Brian's Bear Hug

Spurred on by Comcast Corp.'s surprise $53.1 billion bid to buy AT&T Broadband, institutional shareholders are pressing parent AT&T Corp. to sell off the cable unit, but at a higher price than what Comcast has offered so far.

On Sunday, July 8, Comcast Corp. chairman Ralph Roberts and president Brian Roberts publicly wrapped their arms around AT&T Broadband. They faxed AT&T chairman C. Michael Armstrong — and the rest of the world — a proposal to merge AT&T's 13.5-million-subscriber MSO with Comcast's 8.4-million-subscriber operation. The news taught the cable industry some mergers-and-acquisition jargon: a "subsidiary bear hug."

The Philadelphia-based MSO offered 1.05 billion shares of stock, valued at $39.6 billion at last Thursday's close, and would assume $13.5 billion in cable-system debt.

The deal would make the combined company — of which AT&T shareholders would own 51 percent, but Comcast's super-voting-stock owning Roberts family would control 49 percent —- the top U.S. MSO by far, with 22 million cable subscribers. The current No. 2 MSO is Time Warner Cable, with about 13 million subscribers.

Investors, who figured the buyout offers were likely to get better before they got worse, bid up AT&T shares by a significant 14.7 percent between July 6 and last Thursday. Underscoring that logic, sources said AT&T's institutional shareholders — which cumulatively control about 44 percent of the company's outstanding stock — are pressing for a better deal.

"They [the institutions] are pressing for a
deal, not the current deal," said one investment banker familiar with the situation. "The institutions would like more."

While it is unclear how much more those shareholders would like, sources within the investment community said it appears that they're leaning toward a price between $70 billion and $75 billion.

That would value AT&T Broadband at between $5,200 and $5,500 per subscriber, within the $4,500 to $5,500 per-subscriber range of cable system valuations over the past year.

In its current state, the Comcast deal values AT&T Broadband at about $3,900 per subscriber, down from the $4,300 per-customer figure offered when the deal was first announced July 8. The overall price has declined because Comcast's stock price lost nearly 11 percent of its value between July 6 ($42.28) and last Thursday ($37.70).

According to sources, one of the funds pressing hardest is Fidelity Management & Research Fund, an arm of Boston-based financial powerhouse Fidelity Investments Inc. FM&R is one of AT&T's largest institutional shareholders, with 142 million shares as of March 31.

A Fidelity spokeswoman declined comment, citing company policy not to discuss specific stocks.

Robb Parlanti, senior portfolio manager at Turner Investment Partners, a Berwyn, Pa.-based fund, said that he believes a Comcast deal would be best for AT&T. According to Security and Exchange Commission documents, Turner owns about 97,000 shares of Comcast stock.

"The general consensus is that Comcast is the better bet," Parlanti said. "But the last thing you want to do is sell out too cheap."

Talk in the institutional investment community is that Fidelity is pushing for a deal, Parlanti added.

"I did hear that Fidelity was moving toward recommending AT&T to accept this," Parlanti said. "They own 4.2 percent [of AT&T stock], but it is Fidelity and they can sway people. Personally, if I was an AT&T shareholder, I'd take it."

But others in the investment community — who see the current deal on the table as too low — don't necessarily share Parlanti's view.

One such investor is Liberty Media Group Inc. chairman John Malone, who, in resigning from AT&T's board of directors last week, found the Comcast offer wanting.

"As an AT&T shareholder I find the Comcast offer insufficient," Malone wrote in his resignation letter, according to a source who has seen the document. "The tax-efficient monetization of TWE [Time Warner Entertainment] and Cablevision [Systems Corp.] should be part of any Comcast transaction."

In published reports, Malone refuted speculation that either he or Liberty would make a competing bid for AT&T. He also expressed some support for a Comcast acquisition of AT&T Broadband, telling Bloomberg News that such a deal would make "a lot of sense," but at a higher price.


On June 11, Armstrong and Brian Roberts stood side by side before reporters after a panel discussion at the National Show in Chicago, with Armstrong strongly insisting that AT&T was not for sale.

Armstrong attempted to put to rest speculation that AT&T Broadband was an acquisition target. Such talk had been rampant since October, when the company announced it would split into four separate units — Broadband, Consumer Services, Wireless and Business Services.

By that point, the two men had restarted negotiations that had begun shortly after the AT&T restructuring announcement — talks about Comcast acquiring the cable unit.

In a conference call with reporters, Roberts said that after the initial contact in October, AT&T "wanted some time off" to work on its own restructuring plan, and it wasn't until six or eight weeks ago that the talks between the two companies resumed. But after it was shut down for a second time, Comcast decided to take matters into its own hands.

"There were a number of issues that led to us not being able to reach an agreement, and we decided then to still want to pursue it," Roberts said.

While Roberts declined to elaborate on what those issues were, he said that AT&T's decision to issue a proxy statement for the planned spin-off of the Broadband unit as a tracking stock prompted Comcast to take action.

AT&T issued a preliminary proxy for the Broadband tracker on July 3 and stated that a more detailed statement would be issued before the end of July. At that pace, Comcast feared shareholders could vote to issue a tracker in early September, putting any deal with Comcast in limbo for at least two years.

