available types of cable stocks and may bring investors into the sector who haven't been there before.

"This might, in a sense, whether the tracking stock is exchanged or distributed through a dividend, bring specific AT&T investors into the cable camp," he said.

But so far, the announcement of the restructuring has had little effect on other cable stocks. Of the 10 publicly traded cable operators-including AT&T-only three were up on the day of the announcement, the rest fell by $1 per share or more. Gainers on the day of the announcement were Adelphia Communications Corp., up 69 cents to $28.75; Mediacom Communications Corp., up 13 cents to $15.88; and Classic Communications Inc., up 19 cents to $4.19.

THE CHIEF'S FINAL DAYS?

The restructuring also may mark the beginning of the end of the Armstrong era at AT&T.

Although Armstrong remains chairman, he has said he plans to retire at age 65. He's 62 now, and the AT&T restructuring is expected to take at least two years.

Some industry observers don't expect Armstrong to stick around that long.

"It's hard to imagine that Armstrong will stay around for much longer, although I'm sure that he was hoping to go out on a more auspicious note than this," said one MSO source.

The source also held out hope for the success of the restructuring, but added a note of caution.

"I just hope for their sake that this does make for more independent and efficient operating unit, because if it doesn't then they'll have taken a few steps back and nothing forward," the source said. "The trap they run into is doing financial engineering for the sake of financial engineering.

In the past, managers have complained about AT&T's hierarchical management structure, which required corporate approval for relatively small expenditures. But with the tracker-and the eventual spinoff-AT&T Broadband will have at least a little more control of its destiny.

According to the MSO source, AT&T's stifling management structure has replaced the cable-centric culture of the former Tele-Communications Inc. The addition of MediaOne Group-itself a phone company spinoff-also didn't do much to change things.

"When Somers moved out to Denver, that 'Bellhead' mindset just overwhelmed TCI," the source said.

But under its new structure, AT&T Broadband will need executives familiar with the ins and outs of cable more than ever. And according to the MSO source, Somers may not be the right man for that job.

"Dan's very good at giving direction, but I don't know how well he understands the nuts and bolts of the industry," the source said. "There are other guys in the industry that understand that stuff."

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