The hidden winners of the AT&T/MediaOne deal
It's too early to pick a victor in the phone and cable wars, but Time Warner, Qwest, Broadcom and Aware look like good ways to invest in the battle.
By Jim Jubak
It's not over.
Sure, AT&T's (T) successful bid for MediaOne Group (UMG) is huge. It's big enough to shake up the telephone industry and the cable-TV business and scramble the pecking order among Internet players.
But the battle isn't finished in any of those sectors. In fact, it's still heating up.
And that's at the core of my investment strategy right now. I think it's far too early to pick ultimate winners. I don't know if AT&T will succeed in reassembling the end-to-end phone system that the Justice Department broke up in 1984 or if the Baby Bells will hang onto a near-monopoly on local phone service. I don't know if At Home (ATHM) and AT&T will crush America Online (AOL) or whether At Home and America Online will divide the national market for branded Internet service between them. And I'm not likely to know for years who will win the endgame.
However, I do know what the struggle of the next few years is going to look like. Thanks to the deal between AT&T and MediaOne, there are now really only two camps: AT&T and its cable industry allies clearly are pitted against the regional Bells and America Online. Neither side right now holds a clear winning edge, but each is determined to tip the balance in its favor.
One way to do that, both sides know, is by recruiting allies from among the still uncommitted. Speed is the other factor that could sway the outcome. The technology that moves the fastest will give one side or the other the high ground that could prove decisive. Those two factors are the core of my strategy for investing in these companies in the near term:
Buy shares in those still-uncommitted companies that the two sides will attempt to recruit as allies. Top two ideas: media/cable giant Time Warner (TWX) and next-generation telecom Qwest Communications International (QWST).
Buy shares in technology companies that will get a big boost from faster deployment of the competing services. Top two ideas: Broadband semiconductor makers Broadcom (BRCM) and Aware (AWRE).
Time Warner, the remaining big cable player
No company won so much by doing so little in the AT&T/MediaOne deal as Time Warner.
First, Time Warner saw the paper value of its cable system (at 12 million subscribers, one of the largest in the country) climb by $7 billion to $56.4 billion. AT&T's final bid of $4,700 per cable subscriber topped Comcast's (CMCSA) offer of $4,100. Just last year, AT&T paid TCI just $2,970 per subscriber.
Second, Time Warner gets rid of MediaOne, a troublesome partner that owns significant shares of Road Runner (Time Warner's own cable-modem service venture), HBO and the company's movie operation. The way Time Warner reads the legal work, AT&T won't acquire a say in running Time Warner with its purchase of MediaOne. And that will free up Time Warner to strike a lucrative deal with AT&T -- or anyone else, for that matter -- for local phone and Internet service.
Qwest, the missing ingredient
Qwest and rivals such as Level 3 Communications (LVLT) are likely to be the ultimate beneficiaries of the next stage in the battle over local phone service between AT&T and the regional Bells.
The Bell companies haven't been able to persuade regulators to let them offer long distance phone service; they simply haven't been willing to do all that regulators are demanding to open up their local monopolies. But if regulators allow AT&T to buy MediaOne -- a deal that will give AT&T the ability to eventually offer local phone service to the 62 million homes passed by the cable systems it will own -- the regional Bells will have lost the ability to defend those monopolies.
The regional Bells won't have any choice if they want to remain competitive with AT&T. They'll have to do whatever it takes to get into the long-distance business. And that will mean making deals that allow customers to buy a package of local and long-distance phone services and Internet access. Trying to sell just local phone service, when AT&T can offer a package of all three, just won't work.
The regional Bells won't have any choice if they want to remain competitive with AT&T. They'll have to do whatever it takes to get into the long-distance business.
