Trouble on the Lines for AT&T; Since Its Cable Entry

At the cable industry’s annual convention in Chicago last spring, AT&T; Chief Executive C. Michael Armstrong declared himself “a cable guy,” doing his best to bond with the clubby group his company is spending more than $100 billion to join as the country’s largest cable operator.

In his keynote address, he vowed to usher the industry into the promised land of local phone delivery by lending AT&T;’s trusted name to joint ventures with cable companies that he pledged would give consumers lower rates and a choice of local providers.

But instead of developing cozy relations and quick deals, Armstrong in the last six months has antagonized potential allies by embracing regulatory policies they oppose and by threatening to compete head-on in the phone business against companies dragging their feet in partnering.

The bad blood is just one of several problems jeopardizing one of American business’ boldest bids: Armstrong’s effort to turn around AT&T.; The company’s stock has been battered as AT&T; has suffered price wars in its core long-distance business, a series of top-level executive defections, a battle with America Online over how Internet services over cable lines will be regulated, dissent from cable mogul and AT&T; shareholder John Malone and problems rolling out new services over cable facilities acquired in March from Tele-Communications Inc., one of the most rundown of all cable operators.

“There’s a lot of pressure on Armstrong right now,” said Brian Adamik, a senior vice president at Yankee Group in Boston. “Any one of those things would make me tense.”

AT&T;’s travails are expected to be a hot topic at the cable industry’s annual Western Show at the Los Angeles Convention Center, which opens Tuesday to an audience expected to top 30,000.

Armstrong will be making appearances with Daniel Somers, the former AT&T; financial chief who stepped in to succeed cable head Leo J. Hindery. Hindery, former president of TCI, was ousted in November.

Of particular interest will be AT&T;’s controversial agreement, outlined last week, to eventually sell space on its high-speed cable networks to Mindspring Enterprises and other independent Internet service providers. Cable companies have been battling the proponents of “open access” all year and worry that AT&T;’s concessions set a precedent that could hurt their ability to recover the steep costs of upgrading their networks for new services.

‘No One in the Industry Trusts Them’

AT&T;’s stance has made some cable executives leery about contributing their wires to launch the first nationwide local phone service since the court-mandated breakup of AT&T; in 1984. “They are questionable partners,” one top cable executive said. “No one in the industry trusts them.”

Time Warner and Comcast, the largest cable operators after AT&T;, are expected to eventually join forces with AT&T;, though not in the time frame Armstrong had originally forecast. But it’s possible that none of the dominant Southern California providers will.

Computer billionaire Paul Allen controls Charter Communications, which is expected to take over AT&T;’s MediaOne properties in Southern California in coming months. Allen has announced a $1.65-billion investment in RCN, an emerging Princeton, N.J.-based phone provider that is likely to be its partner.

Cox Communications, arguably the most aggressive cable operator in rolling out phone service, is expected to proceed alone.

And last month, Adelphia Communications, which recently entered Southern California with its purchase of Century Communications, said it is leaning toward using the publicly traded company it controls that now provides phone service to businesses.

AT&T;, however, rejects the notion that relations are strained. “We have been able to do exactly what we said we would do,” said Mark Siegel, an AT&T; spokesman. “Our relations with the cable industry are excellent.”

Yet in an action that underscores the distrust, cable executives held a secret meeting last month, shortly after talk of the Mindspring development first surfaced, to determine whether to admit Armstrong onto the board of the National Cable Television Assn., a Washington trade group.

The door was ultimately opened, but some members remain concerned that AT&T;’s interests are at odds with their own.

Defending Its Main Business

For consumers, the division within the cable industry could lead to more choices. With local phone providers Bell Atlantic and SBC Communications (owner of Pacific Bell, among other companies) preparing to offer customers bundles of services including long-distance, AT&T; is scrambling to show Wall Street it can defend its core business against encroachers, even without cable allies.

In New York, where Time Warner and Cablevision divide the cable market and have yet to finalize partnerships with AT&T;, Armstrong proposes to compete against Bell Atlantic by leasing lines from the company itself. That could mean competitive wars fought by three providers rather than two, because Cablevision has its own phone offering.

Sources say Armstrong also is considering going after San Diego, where Cox Communications has several hundred thousand phone customers, to bully that company into cooperating.

Few cable companies are ready to rush into the phone business. Most already are stretched to the limit now in rolling out high-speed Internet access and digital cable services to battle the immediate threat posed by the fast-growing satellite providers in television and the phone giants peddling digital subscriber lines for fast Internet connections.

For AT&T;, the disappointing progress in forging cable partnerships comes on top of problems in other divisions. Wall Street rewarded Armstrong’s arrival two years ago and his flurry of deal making by lifting AT&T; shares to a five-year high. But the risks of his turnaround strategy are becoming more worrisome.

A 30% drop in stock value this fall irritated major shareholders, including Malone, who had become one of the phone giant’s largest shareholders in the sale of TCI to AT&T.; Analysts say Malone, who continues to control the Liberty Media programming arm that is a subsidiary of AT&T;, has sold some of his $2 billion in AT&T; shares.

Sources say his lack of faith in AT&T; is reflected in behind-the-scenes maneuvers to persuade the company to severe ties with Liberty or to trigger a government-mandated divestiture.

Malone did succeed in prodding Armstrong into forming a new stock, announced last week, to track the performance of AT&T;’s wireless assets. The idea was to unlock value by freeing the booming wireless group from the troubled long-distance and capital-intensive cable divisions. The plan has helped lift stock in New York-based AT&T; from the mid-$40 a share in October to close at $57 a share on Friday on the New York Stock Exchange. Sources say the uptick may prompt a sell-off by TCI shareholders, including Malone, in March, when their one-year holding period ends.

