First Quarter Blues

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As the date for its planned spinoff as an asset-based company draws nearer, AT&T Broadband continues to report operating results that might not be all that appetizing to stock buyers.

The MSO is expected to detach from parent AT&T Corp. as a separate tracking stock in an initial public offering this fall. The next step would be a full-blown, asset-based stock by the middle of next year, part of an overall restructuring that would split Ma Bell into four separate units.

Industry analysts said prospects for that spinoff aren't helped by the dismal operating performance AT&T Broadband continues to report. Last week, its first-quarter results showed that cash flow fell 5.1 percent on a year-over-year basis, the second consecutive period of decline.

Worse, cash flow as a percentage of revenue — a key operating indicator — fell. The cash-flow margin for the quarter was 16 percent, 6.8 percentage points lower than the same period last year. AT&T reported margins of 25 percent to 30 percent last year. At other publicly traded MSOs, cash-flow margins range from about 39 percent to about 49 percent, analysts said.

"If they are going to do a tracker and a spinoff, I think they need a better story than they have been able to tell this quarter," said one MSO executive who asked not to be named.

CIBC World Markets analyst Tim Horan wrote in a report last week that AT&T Broadband's results were "clearly disappointing after management's [fourth-quarter] comments that there should be a significant uptick in profitability as revenue ramps and costs are wrung out of the business."

Horan also expressed doubt the unit would be able to meet management's forecast of revenue growth in the mid teens and margin expansion of 3 percent.

AT&T's results come in as other MSOs begin to file their first-quarter reports. So far — with AT&T, AOL Time Warner Inc. and Cox Communications Inc. reporting — the trend appears to be toward continued robust growth.

AOL Time Warner, which reported its first-quarter results on April 18, posted 15-percent cash flow growth and margins of 47 percent at its cable unit.

Cox, which reported last Thursday, delivered 12-percent cash flow growth and a 39-percent cash-flow margin in the period.

Adelphia Communications Corp. apparently won't show quite that much growth, though it's doing better than AT&T. In a securities filing last week, Adelphia said it expected first-quarter cash flow to be $320 million to $325 million, up about 5 percent over the same period last year. Adelphia, too, has borne high costs for rolling out new services — in its case, digital cable.

DIALING TELEPHONY

AT&T blamed the poor margin performance on additional expenses associated with the rollout of broadband telephony, higher programming costs and increased restructuring charges.

But an executive at another MSO, who asked not to be named, observed that AT&T Broadband reported $56 million in restructuring charges in the quarter.

"If you add that back, they're still only at a 19 percent operating margin," the executive said. "Cox has been rolling out telephony for years, and this quarter they had 39 percent operating margins."

Growing those margins was a top priority, AT&T Broadband CEO Daniel Somers told analysts during a conference call.

"I'm confident we have reached the low-water mark in terms of margins," Somers said. Though cash-flow results were disappointing, Somers said he believed the company had turned a corner and the future "will include profitability growth well above industry rates."

Just how that would happen was unclear and Somers offered no further details last week. An AT&T spokesman declined to comment.

One cable analyst, who asked not to be named because he doesn't specifically cover AT&T, said the company has time to turn things around.

"If they're trying to put an IPO together in the fall, they at least have two quarters, maybe three quarters to show improvement," the analyst said. "There is a lot of ground they have to cover."

The analyst likened the situation with the broadband unit to AT&T's Wireless Group, which completed the largest IPO in history — $10.6 billion — last April.

"If you look at the AT&T Wireless IPO, the wireless group initially had low margins compared to the rest of the sector. But AT&T anticipated those problems, identified what the problems were and explained to the Street how they were going to solve them," the analyst said. "That's an interesting model for what they can do with Broadband."

News of AT&T's first quarter wasn't all bad. New revenue-generating units grew by 700,000 and the company managed to shave 15 percent, or $8.7 billion, off its $56 billion debt load through sales of assets, such as a 10-percent stake in Japan Telecom to Vodafone Group plc.

Other MSOs are watching AT&T's troubles with the eyes of prospective buyers, hoping to find bargains in the form of cable systems they could presumably manage more effectively. In fact, the top domestic MSO has recently sold some cable systems.

In an SEC filing, Adelphia last week said it has a deal to buy AT&T Broadband cable systems in Pennsylvania, Ohio and New York for about $300 million in cash and stock. Sources said last week the systems are mainly in small areas in Pennsylvania, Ohio and New York. The largest is a 40,000 to 50,000-subscriber system in State College, Pa. Adelphia said it expected to close the deal in third quarter.

The purchase price works out to about $2,600 per subscriber, significantly lower than recent Adelphia purchases which have topped $6,000 per customer.

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