AT&T Wants to Tweak Digital Packages Again

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Just five months after initiating a major overhaul of its digital-cable strategy, AT&T Broadband is set to do it again.

"We're going to refine our digital-video strategy," Broadband CEO William Schleyer told analysts at Salomon Smith Barney Inc.'s Global Media and Entertainment conference in Scottsdale, Ariz., last week.

"AT&T Broadband has had some bad [press] around its [cash] margins relative to its peers," he continued. "A lot of that can be explained through telephony and some out-of-market contracts, but a big chunk — almost three [percentage] points — can be explained because its digital-video strategy, relative to its peers, is not producing the cash flow it should.

"We've identified the problem. We have a number of solutions we can choose from."

While Schleyer would not elaborate on the changes, Broadband spokesman Andrew Johnson said they would likely involve packaging and pricing of the digital product. He said those modifications are still being worked out and declined to specify them.

AT&T's last digital-cable packaging overhaul was in August, when the MSO said it would split the service into four tiers called "Digital Value Packages." The packages started with "Digital Bronze" at $39.99 per month, which bundles core analog programming with digital basic, Encore, three Starz Encore Group LLC thematic movie channels, expanded pay-per-view access, digital music and an electronic programming guide.

"Digital Silver," "Gold" and "Platinum" each add multiple feeds of Starz! movie channels, plus one, two or all available premium services, respectively, including Home Box Office, Showtime, The Movie Channel and Cinemax.

At the conference, Schleyer said the "full impact" of the new digital strategy won't be felt until the second half of 2003.

The digital overhaul is just one of the initiatives Schleyer has started as Broadband moves closer to its pending $72 billion merger with Comcast Corp., expected to be completed by the end of the year.

Schleyer also said that Broadband will "moderately" increase its capital expenditures in 2002, mainly for upgrades in its Boston, Chicago and San Francisco operations.

"We're going to focus on what allows us to accelerate RGU [revenue generating unit] growth," Schleyer said.

Schleyer, the former president of Continental Cablevision Inc., signed on as CEO of AT&T Broadband in October. And though he's likely to be replaced by Comcast management when the merger is completed, he will continue to run the operation until the deal closes.

ROBERTS BACKS PLAN

Speaking at the same conference, Comcast president Brian Roberts said that the accelerated upgrade plan is part of the merger agreement.

"That's all factored in to the economic equation as part of the purchase price," Roberts said. "There is no business incentive for AT&T not to build quickly."

AT&T Corp. chairman C. Michael Armstrong — who will become chairman of AT&T Comcast once the deal is completed — said that capex will increase this year to accelerate the upgrades. Proxy statements for the Comcast merger will go out to shareholders in the first quarter, leading to a shareholder vote in May or June, he added.

Schleyer said the primary goal for himself and his management team is to assure a smooth transition to Comcast. While Broadband has made some strides in that direction, the work is far from over.

Schleyer inherited an operation that was heavy on bureaucracy and low on upgraded systems. Broadband — the largest MSO in the country, with 13.5 million subscribers — also has the industry's lowest cash-flow margins.

The plan is to get Broadband's cash-flow margins to industry levels by the end of 2003, he said. Currently, those margins are at about 26 percent, compared to industry averages of between 35 percent and 45 percent.

Getting there may not be as easy as was originally thought. Last week, Schleyer said that costs associated with the transition of high-speed data customers from Excite@Home Corp. — which went bankrupt in September — to its own network would remove about $60 million to $65 million from the cash-flow line. That charge will be taken in the fourth quarter.

Keeping costs down also has been a priority, Schleyer said, adding that Broadband reduced its employee rolls by about 12,000 last year. Half those cuts came through systems sales and half through layoffs and operational efficiencies. Management also adopted a more streamlined, decentralized structure, he added.

HIGH ON PHONES

One area where Broadband hopes to boost margins is through cable telephony service, a product for which Roberts has high hopes.

AT&T already has about 924,000 telephony subscribers. The infrastructure is in place to offer telephony in 14 of its top 15 markets.

Roberts said the plan is to roll out cable telephony to about 1 million Comcast homes in Philadelphia and Detroit in 2003. Roberts had been lukewarm on cable telephony in the past — before the merger agreement, Comcast had said repeatedly that it would wait for lower-cost Internet-protocol telephony to become a reality — but he's now one of its biggest proponents.

The economics of cable telephony are much better for Comcast with AT&T Broadband in the mix. Roberts said telephony can be rolled out in Philadelphia and Detroit for between $5 and $50 per customer, because AT&T has already invested in the switching infrastructure in those markets. That $5 to $50 cost would mainly power the phone service at each customer home.

If capital costs are low, the returns from telephony can be high: AT&T Broadband reported average revenue per unit of $53.41 per month in the third quarter.

"If the numbers come out the way AT&T and Bill Schleyer and others believe telephony is, this is going to be a huge opportunity," Roberts said. "If it turns out to be different than that, we can steer the course as needed."

Armstrong added in his presentation that with 38 million homes passed, the combined AT&T Comcast will have a larger footprint than any single regional Bell operating company, which will also give the company an advantage.

"We will concentrate on any service to any home or business," Armstrong said.

TWE STAKE FOR SALE

Roberts said the 25.5 percent interest in Time Warner Entertainment that his firm would inherit in the AT&T Broadband deal would either be sold to AOL Time Warner Inc. — which owns the rest of the partnership — or to another party.

"In our planning for the deal, we assumed that they [AT&T Corp.] just register it [for public sale]," Roberts said. "Either AOL buys it or it doesn't. Over a couple of years we will exit [the partnership], pay taxes and move on."

Last February, AT&T Broadband requested that AOL Time Warner register its TWE shares for possible sale, which at the time was considered to be a move to force AOL to buy out AT&T's interest. Both companies have haggled over the value of AT&T's interest in the partnership, which some analysts have valued at as much as $12 billion.

That registration was delayed after Comcast made its initial unsolicited bid for Broadband in July, triggering an auction for the MSO. "Probably that will get resumed," Roberts said.

But later at the same conference, AOL co-chief operating officer Bob Pittman said that his company is in no rush to unwind TWE.

"We're perfectly happy with the relationship with TWE," Pittman said. "There's no pressure to do a deal. We would be amenable only if we get something out of it."

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