Washington-As expected, the Federal Communications Commission is resisting AT & T Corp.'s wish to acquire Media-One Group Inc. without some rearrangement of the corporate furniture.
That was the status quo last week after the commission's Cable Services Bureau recommended the deal be approved only if AT & T agrees to make at least one of two moves within one year: Spin off programming subsidiary Liberty Media Group, or divest MediaOne's 25 percent stake in the Time Warner Entertainment limited partnership, which owns cable systems and programming assets.
AT & T is unhappy with that decision, having tried for months to persuade CSB chief Deborah Lathen and her team that the $56.4 billion merger would conform with agency rules and promote the public interest.
A cable-industry source said America Online Inc.'s Jan. 10 announcement that it was buying Time Warner Inc. may have influenced the FCC's review of AT & T-MediaOne.
Prior to the AOL-Time Warner deal, the source said, the FCC's views on restructuring centered on Liberty, and not TWE. "Up to that point, they were focused exclusively on Liberty," the source added.
Despite the setback, AT & T still has a chance to modify the bureau's proposal by seeking support from a majority of the five FCC commissioners who occupy the agency's lofty eighth-floor office suite.
"I can tell you that the unhappiness with [the bureau's recommendation] has been made manifest to the eighth floor," an AT & T source said. "We are a ways away from the commission voting on this."
FCC sources said chairman William Kennard was eager to vote the merger at the agency's May 15 meeting, if not earlier. But they also said the mid-May deadline could slip due to lobbying pressure from AT & T and ongoing efforts to approve the Viacom Inc.-CBS Corp. merger.
Last Wednesday, Viacom and CBS said the Department of Justice declared it would not oppose their merger, and FCC approval was expected to be "imminent."
It is expected that AT & T will seek support from FCC commissioner Susan Ness, because many see Kennard and commissioner Gloria Tristani as closing ranks behind the bureau, and Republican commissioners Michael Powell and Harold Furchtgott-Roth as siding with AT & T.
Ness, a Democrat, is the crucial swing vote in a high-stakes merger at a politically sensitive moment in her FCC career. Ness' nomination for a second five-year term is pending in the Senate Commerce Committee.
"The FCC staff draft that has been circulated on AT & T-MediaOne is just that. We don't know if there are going to be three votes for it," said Andrew Jay Schwartzman, president of the Media Access Project, a merger opponent. "The story I hope you will be looking at is the lobbying we expect AT & T to be doing to turn that around."
AT & T's problems resulted from an apparent clash with FCC cable-ownership rules, which bar a cable operator from owning more than 30 percent of subscribers to pay TV services.
After buying 5 million subscribers in the MediaOne deal, AT & T would have 40 percent of the market, but only if the TWE stake were included in the calculation. Without TWE, AT & T's total would come in at 29 percent.
Over AT & T's objections, the bureau is recommending inclusion of TWE because AT & T-owned Liberty sells programming to TWE. FCC rules allow for the insulation of a limited partnership like TWE if the limited partner is not materially involved in the general partner's programming activities.
While acknowledging Liberty's vendor status with TWE, AT & T has said it would erect elaborate safeguards to ensure that AT & T is separated from TWE's programming activities. As a result, AT & T wants the FCC to exclude TWE's 9.4 million subscribers from its ownership total.
Evidently, the commission's programming-related problems are not limited to Liberty. AT & T, which owns about one-third equity in MSO Cablevision Systems Corp., also owns a stake in the cable networks owned by Cablevision's Rainbow Media Holdings Inc.
And AT & T would acquire stakes in nearly one-dozen cable networks via MediaOne, including Outdoor Life Network, Speedvision and New England Cable News. All or nearly all of those networks outside of the Liberty family sell to TWE.
It was not clear last week whether the FCC would require AT & T's separation from those networks in addition to the Liberty spinoff. It was also unclear whether the FCC's one-year deadline to divest would toll from the date of the merger's approval or from the date when AT & T and MediaOne closed.