AT&T; was woefully bloated and unfocused when Armstrong took over in October 1997 after serving for more than five years as chief executive of Hughes Electronics. Armstrong had weaned Hughes from the shrinking defense business to focus on commercial businesses such as DirecTV. To reduce AT&T;’s reliance on the long-distance business, in which competition is narrowing profit margins, he consummated a deal to buy Teleport, entering the prized corporate segment of the local phone market. A subsequent $10-billion alliance with British Telecom is strengthening AT&T;’s reach overseas, and the purchase of IBM’s global data network has made it a powerhouse in managing other companies’ computer and communications needs.

Sources say Armstrong tried to buy America Online to jump-start its sputtering WorldNet Internet access service, and was negotiating with regional phone provider BellSouth when he seized upon TCI instead, and then snagged MediaOne Group in a bidding war with Comcast to make AT&T; the nation’s largest cable operator.

His decisiveness has earned some praise. A former AT&T; executive said recently: “It’s a job for a superhero, and Mike has done a monumental job of shaking up a company steeped in a 100-year tradition of not creating waves.”

Yet many current and former AT&T; insiders criticize Armstrong for failing to end the company’s history of seeing its best and brightest executives leave to join cutting-edge concerns.

(None of the former AT&T; executives contacted for this article would speak on the record, citing options payouts that would penalize them for disparaging the company.)

“Armstrong is pumped about the team he has assembled,” said Siegel, the AT&T; spokesman.

Yet since Armstrong’s arrival, several top executives have left, including Hindery and Robert Annunziata, the respected head of Teleport, who resigned in February to become CEO of Los Angeles-based Global Crossing. Jeffrey Weitzen, the former head of AT&T;’s business unit, is now chief operating officer of computer maker Gateway. Daniel Schulman, the former head of AT&T;’s WorldNet, joined Priceline.com in June.

Sources close to the company say a key date for stock options next October could prompt another wave of departures.

Executives who have worked for Armstrong at Hughes or AT&T; describe him as a demanding boss with a sharp marketing and communications skills. But detractors say he is a meddler who relishes pitting executives against one another and giving the same assignments to opposing teams.

“Mike has many strengths, but when it comes to creating a team spirit, that is not Mike’s style,” one former executive said.

AT&T; said Armstrong and other senior executives were not available for comment for this article.

In Hindsight, Some Question TCI Buy

Widespread discounting in long-distance is forcing Armstrong to make deeper cost cuts to maintain stable earnings. At the time of the TCI announcement, AT&T; said it would find $2 billion in savings to keep the deal from diluting its stock price. But company sources say AT&T; has internally revised that figure to $5 billion because of erosion in long-distance.

AT&T; insists its aggressive investment schedule for upgrading TCI’s systems for two-way services should be mostly carried through by the end of 2000.

Still, cable industry executives fret that Hindery’s departure and a lack of experienced management in cable could hamper the complicated roll-out of new products, the completion of the phone partnerships and the smooth integration of TCI and MediaOne. TCI executives say that morale has hit bottom and that decision-making has radically slowed since Hindery’s departure Nov. 1. “My biggest worry is that their lack of cable management will cause AT&T; to stumble, bringing down the whole sector,” said a top executive at a leading cable firm.

That is not how the cable strategy was supposed to play out. In the spring of 1998, sources say, Armstrong presented to AT&T;’s board a plan to buy BellSouth, which would give AT&T; nearly 17 million households for local phone services. But they say Malone persuaded Armstrong to buy TCI instead, with its 11 million subscribers.

In addition to TCI’s customers, Armstrong was interested in the company’s existing partnerships with a dozen cable companies, which Malone said could be pressed into joining AT&T;’s local phone efforts, extending the reach of the deal to more than a third of the nation’s households. Hindery, a master deal maker, would bring in the rest of the industry, as chief of AT&T;’s cable operation.

In hindsight, many in the cable industry and on Wall Street question whether TCI was the best cable bet. Despite its vast reach, TCI’s systems are antiquated and geographically scattered. Its service record is deplorable, making it vulnerable to satellite rivals and to regional and federal regulators deciding the outcome of the “open access” debate.

Upgrading TCI’s systems for the delivery of advanced services could cost AT&T; close to $10 billion, according to cable industry executives--far more than the $2 billion Armstrong projected when the deal was completed. Sources say AT&T; latched onto the MediaOne in part to buy time on Wall Street to work out the kinks in the TCI systems. MediaOne’s advanced cable networks already deliver local phone and high-speed Internet services in cities such as Boston and Los Angeles.

AOL Fight Forces Cable Industry’s Hand

But the MediaOne acquisition also raises AT&T;’s costs for acquiring cable to an average of $4,600 per home, not including the upgrade costs. So even if AT&T; reaches its goal of selling 30% of its cable customers local phone service, it would have fewer phone customers than it would have had by buying BellSouth. And 30% is far from a sure thing, as rival RCN builds its own cable systems targeting key AT&T; strongholds such as Boston and San Francisco, at a cost per household of about $1,200.

But perhaps the most unanticipated side effect of the TCI purchase is the onslaught waged against AT&T; by America Online.

Together with the local phone firms, AOL has pressed local regulators to require cable operators to open their high-speed networks to rivals, claiming that otherwise they would favor their own services over rivals. Though federal regulators have sided with the cable industry, several municipalities have voted to require “open access,” and AT&T; is in the midst of a federal court battle on the issue with Portland.

Even critics agree that Armstrong has made the best of the bad hand he was dealt, and that buying cable was the most direct route into consumers’ homes. But success depends on near-flawless execution, given the financial erosion of long-distance and the uncertainty and expense of his bet. “The key to Armstrong’s legacy at AT&T; is going to be defined not by what he’s done so far, but what he does next,” Yankee Group’s Adamik said.