AT&T;, Disney to Discuss Forming Cable Alliance

Top executives from AT&T; Corp. and Walt Disney Co. are scheduled to meet in Los Angeles today to discuss a potential strategic alliance in the cable television business, according to people close to the situation.

AT&T; Chairman C. Michael Armstrong is searching for alternatives to an unsolicited bid from Comcast Corp., which in early July offered $40 billion in stock to take control of the telecommunications giant’s struggling cable systems unit, the nation’s largest.

Sources close to Disney say the company is unlikely to buy the cable operation because of the huge price tag, the high risks of entering the cable system business and the company’s stated goal of focusing on its core content business.

More probable, however, is an investment of cash or assets by Disney into the struggling cable unit, AT&T; Broadband, according to sources close to the company. Disney owns the most powerful and profitable television network in the world in ESPN. It also owns the Disney Channel, SoapNet and Toon Disney and has investments in E! Entertainment Television, Lifetime Television and A&E.;

Armstrong did not return phone calls Wednesday afternoon after he checked into a Beverly Hills hotel. AT&T; spokeswoman Adele Ambrose would not comment. Disney spokesman John Dryer also refused to comment.

Sources say short of a sale, Armstrong could revive a public offering of the cable unit by bringing in a blue-chip investor, such as Disney, to make it more palatable to investors. A spinoff of AT&T; Broadband was temporarily postponed by the AT&T; board last month, in the wake of the Comcast bid.

One person close to the discussions said AT&T; is looking for a partner to put several billion dollars into the cable unit to help pay down its sizable debt and dress it up for investors.

However, sources doubted Disney would invest such a large chunk of capital in cable systems it would not control. Institutional investors say investment capital, without skilled cable management, isn’t enough to match Comcast’s offer.

Comcast is vowing to dramatically improve financial results by bringing AT&T; Broadband’s profit margins of 23% closer in line with its own, which are among the industry’s highest at 43%.

Since AT&T; entered the cable business two years ago through two major acquisitions, its operating performance has steadily deteriorated, ranking AT&T; Broadband as one of the worst performers in the industry.

The AT&T; board rejected Comcast’s bid as inadequate last month and instructed Armstrong to explore alternatives and be ready to brief directors at the next regularly scheduled meeting in September.

Armstrong has since been meeting with media companies, including AOL Time Warner Inc., to explore strategic partnerships or a merger involving AT&T; Broadband. The cable unit was scheduled to be spun off to investors by the parent company into its own tracking stock before the end of the year.

One scenario involving Disney that could pique investor interest is a merger of its cable channels with AT&T; Broadband. That would put Disney on more equal footing with AOL Time Warner, which owns both cable systems and channels. Disney also has been rumored to be part of a bid for AT&T; Broadband with mid-size cable operators Charter Communications and Cox Communications. Under such a scenario, Disney would acquire the cable company and shed some of the systems to Cox and Charter for cash.

But that would not fit with Disney’s stated goals.

Just last month, in announcing the $3-billion acquisition of Fox Family Worldwide, which owns cable channels, Disney President Robert Iger said the company was likely to target further acquisitions in the content rather than the distribution arena.

Yet days later, Iger said the Burbank-based entertainment company might be open to investing in AT&T; Broadband, which serves about 16 million cable subscribers.

Analysts say cable program suppliers such as Disney are eager to block further consolidation among cable providers that could make it harder for them to raise subscriber fees or launch new channels. Disney was among the most vocal opponents of AOL’s merger in January with Time Warner on the grounds that the combined company could use its distribution clout to favor its own content, especially once the company moved into uncharted territory and begins charging customers to download music and video content from the Internet.

Merging with AT&T; Broadband would give Comcast about 22 million cable subscribers, but it would give AOL Time Warner, already the second-largest cable operator, 27 million cable customers. That would make AOL nearly three times bigger than the next largest pay television provider, DirecTV, which has 10 million customers.

Some large AT&T; shareholders prefer a sale to a strategic investor. Sources say AT&T;’s largest shareholder, Capital Research & Management Co., which holds an 8% equity stake, has told the company that spinning off AT&T; Broadband and leaving it in the hands of current management is not an acceptable option.

They said Capital Research executives relayed that message Tuesday in a meeting in Los Angeles with AT&T; Chief Financial Officer Charles Noski, who sources said would be joining Armstrong in the Disney meeting.

But it is unlikely that Disney would ultimately make a bid for AT&T;, according to Wall Street bankers and industry executives.

Disney is expected to kick the tires, as it typically does when properties come up for sale. With Disney’s stock stuck in the doldrums for the last five years, some investors say Chairman Michael Eisner may be ready to make another bold move after its $19-billion purchase of ABC and ESPN in 1996.

Yet Eisner has been reluctant to do any deal that dilutes Disney earnings, and has largely stood on the sidelines during the merger frenzy of the last five yearsas rivals such as Viacom, AOL Time Warner and News Corp. bulked up.