According to SEC regulations, if a company sells the assets in a tracking stock prior to the two-year anniversary of the tracker, it could face a hefty tax liability.

"We concluded that the train's leaving the station, and it was now or never," Roberts said in a conference call with analysts last week.

AT&T spokeswoman Adele Ambrose denied that plans for the tracker were being accelerated.

"We're on the same path we've been on for months," Ambrose said.

Roberts fired off a two-page proposal letter and sent it to Armstrong's home fax machine late in the afternoon on July 8, the same time it was sent to newspapers across the country. While Armstrong told an audience at the Greater Boston Chamber of Commerce last week that the board will "seriously consider" the Comcast offer, he also appeared miffed at Roberts' method.

"I don't know if it bothered me as much as it surprised me," Armstrong told Reuters. "But how would you feel if you learned about something like this about the same time as the newspapers?"

In an electronic-mail message sent to AT&T Broadband employees last Thursday, Armstrong said the Comcast proposal "recognizes at least some of the value that we've created in AT&T Broadband. The question is whether it recognizes the right value. Only our board of directors can make that call and they will do what is in our shareowners' best long-term interest."

Armstrong added that analysis of the offer will take weeks, rather than quarters.

The longer the AT&T board waits, the greater the possibility that a third party could come in to trump Comcast's bid. While Comcast had to deal with that in its 1999 bid for MediaOne Group Inc. — with AT&T no less — most analysts believe that it is unlikely another company would come in with a larger offer.

Possible suitors include Charter Communications Inc., Cox Communications Inc., Vivendi Universal S.A., Viacom Inc. and The Walt Disney Co. But because of the structure of the deal, most analysts believe Comcast will be the sole bidder.

In order to make an acquisition of AT&T Broadband tax-free, Comcast would essentially give 51 percent of the ownership of the combined company to AT&T shareholders. While those shareholders will control the majority of the vote, the Roberts family — with a little more than 1 percent of the shares — would control more than 40 percent of the vote.

According to several observers, it is that structure that makes it difficult for another suitor to step in. Any potential bidder would have to be smaller than AT&T, but big enough to do the deal.

Those criteria work against Charter, much of whose stock is owned by chairman Paul Allen, and Cox, whose major shareholders have been averse to having their holdings diluted, analysts said.

Cable-broadcast cross-ownership restrictions would complicate matters for both CBS parent Viacom and ABC Inc. owner Disney.

AT&T is likely to look for a sweeter deal, which some observers said could include cash, more stock or the assumption of more debt.

"I don't think the deal as it stands today gets done," said one MSO executive. "There are some limitations as to what the pricing is."

According to one Wall Street analyst, debt reduction may be more attractive to AT&T than a cash component to the deal.

"Cash doesn't mean anything to them," said an investment banker who asked not to be named. "It's better for them to push the debt around."

AT&T has worked hard to pare down its debt load this year, trimming its burden from $65 billion to $47.5 billion. According to the July 3 proxy, Broadband would be responsible for about $15.6 billion of that debt.

Comcast has said it could sweeten its offer by agreeing to purchase for additional stock AT&T's 25.5 percent interest in TWE and its 30 percent stake in Cablevision. Those two stakes have been valued at between $10 billion and $20 billion.

If it were to buy the TWE and Cablevision stakes, Comcast said it would likely sell them off. AT&T has been in protracted negotiations with AOL Time Warner Inc. – its other partner in TWE – but has been stalled over disagreements on the asset's worth.

Comcast has stressed that its proposal merely accelerates the plan AT&T already had for Broadband.


Joining Comcast's existing 8.4-million-subscriber operations with AT&T Broadband's 13.5 million customers would create a combined entity with immediate synergies. In the analyst conference call, Roberts said the new Comcast would generate $1.25 billion in cost savings annually, with the potential to increase those benefits to between $2.6 billion and $2.8 billion as the companies work together to improve Broadband's cash-flow margins.

Those margins have been a topic of debate since the first quarter, when Broadband reported margins well below the industry average. At the end of the first quarter, Broadband's cash-flow margins were 16 percent, significantly short of its cable peers, which range from 39 percent to 47 percent. Comcast's cash flow margins are at about 42 percent.

To drive home its point, Comcast pointed to systems it purchased from AT&T in January. In just the first six months of owning those systems, which have about 765,000 subscribers, the MSO has raised operating cash flow by 32 percent and its cash-flow margins have increased by 6 percent.

"It sounds like out of the box, there are some easy ones," said SG Cowen Securities Corp. analyst Gary Farber. "Corporate overhead — they say they can run those systems for $50 [million] and they're being run for $500 [million] — telephony and programming costs. You've got two or three items that look like, in the near-term, [they] could be addressed pretty quickly."

Yankee Group president Brian Adamik said that one factor in Comcast's favor is its management team.

"When Comcast talks about improving margins, that's credible," Adamik said. "What they will do is change [AT&T's] priorities. Their management team are all cable managers. The problem with AT&T Broadband is that it's a cable company run by a telephone company that thinks its a broadband company."

AT&T has maintained that it will be able to raise margins on its own, blaming the poor performance on greater capital expenditures to upgrade plant.