Where will the long-distance piece of that package come from? You can see a prototype for how these packages will be put together in the recent marketing deal between Qwest Communications and BellSouth (BLS). Because of the current regulatory climate, the two companies have had to carefully limit their deal to a referral from BellSouth to Qwest of customers who want to buy long distance, data and imaging services. Adding long-distance service from a provider such as Qwest could be a powerful marketing weapon against AT&T. Because the newer long-distance companies have more efficient networks, they can sell -- and the regional Bells can resell -- long-distance service for less than AT&T can. Lower prices are always a pretty good marketing edge.
Qwest isn't the only long-distance company that will strike these deals, they've just been more forward in pushing this strategy than their competitors. I expect a long list of marketing arrangements and equity investments by regional Bells in long-distance carriers over the next year. That should help revenue grow at these companies faster than analysts now project.
About two weeks ago, I sold Qwest out of Jubak's Picks because I thought the stock had moved too high too quickly (see my April 27 column "Like people, some stocks improve with age"). At that time, I said that I thought the stock was fairly valued at $77. In light of the AT&T deal, I'd now move that figure out to $82. I think Qwest is a buy at that price or less and I'll add it back for Jubak's Picks if it trades to that level over the summer.
Broadcom and Aware, the speedsters in the race
Just before I started this column, I went to the At Home Web site to see if I could actually sign up for high-speed Internet service where I live. No way. And the truth is that's a pretty good description of the status quo for high-speed Net access and cable-based local phone service in most of the country right now. For all the ballyhoo, At Home, the largest of the cable-modem access companies, had just 460,000 customers nationwide at the end of the first quarter of 1999. The total number nationally is about 750,000, according to Forrester Research.
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My favorite way to play this acceleration remains Broadcom, because it sells to both camps.
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But don't count on seeing small numbers like that for long. AT&T didn't spend more than $109 billion to buy TCI and MediaOne to serve just a few hundred thousand customers. By the end of the year, nearly three quarters of MediaOne's cable network and about half of TCI's system will be upgraded to handle two-way traffic. That means AT&T will be able to market its phone and Internet services to about 6 million households.
The regional Bell companies and their ally America Online can't afford to let AT&T get much further ahead. Analysts estimate that there were only 50,000 customers using the copper-wire-based DSL technology at the end of 1998. But America Online already has signed deals with SBC Communications (SBC) and Bell Atlantic that bring the company about halfway to its goal of being able to offer high-speed DSL-based access to anyone in the U.S. with a phone -- and an interest in paying the extra cost.
It's safe to count on both sides pushing their preferred technology as fast as possible. That means faster-than-expected growth in cable modems and the chips that run them and a similar surge in sales for DSL companies.
My favorite way to play this acceleration remains Broadcom, because it sells to both camps. I added the stock to Jubak's Picks on June 29, 1998, because I thought the company would benefit from the AT&T purchase of TCI (see "The real winner of the AT&T deal"). I still like the stock -- I recently set an April 2000 target price of $118 a share based on the potential for faster revenue growth (see the update at the end of my May 7 column, "4 steps to upgrade on the downgrade").
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• Buying or selling at the fork in the road, 5/4/99
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But Broadcom isn't the only company that will gain from this stage in the battle. Check out Aware, a leading ADSL company at the forefront of developing easier-to-use flavors of the technology that can be built into PCs. Conexant Systems (CNXT), a recent spinoff of Rockwell International's semiconductor operations, just introduced a single-chip cable-modem product now being evaluated at several cable-modem makers. I'd also take a look later in the year at Terayon Communication Systems (TERN) after selling by early investors in the company clears up. (Nothing caused the selling, I believe, except the expiration of the lockup on about 10.5 million shares that now can be sold in the public market for the first time.)
I think these intermediate-term picks -- meaning good for the next 12 to 24 months -- give investors a reasonable chance of profiting from this battle without getting beaten down by crazed hordes if the fight goes in unexpected directions. In my next column, though, I'm going to analyze the stock that, if my e-mail is any indication, would get the most votes for the one you have to own long-term. I mean At Home, of course.
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