AT&T, Time Warner Finally Dance Is Telephony Deal a Template for Rest of Cable?


AT&T Corp. broke through on the cable front last weekin a high-stakes 20-year deal with Time Warner Cable pegged toward achieving 25 percenttelephony penetration within six years.

The two companies said they will work together to exploitthe full power of co-branded and bundled broadband-communications services, while puttingall telephony operations under the control of a joint venture. That will leave cable andhigh-speed data under Time Warner's control.

Officials predicted that the venture will generate $4billion in annual long-distance and local telephone revenues starting in year four ofoperations.

"We're really putting together the best brand incommunications with the best broadband infrastructure in America," AT&T chairmanand CEO Michael Armstrong said.

AT&T, with a 77.5 percent state in the venture, has nowarranged access to 43 percent of the nation's cable households, and it appeared setto close other deals that would meet or exceed its goal of reaching 67 percent.

"We have some work ahead of us," Armstrong said,"but we believe that we've established a template [for cable dealmaking] thatwill allow us to fill the glass quickly."

Time Warner chairman and CEO Gerald Levin said hiscompany's forthcoming five-year plan would put a net-present value on the deal thatis even more optimistic than the assumptions underlying the venture.

"I assume higher [voice] penetration that comes fasterfrom Time Warner's perspective," he said, noting that he also anticipated thatthe deal would drive cable penetration higher, as well.


Executives voiced virtual certainty that thetelephony-services agreement would win the approval of MediaOne Group Inc., which holdsveto power by virtue of the 25 percent stake in Time Warner Entertainment that itinherited from U S West.

Armstrong and Time Warner president Richard Parsons bothsaid they had received supportive feedback from MediaOne CEO Chuck Lillis.

In fact, Parsons said, it was a "fair assumption"that no deal would have been announced if the parties weren't sure that they couldobtain MediaOne's approval.

Leo Hindery -- currently president and chief operatingofficer of Tele-Communications Inc., and in line to head up all of AT&T'scable-service operations once its acquisition of TCI is completed -- went even further.

"We wouldn't be where we are now, saying that wecan achieve the two-thirds [national cable coverage], if we weren't completely surethat we will achieve this goal," Hindery said.

MediaOne spokesman Steve Lang didn't dispute thecharacterizations of a positive reaction from Lillis, but he stressed that there were nocertainties with respect to either MediaOne's signing off on the deal or reaching aseparate agreement of its own with AT&T.

"We're open to the right deal, but we're notprepared to say how we will react until we see the details," Lang said.

Comcast Corp. CEO Brian Roberts was similarly upbeat butcautious about the deal.

"Conceptually, this is yet another affirmation of thevirtually unlimited uses of broadband cable and of how serious a player this industry isgoing to be in telephony," he said. "It is potentially terrific."

Industry sources said MediaOne, Comcast and CoxCommunications Inc. were weighing a joint negotiating approach to dealing with AT&T.

One source said AT&T was likely to seek somewhat betterterms on the grounds that Time Warner's reach and system quality were the best in theindustry, but the group would argue that their combined size and overall system qualityleft little, if any, room for less favorable terms.


AT&T and Time Warner officials said they had devised aflexible template for further cable dealmaking that would allow different MSOs to shapethe pieces based on their individual situations.

In exchange for its big equity stake, AT&T has agreed:

• To pay Time Warner $15 per upgraded Time Warnernetwork home passed, anticipated to total about $300 million;

• To chip in approximately $300 million forbackup-power costs, as well as the costs of provisioning telephony to each subscriber.This is estimated at $300 to $500 per subscriber, or about $2 billion, assuming 25 percentpenetration and an average per-subscriber cost of $400.

• To pay a monthly fee per telephony subscriber,starting at $1.50 and scaling up to $6 over the first six years of operations.

All of these costs and charges pale against the prospectsfor garnering monthly telephony revenues in excess of $100, Parsons said. The $6-per-homeguaranteed monthly fee for 25 percent of Time Warner's customer base is "a veryde minimis cost," he added.

Parsons said that given the access fees that AT&T nowhas to pay local carriers as a percentage of its long-distance revenues -- averagingaround 40 percent -- the $6 becomes an even smaller piece.

