June 26, 1998
Heard on the Street
Concerns Over TCI Deal
Push Down AT&T Shares
By STEPHANIE N. MEHTA and LESLIE SCISM
Staff Reporters of THE WALL STREET JOURNAL
Ma Bell plans to marry cable cowboy Tele-Communications, but some investors aren't
sticking around for the wedding.
AT&T shares have sunk 10.7% since it announced plans Wednesday to acquire TCI for $37.3
billion in cash and stock, as investors wary of how AT&T's profits will be diluted by
low-earning TCI have pulled away.
AT&T is also likely to spend billions more to upgrade TCI's still partly low-tech network to
deliver the plethora of voice, video and data services it has promised. That could eat into
earnings for years.
Critics say the strategy is fraught with other risks. AT&T is vague about what technology it
will use to send phone calls over cable-TV lines into millions of homes; such past attempts
largely have been disappointing.
"At some point it may be appropriate" to buy AT&T shares, "but the stock will probably drift
lower from here, until people understand some of these issues, or the company does a real
good job of convincing us it will work," says Ophelia Barsketis, a portfolio manager with
Chicago fund-management group Stein, Roe & Farnham.
Other investors wonder whether AT&T will
purchase other cable companies to connect to
customers outside TCI's reach, currently
about one-third of U.S. homes, resulting in
further dilution. In an interview this week, C.
Michael Armstrong, AT&T's chairman and
chief executive officer, dismissed such a
strategy -- perhaps to prevent the stock of
such acquisition candidates from soaring.
Partnerships between cable and phone
companies have a checkered past: TCI's
planned marriage with Bell Atlantic in 1993
fell apart before it was consummated, and
UÿSÿWest's cable strategy failed because the
phone and cable businesses didn't produce the
expected "synergy." UÿSÿWest paid $4.7
billion for Continental Cablevision in early
1996, but has since spun off the business.
AT&T's acquisitions haven't always panned
out, either. It took a bath with its purchase of
computer maker NCR, finally unloading it
after billions of dollars in losses. "TCI could
be Mike Armstrong's NCR," says Scott Cleland, an analyst with Legg Mason Wood Walker's
Precursor Group.
Robert Wilkes, a telecommunications analyst with Brown Brothers Harriman, downgraded
AT&T Thursday to "short-term neutral" from "short-term buy," citing the dilution factor.
"Basically this transaction signifies the coming together" of two industries with different
earnings' characteristics and valuation approaches, he says, adding: "No one knows right now
how the valuation methods will converge. Frequently, if there's uncertainty, investors are
inclined to sell -- or at least not to buy."
The purchase will dilute AT&T's earnings because it is using stock trading at about eight times
cash flow to buy a company at 14 times cash flow. What's more, Salomon Smith Barney
analyst Jack Grubman estimates the deal will create $750 million a year in accounting goodwill
that must be deducted from earnings, even as the number of shares grows by 440 million. The
TCI businesses will be contributing only modest profits to offset these factors, he notes.
But others say AT&T's gamble could pay off big: On paper, a combined AT&T-TCI poses the
greatest threat yet to the local Bell monopoly. That already is putting pressure on Bell stocks.
"Given the current environment, I don't think you can project with confidence continued
double-digit earnings growth beyond the next four quarters" at the Bells, says Tod A. Jacobs,
a telecommunications analyst with Sanford C. Bernstein & Co. Mr. Jacobs, who had been
bullish on the Bells, Thursday downgraded shares of UÿSÿWest, Ameritech and SBC
Communications to "market perform" from "outperform."
Mr. Jacobs's move followed downgrades of Bell Atlantic, SBC and Ameritech by Merrill
Lynch & Co. analyst Daniel P. Reingold. Mr. Reingold on Wednesday cut SBC's and Bell
Atlantic's near-term and long-term ratings to "accumulate" from "buy." He lowered
Ameritech's long-term rating to "accumulate" from "buy."
AT&T's entry into the local telephone market via the TCI network probably won't be a reality
until 2000, analysts say. But if AT&T can pull it off, it will be able to offer consumers a
discounted bundle of entertainment and communications services -- including wireless
services, courtesy of AT&T's highly complementary acquisition of McCaw Cellular
Communications in 1994 -- that the Bells may be unable to rival.
A few of the Bells slowly are building cable-TV systems in their regions, but some analysts
question the carriers' stomach for the entertainment business. And unlike the Bells, which are
required to provide local dial tone to every bill-paying customer, AT&T could "cherry-pick,"
offering the new digital services only to big spenders.
Carriers such as AT&T love service bundles because they can spread their sales and marketing
costs over several channels. And if a customer is paying for five or six services from a single
provider, he's less likely to run to a competitor just to save a penny a minute on long distance.
AT&T and TCI may start to market a pared-down version of the bundle even before AT&T is
able to offer local dial tone.
The timing couldn't be better. AT&T faces increasing price pressure from companies such as
Qwest Communications International and ICG Communications, which offer super-low rates
using Internet technology to bypass access fees that AT&T must pay to the Bell companies for
connecting to their local networks. And the pending merger of MCI Communications and
WorldCom, which has a major Internet and data business, is an added threat to Ma Bell.
As part of the TCI acquisition, AT&T also announced a plan to use tracking stocks, faddish
securities that are supposed to move in relation to the earnings' of particular segments of a
large corporation. Tracking stocks, unlike regular common shares, don't represent legal
ownership of a corporation's assets. Mr. Armstrong is familiar with tracking stocks from his
days at the Hughes Electronics unit of General Motors, which trades as GM's "H" stock.
Under the proposed deal, AT&T's main stock, which trades under the symbol T, would
include its wholesale and business communications services. These shares would pay a
dividend and will be measured, as AT&T now is, by earnings per share.
The company also would issue a stock to "track" the performance of a new consumer-services
group, which would include local, long-distance, Internet and cable-television services for
consumers. This subsidiary would be the fast-growth and high-spending-business. AT&T
expects analysts to measure the performance of this stock by its cash-flow growth, just as
cable stocks are usually valued today. A second tracking stock would follow the performance
of TCI's Liberty Media Group subsidiary, which produces broadcast programming.
One other risk is that by articulating its push into the local residential market, AT&T could
open itself up to additional competition on the long-distance side. Under the
Telecommunications Act of 1996, the Bells must prove they've opened their local markets to
competition before they can provide long-distance service in their territories.
AT&T's move with TCI could accelerate that local-market opening. If let into the long-distance
market, the Bells by some estimates are expected to quickly grab a roughly 25% share of the
residential market from big carriers such as AT&T, Sprint and other incumbents.
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