THE BIG TWEAK

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A little more than three months after taking the helm of AOL Time Warner Inc. from cable legend Gerald Levin, CEO Richard Parsons has managed to achieve what his former boss couldn't for nearly 10 years — he's unwound the Time Warner Entertainment L.P. partnership.

Parsons, known for his smooth negotiating tactics and personable manner, must have been pushing those attributes to the limit over the past few weeks, as he hammered out a deal that not only removes a major albatross from around AOL Time Warner's corporate neck, but manages to win a long-sought broadband cable carriage deal for its America Online Internet service.

The agreement didn't come cheap. In addition to a $2.1 billion cash payment, AOL will surrender $1.5 billion of its own stock, and a 21 percent interest in a new cable entity — Time Warner Cable Inc. — with 10.8 million subscribers and an estimated value of $5.4 billion.

AT&T Corp., AOL's partner in TWE, surrenders its 27.6 percent stake in the entity.

In return AOL Time Warner will get full ownership of its Home Box Office Inc., and Warner Bros. studio assets and will assume TWE's interests in The WB broadcast-TV network and cable channels Court TV and Comedy Central.

In addition, AOL gets a three-year broadband carriage deal for its Internet service over AT&T Broadband cable systems — and eventually AT&T Comcast Corp. systems, when the Broadband unit completes its planned merger with Comcast Corp. later this year. It would be the first carriage deal for AOL Broadband, beyond corporate sibling Time Warner Cable.

Time Warner Cable Inc. is expected to be spun off in an initial public offering in the first half of 2003. Until that time, AT&T Comcast will hold its interest in the cable unit in a trust, to avoid any regulatory hang-ups.

For AOL, which will own 79 percent of the TWC entity, the IPO will help pay back the $2.1 billion it will have to borrow to pay AT&T Comcast. In the conference call, AOL CFO Wayne Pace said the borrowing would be made by the cable entity.

AOL's high-speed Internet service will initially be rolled out in two AT&T Broadband markets, Boston and Seattle, and two Comcast markets, Indianapolis and Nashville, Tenn. Ten million homes will have access to the service within two years.

An additional 9 million AT&T Comcast homes would be added to the deal in the future.

AOL Time Warner did not release the economics of the deal, as Parsons said that the company is negotiating with other operators and did not want to tip its hand. But details point to an arrangement that appears to be heavily in favor of AT&T Comcast.

Sources confirmed published reports that AOL Time Warner will pay AT&T Comcast between $35 and $40 per month for each subscriber it signs up. That's one of the more lucrative deals in the industry. In comparison, EarthLink Inc., the third-largest ISP in the country, pays Time Warner Cable less than $30 per subscriber. AOL Broadband also will give AT&T Comcast about 25 percent of advertising and electronic commerce revenue from the service.

According to some analysts, although those are not the official figures, they will serve as a template for future cable deals for the AOL Broadband service.

"It puts down a benchmark," SunTrust Robinson Humphrey cable analyst Gary Farber said. "But I think you can assume that the deal that Comcast got is probably going to be the best in the market."

GOOD FOR COMCAST

For Comcast, the deal appears to be another in a growing line of favorable bargains cut with other cable operators, beginning with the $1.5 billion breakup fee it received from AT&T for backing away from its planned purchase of MediaOne Group Inc.; its restructuring of its Excite@Home Corp. broadband arrangement; and its winning bid last December for AT&T Broadband.

"It looks like they [Comcast] got another pretty solid deal," Farber said.

The deal addresses what has been one of Parsons' top priorities since assuming the CEO job in May and removes a major drag on AOL Time Warner's stock.

Investors also appeared to be in favor of the deal, driving up the stocks of all three companies involved.

By spinning off Time Warner Cable, AOL Time Warner also gets a deal currency in a low-leveraged, pure-play cable operator that it could use for future acquisitions. On a conference call with analysts, Pace said the debt-to-cash flow ratio of the cable unit would be about 3 times its pre-IPO figure and about 2 times after the offering. Some of the IPO proceeds would be used to pay down additional debt.