Levin said the deal had taken longer than some parties hadanticipated because of the difficulties of defining the scope of services to be offered bythe venture.

With Time Warner retaining control of the data side of itsbusiness, there are no discussions under way to merge the Road Runner venture -- whichTime Warner shares with MediaOne -- with At Home Corp., parent of @Home Network, in whichAT&T will hold a major stake, officials said.

Hindery made it clear that there were no plans for @Home tocompete with Road Runner.

Asked how this squared with At Home CEO Tom Jermoluk'srecent comment that @Home would go into markets where it doesn't have cableaffiliates -- using broadband telco or wireless links to compete -- Hindery replied,"Tom was wrong about that. There are no preparations to do that."

Hindery said AT&T will shape telephone service in TimeWarner's and TCI's markets as planned, using the IP (Internet protocol)platform, rather than traditional switched-circuit systems.

"This announcement was an IP-telephonyannouncement," he added.


The companies said one or two pilot voice-service trialswould be launched in unnamed Time Warner markets this year, along with 10 over TCIsystems. TCI is already offering voice service in Hartford, Conn., and Fremont, Calif. --the latter in tight coordination with AT&T.

Commercial launches over these and other MSOs' plants-- including the plants of five smaller MSOs that recently signed on with AT&T -- willbegin in 2000.

"It's hard to give a precise schedule at thispoint, but we expect to achieve 25 percent-penetration over a three- to four-year timeframe," Armstrong said.

Reaction on Wall Street was lukewarm.

Even after reporting strong across-the-board performancefor the fourth quarter in all of its divisions, Time Warner saw little movement in itsstock all week. AT&T's shares rose a bit early in the week after the news, butthey declined with the late week slump.

Nonetheless, analysts following cable stocks were elatedover the deal.

"This is the thing that all of us have been hopingwould happen," said Tom Wolzein, senior analyst for Sanford C. Bernstein & Co.

While some investors might have hoped for a higher-risk,higher-return position for Time Warner, the deal is "great" for the MSO, becauseit fits into Levin's strategy of keeping capital costs flat while growing cash flowinto the mid-teens, Wolzein said.

"There's some equity upside in return for takinga low-risk position while giving them a return on their plant investment," he noted.

"For Time Warner, finding a way to leverage its plantwithout putting up any more capital is very beneficial," Merrill Lynch & Co.managing director Jessica Reif-Cohen said.

Parties on all sides dismissed any notion that there mightbe cause for concern with regard to the assumptions underlying the deal. These include aprojected 25 percent-penetration rate and the fact that the cable industry will continueto enjoy the benefits of regulatory advantages.

Moreover, the Federal Communications Commission couldchange regulations favorable to the deal as it reacts to the changing dynamics of marketcompetition. Those rules allow the parties to demand that local telephony subscribers takelong-distance service, as well, and they require long-distance carriers to pay access feesto local carriers.

"From where we sit today, it seems that under thegoals set by the Telecommunications Act [of 1996], the fastest, easiest way to fostercompetition would be for cable companies to proceed along these lines," Reif-Cohensaid.

While the rules might eventually change, Wolzein noted, theFCC has signaled that it won't act, "at least until things get built." Theattitude at the commission, he added, "seems to be, 'We can wait to regulateanother day.'"

What the AT&T forces face as the market evolves becameclear last week, with MCI WorldCom's announcement that it will roll out local voiceservices over Bell Atlantic Corp.'s lines in New York state, starting immediately, ata discount of about 5 percent to existing rates.

MCI officials said a much more favorable"platform-access" policy had been implemented in New York than exists elsewhere.But other states are moving in similar directions -- including Texas, Pennsylvania and NewJersey -- MCI spokeswoman Elenna French said.

"We're looking at the possibility of moving tothese states with local service as soon as the rules are firmed up," French said.With 20 percent of long-distance penetration, MCI is in a good position to take a largeshare of local customers, she added.

Eventually, MCI plans to build its own local-accessinfrastructure, but going in immediately over the new low-cost regional Bell operatingcompany platform gives it a shot at garnering the revenues that will supportinfrastructure build-out on a pay-as-you-go basis, officials said.

Like MCI, AT&T tried resale under previous rules, butit found that the business case didn't work.