But a cable-industry source said it was highly likely that the FCC wants AT & T to shed other programming interests in addition to Liberty if AT & T were to retain the TWE stake. "AT & T is very unhappy," the source added.
The FCC is not enforcing the ownership cap while it is under review by the U.S. Court of Appeals for the District of Columbia circuit. Instead, the commission is proposing the TWE or Liberty options to AT & T under its authority to ensure that the merger would promote the public interest.
Analysts said if the bureau's recommendation were adopted, AT & T would have plenty of options. They suggested that AT & T could exit TWE with telephony and Internet-access deals in hand from Time Warner and its future owner, AOL, satisfying much of AT & T's and AOL's strategic interests in cable.
"I don't know that having Liberty is key to the game plan," said George Reed-Dellinger, senior vice president of Washington Analysis, a telecommunications-research firm.
In the past, Reed-Dellinger has predicted that AT & T would receive FCC waivers to keep TWE and Liberty. But, he added, AT & T would still have leverage to reach deals with AOL-Time Warner even if it is under an FCC deadline to back out of TWE.
"Time Warner still needs AT & T's expertise for telephony, and AOL would still have to negotiate with AT & T for access to the cable systems," Reed-Dellinger said. "I am saying that regardless of what they do with TWE, I think TWE is going to need AT & T."
Bruce Leichtman, vice president of Internet-markets strategy for market-research firm The Yankee Group, was equally optimistic that AT & T could turn a TWE divestment into a positive situation.
"Certainly, formalizing a telephony agreement could be part of it, as well as [settling] the open-access debate and any relationship with AOL. Those are two major, major things in the relationship between both parties," Leichtman said. "Getting out of [TWE] allows them maybe to reach some very important contractual agreements."
Bear Stearns & Co. telco analyst William Deatherage said the most likely scenario would see AT & T divest Liberty and keep its TWE stake. He added that investors aren't that concerned about losing the Liberty stake as long as the MediaOne deal goes through.
"I don't think this issue keeps [AT & T shareholders] awake at night. Much more, they just want to get the company out of deal purgatory," Deatherage said. "Stocks don't typically perform well when you have deals pending and uncertainty."
So far, AT & T's stock hasn't been adversely affected by the possibility of divestiture. AT & T shares closed at $51 each April 26, down 88 cents.
If the FCC forces AT & T to restructure, the company wants 18 months to get its affairs in order. According to several sources, AT & T needs until at least March 2001-the second anniversary of its Tele-Communications Inc. and Liberty acquisitions-to shed Liberty and avoid a tax payment to the Internal Revenue Service that is said to run into the billions of dollars.
"There are tax consequences there that I don't have the answer to," Reed-Dellinger said.
Sanford C. Bernstein & Co. analyst Tom Wolzien said that aside from the tax issues-which could be lessened if AT & T is forced into a Liberty sale-AT & T may be better off unloading Liberty.
"The TWE thing is just so complicated that it's probably a bit more difficult to deal," Wolzien said. "Liberty can be broken apart without anybody being damaged or having negotiating leverage over the other guy, whereas if you're forced to get rid of TWE, AT & T would be at a disadvantage to Time Warner in terms of those negotiations because Time Warner is the only buyer."
Wolzien added that divesting the TWE partnership could have substantial tax implications for MediaOne on its own. U S West Media Group-MediaOne's predecessor-invested about $2 billion when TWE was formed. That position, Wolzien said, is worth substantially more now.
"It's in everybody's interest to try to sort it out privately and use it as trading chits against other things, rather than just plain flat-out monetize it," Wolzien said. "It's reasonable to say that [stake] is worth an awful lot more. The tax implications [were they to sell it] would be pretty hefty."
In an interview with CNBC that aired April 18, Liberty chairman John Malone pegged the tax hit at $7 billion and virtually ruled out a Liberty spinoff to appease the FCC.
"I just don't think [it is] in the cards at this time to resolve MediaOne by spinning off Liberty. I don't think we're at the stage yet where.that is likely to be the outcome," Malone said.
Mike Farrell contributed to this story.