"What this transaction is about is giving us both a simple transparent structure that people can understand, and that frankly we can manage better, and giving us increased flexibility going forward in terms of how we participate in the evolution of the marketplace," Parsons said on a conference call with analysts. "There's not a secret second shoe to drop here. By creating a cable-only [subsidiary], we've maximized our flexibility for participating in the continued consolidation of that space. That we think is a good thing."

CABLEVISION ANGLE?

That helped fuel speculation that AOL Time Warner could use the Time Warner Cable stock as a means to acquire Cablevision Systems Corp., the other MSO that operates in the New York metropolitan area. Speculation of a possible deal helped drive Cablevision stock up more than $1 per share last Thursday.

While AOL Time Warner has expressed interest in buying Cablevision before, most analysts did not believe that any deal between the two was imminent.

"The Cablevision rubber-band effect is still in place," Farber said. "Looking at the history of Cablevision, the last two transactions they did were at $5,000 per subscriber. The company [stock] is trading at half of that.

"I think it [a Cablevision-Time Warner Cable deal] is not that likely in the near-term, and is more something that you'd be looking at over the next two years as a prospect.

"Look at all of the assets that investors wanted them to sell in the past year and didn't," Farber added. "What that highlights is they're interested in selling, but they're interested in selling for the maximum [amount] available."

Another analyst who asked not to be named was more blunt.

"How many times have you heard that one before and nothing has happened?" said the analyst who asked not to be named. "It's like waiting for Generalissimo Franco to die."

Even if AOL Time Warner were ready to do a deal to acquire Cablevision, an IPO of Time Warner Cable wouldn't happen for at least a year — and only if market conditions change dramatically.

Parsons said that no deals are in the works, and added that the company also continues to look at selling off non-core assets to pare debt.

"I've said wholly apart from this restructuring that we are going to be keenly focused on the strength of our balance sheet," Parsons said. "Looking for opportunities perhaps to do some deleveraging is something that has been on our agenda. We have no firm plans or commitments, nothing to announce at this time. One of the benefits of this restructuring, it gives us more flexibility to move in whatever direction we think is appropriate going forward."

SOME HISTORY

Unwinding TWE has been a sore spot for AOL Time Warner management practically ever since the partnership was formed in 1992, with Japanese investment bank Itochu Inc. and electronics giant Toshiba Corp.

Originally created to raise money to pay down the huge debt accumulated through Time Inc.'s acquisition of Warner Communications Inc., Time Warner quickly realized some of its most valuable assets were in the partnership and tried to unravel it.

Things got worse after U S West Inc. — and later the telephone company's cable subsidiary, MediaOne — acquired a 25 percent stake and regularly flexed its voting muscles in the partnership, including a failed attempt to block Time Warner's merger with Turner Broadcasting Systems Inc. in 1996.

Although AT&T Corp. had no voting rights when it acquired the TWE stake in its purchase of MediaOne in 2000, that didn't end the negotiations. But it also didn't end the acrimony — AT&T wanted to cash out of a partnership it had no control over, and Levin saw little incentive to pay top price for what was essentially a passive investment.

AT&T played its trump card last year when it registered the TWE interest for public sale, a move that shook AOL Time Warner from its complacency. Not wanting its prized content assets to have public owners, the negotiations began with earnest.

Still, both sides haggled over the value of AT&T's TWE interest — AT&T believed it was worth as much as $10 billion, while AOL Time Warner valued it at a considerably lower sum. But while Levin seemed to be content with placing the partnership in limbo, Parsons made unwinding it one of his top priorities.

Negotiations appeared to be at a standstill until earlier this month, when both AT&T and AOL Time Warner said they had asked Banc of America Securities LLC to halt its valuation of the partnership. Banc of America's valuation was the next step before a TWE IPO.

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