AT&T;, AOL Consider Splicing Cable Units

Hoping to scuttle an unsolicited bid from rival Comcast Corp., AT&T; Corp. has opened exploratory talks with AOL Time Warner Inc. about merging their giant cable operations into a network that would control nearly 40% of the national market, according to sources close to the companies.

Skeptics immediately said such a deal--combining the nation’s No. 1 and No. 2 cable networks--was unlikely to win government approval and may just be a stalking horse to force Philadelphia-based Comcast to raise its bid.

Comcast made a $40-billion stock offer for AT&T; Broadband this month, but AT&T; rejected the bid last week as too low.

Officials at all three companies declined to comment Wednesday, as did antitrust officials at the Justice Department and the Federal Communications Commission.

“The fundamental antitrust problem is pretty simple,” said Reed Hundt, former chairman of the FCC and now a principal at consulting firm McKinsey & Co. “This is a combination of No. 1 and No. 2. It’s as close to unthinkable as you can imagine, even given the Republican administration.”

Hundt, who has worked as a consultant to Comcast, said a combined AOL Time Warner and AT&T; would control as much as 60% of the cable market, including AT&T;’s investments in other cable operators such as Cablevision Systems Corp.

FCC rules once banned cable operators from controlling more than 30% of the pay-television market, but those regulations were struck down as unconstitutional by a federal appeals court this year.

FCC Chairman Michael Powell, a frequent critic of ownership caps, has not said whether he plans to establish a new cap. But the agency still has broad authority to block or restrict mergers that it believes are not in the public interest.

Analysts predicted that AOL Time Warner and AT&T--both; of which are operating under government-imposed restrictions from previous acquisitions--would face a torrent of opposition, ranging from consumer groups to giant corporations including Walt Disney Co. and Microsoft Corp.

Many were surprised that AOL, which spent most of last year fighting for government approval of its Time Warner merger, would be ready for another bruising battle.

“For AOL to try to buy AT&T; Broadband would be like Napoleon going to Moscow,” said Blair Levin, analyst at Legg Mason in Washington. “It’s the battle they should not fight and ultimately could not win.”

According to sources close to the companies, the talks are focusing on spinning off AT&T; Broadband and its 15 million subscribers into a new company and then merging it with Time Warner Cable, which has 12.5 million subscribers. AOL would own about 45% of the combined company, giving it effective control, sources said.

As part of the deal, AOL Time Warner also would receive AT&T;’s 25% stake in Time Warner Entertainment, which is parent of Home Box Office and Warner Bros.

Officials at Comcast, which had been assuring major investors that AOL Time Warner would stay out of the bidding, were said to be stunned by news of the talks.

In addition to AOL Time Warner, AT&T; is seeking interest from other cable and media companies. Investment banker Goldman Sachs has been retained to help find alternative buyers.

A spokeswoman for Disney said the company is reviewing a proposal it has received to invest in AT&T.;

Consumer groups said a combination of AT&T; Broadband with either AOL Time Warner or Comcast would be bad for customers.

“What we’re seeing is the world’s largest media companies playing a game of divide-the-monopoly,” said Gene Kimmelman, executive director of Consumers Union in Washington.

He said the negotiations were the result of the Bush administration’s emphasis on deregulation. “You wouldn’t have this kind of wheeling and dealing going on in the marketplace if cable companies thought they would get hit with strong ownership limits,” Kimmelman said.

On Wall Street, investors seemed unimpressed. Shares in AOL Time Warner rose $1.05, more than 2%, to $43.75 in New York Stock Exchange trading. AT&T; stock was up 69 cents, less than 4%, to $20.15, also on the NYSE.

*

Sanders reported from Washington and Hofmeister from Los Angeles.