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AT&T for sale?

Despite AT&T Corp. Chairman Michael Armstrong's proclamations about the rosy future for his cable unit as an independent company, other cable operators are salivating over the troubles at AT&T Broadband. They believe the cable systems now serving 16.4 million may soon be up for grabs.

Cable and Wall Street executives widely expect that the planned splintering of AT&T into five pieces will give them a chance to either mount a takeover on the cable unit or parcel its assets among several operators. The most likely suitors are the 2000 version of the "three C's": Cox Communications, Comcast Communications and Charter Communications.

The portfolio is too massive for a pure financial player, and, learning from AT&T's experience, other established media or telcom companies are expected to avoid cable deals.

One big believer in a short life for AT&T Broadband is John Malone, AT&T director and major shareholder as well as chairman of AT&T tracking-stock subsidiary Liberty Media. Speaking at the Western Cable Show in Los Angeles last week, Malone predicted a "feeding frenzy" for AT&T's cable systems but only if AT&T doesn't erect fences to repel potential suitors.

"This is not going to stay an independent cable company for long," says a senior executive with one major MSO, who acknowledges that his company is studying AT&T Broadband. "Everybody is paying attention."

"Of course we're interested," says another MSO executive. "The question is, how will the thing be structured and how can you take it over?" Or, as a finance executive at another MSO ponders, "Can you take over a tracking stock?"

Indeed, AT&T Broadband could spotlight the downside of the fashionable "tracking-stock" spin-offs, in which shareholders have even fewer rights than they do in conventional companies.

When AT&T swallowed MSOs Tele-Communications Inc. and MediaOne Group Inc., the conventional wisdom dictated that those systems were gone from the market forever. Spending $120 billion-before selling off billions in stray assets-AT&T was making such a huge commitment to cable that few expected the company ever to exit the market.

But sliding cable cash flow, the accelerating decline of AT&T's core long-distance business, and new problems at its business-telephone unit resulted in a dramatic 70% decline in AT&T's stock. Led by ex-TCI Chairman Malone, investors put enormous pressure on Armstrong to restructure the company and reverse the decline.

Armstrong responded with a plan to divide the company into five pieces: AT&T Broadband, cellular, consumer long distance, business telephone, and Liberty Media.

AT&T Broadband is to be tied to a tracking stock next spring. Over the following year, the tracking stock is to be converted into a conventional common stock. The lure to other operators is the sheer size of AT&T Broadband's 16.4 million-subscriber portfolio, concentrated in 80% to 90% of the cable homes in lucrative markets including San Francisco, Chicago, Seattle, Denver and Atlanta. Four years ago, operators bragged when they owned just 40% of a market.

Further, the company's cash flow has deteriorated so dramatically in the past two years that, even at a relatively high multiple, AT&T's systems could be cheap. Assuming that the cable operations generate double-digit gains in cash flow for each of the next two years-a tremendous success given the division's recent performance-an operator paying a healthy 17 to 18 times forward cash flow could get the properties for just $3,500 to $3,600 per subscriber. That's far less than the $5,000 to $6,500 paid for other systems.

Moreover, unlike other major cable companies such as Cablevision Systems, Adelphia or all the three C's, AT&T Broadband would have no single controlling shareholder to thwart a hostile takeover.

But just because AT&T Broadband is coming loose, suitors wouldn't necessarily have an easy time. The markets for financing such a huge deal are terrible and not expected to recover for months. An operator might have to sell off some systems to avoid limits on system ownership.

The most difficult obstacle is Armstrong. After casting himself as the savior of AT&T, he has been tremendously embarrassed by the 70% stock slide that is prompting the spin-off. He is unlikely to assent to something that could be construed as a fire sale. "Armstrong has to somehow save face to make it work," says the CEO of a cable operator who is not interested in a complete takeover but hopes some system clusters shake out of a takeover mounted by someone else.

AT&T Broadband Chairman Dan Somers dismisses the talk as "speculation." Cox, Charter and Comcast would not comment.

One big issue is what an outsider can do with a tracking stock. "If Armstrong won't sell, can we launch a tender offer and take control of the AT&T Cable?" asked one MSO executive. "Do we have to sit around until it converts into a common stock? Can we force them to convert?"

Investment bankers say that such questions point up the pitfall of investing in a tracking stock. A shareholder is entitled to the economic interest of the assets of a tracking-stock company but doesn't actually "own" the assets. That ownership, in this case, would belong to AT&T. And once the cable unit becomes a tracking stock, AT&T would have no economic interest in selling AT&T Broadband's assets to anyone.

"You don't get ownership of the assets," says one investment banker who has studied taking over other tracking-stock companies. "You're buying stock in the parent company. It's kind of a legal, economic, contractual relationship." Worse still, financial executives disagree on what kind of fiduciary duty AT&T's board of directors would owe AT&T Broadband shareholders. Normally, the board of a company facing a takeover bid would have a legal obligation to consider it and justify rejecting it. Depending on how AT&T Broadband is structured, that may not be the case.

"The tracker can have a separate advisory board, but the board is the parent company's board," says one media-company CEO who has looked into the creation of tracking stocks. "Here the fiduciary responsibility is to the AT&T shareholders, not to the tracker."

However, a senior executive at another investment company disagrees: "If AT&T is issuing the security, its board has a fiduciary duty to holders of that security." He points to AT&T's Liberty Media, a tracking-stock subsidiary that is managed separately by Malone. "AT&T's board has a fiduciary obligation to those shareholders." What's interesting, the executive adds, is that Liberty executives have no fiduciary duty or much accountability. "Fortunately, the chairman is the largest shareholder so everyone's interests run the same direction."