REACH OUT AND TOUCH TCI

The big deal that wouldn't die finally happened — and John Malone promised that it will close, too.

AT&T Corp. decided that the best way to bypass the Bells and to grab local customers was to buy Tele-Communications Inc.'s cable business, in a deal valued at about $48 billion in stock, assumed debt and cash.

Since his first days on the job in November, AT&T chairman Michael Armstrong apparently wanted to partner with TCI chairman and CEO Malone. Armstrong flew to Englewood, Colo., to talk it over during his second week at AT&T and, along the way, they discussed a variety of options, including a failed attempt to match-make a marriage of cable high-speed-data services and AT&T.

"This was always the best idea," Armstrong told analysts in New York after announcing the deal last Wednesday. In fact, he said, "there really wasn't any alternative, to be honest. I can say now that thedeal's done."

Malone — whose sights will shift to control of Liberty Media Group and TCI Ventures Group — vowed that this merger won't crash and burn, like his 1993 deal to sell TCI to Bell Atlantic Corp.

And while Malone's TCI holdings will rise to, by his estimate, $1.8 billion when the deal gets done, he said he also backed his play with a $240 million purchase of TCI shares last week.

"I'm betting very substantially personally that this will be a very successful financial investment, long-term," Malone said at a New York press conference.

Malone will leave TCI having extracted $5.5 billion in tax-free cash from AT&T for his new deal vehicle: a combined Liberty Media Group and TCI Ventures Group, under the Liberty name. That comes from Ventures selling to AT&T its controlling stake in @Home Network, the National Digital Television Center and Western Tele-Communications Inc. ($2.5 billion); and AT&T's own stock, which will come when an earlier deal to sell Teleport Communications Group closes ($3 billion).

Malone's move to the enlarged Liberty should help to ensure the deal's health by averting an ego clash such as what happened with Bell Atlantic chairman Ray Smith, analysts said.

"The message was clear to me: Malone is ready to step away," Salomon Smith Barney high-yield analyst Stevyn Schutzman said.

Malone and TCI president and chief operating officer Leo J. Hindery Jr. -- whom Malone hired in February 1997 to help right a listing ship -- said they felt that TCI needed help expanding into telephone and other two-way communications services.

Hindery said TCI believed in its strategy, which includes a big push into residential telephony using new Internet-protocol technologies.

"It was the implementation about which we had grown somewhat concerned," he said.

Under the merger plan, Hindery would become president and COO of the planned AT&T Consumer Services Co., serving under current AT&T president and COO John Zeglis.

AT&T Consumer Services will combine the cable operations and high-speed-data services with AT&T's residential long-distance offerings, dial-up Internet access, wireless networks and, when available, IP-based local phone service. This would create a company that would be measured by its cash-flow performance. Armstrong said it would generate $7.5 billion per year in cash flow from $33billion in annual revenue

That company will be separated from the"wholesale" network-services operation, which serves business customers, bymeans of a new tracking stock. The wholesale arm would be a profitable, dividend-paying investment, generating $36 billion in annual revenue and $12 billion in cash flow.

AT&T said it hadn't yet determined exactly how the new stock would be distributed to existing AT&T holders.

As Malone said last week, Armstrong, who was chairman and CEO of General Motors Corp.'s Hughes Electronics Corp. subsidiary, is probably "the guy that, next to me, knows [the most] about tracking stocks and their appropriate use for shareholder value."

AT&T will acquire TCI Group's stock by issuing newAT&T shares and exchanging them at a ratio of 0.7757 shares of AT&T stock for each share of TCI Group Series A stock and 0.8533 shares of AT&T for each share of TCI Group Series B stock. The premium paid for the supervoting B shares, controlled by Malone, has already prompted a lawsuit filed by a Series A holder last week in Delaware Chancery Court.

The equity portion of the deal worked out to nearly $51 per TCI share when it was announced, or about $31.8 billion in AT&T equity.

AT&T will also assume about $11 billion in TCI debt and buy the $5.5 billion in assets from Liberty.

For that, AT&T will buy broadband access to millions ofhomes. After TCI closes pending system deals, its cable plant will pass about 16 million homes, and it will be hooked up to some 10.5 million customer homes.

TCI also owns stakes in other MSOs, including Cablevision Systems Corp., and it is involved in joint ventures. AT&T considers those stakes to present at least theoretical access to another 17 million homes and 10 million current cable customers, giving it a total of about one-third of all U.S. homes.

That's a big bite, but far short of the nationwidelocal access that AT&T craves. Armstrong said AT&T wants to align with other cable operators, and it is working on fixed-wireless-local-loop service that would use AT&T's extensive wireless spectrum.

Hindery said MSOs within TCI's affiliate camp were all excited about the prospects of tapping AT&T's capital and branding for phone efforts. Those deals could be worked out as equity or franchise deals, but Hindery said he suspects that they will be widespread.

Executives at two MSOs that haven't committed to telephone deployment yet agreed that AT&T could be a big help in introducing phone service.

"This transaction says to us that AT&T firmly believes that there's a business opportunity for them in the local loop, and it's the ultimate endorsement of the cable network into the home," said Comcast Corp. senior vice president John Alchin. "If you're going to be in the localtelephone business, what better partner to have than AT&T?"

"Certainly, if you have adjacent systems, given their plans and their branding, it may make sense to join forces in a given market," Charter Communications Inc. president Jerry Kent said.

Adelphia Communications Corp. executive vice president Timothy Rigas — whose MSO has a business-telephone unit and is testing residential phone service — agreed that AT&T could help to drive cable telephony.

"I would think that it would leave the door wide open to explore telephone strategies that AT&T, Cox [Communications Inc.] and others have started," Rigas said. "This is a win-win for everyone in the industry."

If AT&T and TCI help to get IP-telephone service established, that helps the rest of the cable industry, too, InterMedia Partners general counsel Bruce Stewart added.

InterMedia is one of the affiliates in the 17 million-home camp cited by Armstrong. Stewart said InterMedia, as an affiliate, was thrilled that "a substantial investor in our company has made such a bold strategic move with the pre-eminent telecommunications provider."

But getting TCI's plant ready for IP-phone service won't be cheap or come especially fast. AT&T figures to accelerate TCI's existing plan to spend about $1.8 billion over the next three years to enable two-wayservices across its entire footprint. But, as Hindery said, there are limits to how much faster that labor-intensive work can be done.

MediaOne Group chief financial officer Richard Post — who said his own company's talks with AT&T snagged over which potential partner would own which business opportunities — guessed that it would cost at least $5 billion to get TCI's major markets fully ready for two-way services.

"AT&T brings them the financial strength to do it," he added.

Near-term dilution and concerns about longer-term capital costs drove down AT&T's share price last week, from $65.25 at last Tuesday's close to $58.56 at Thursday's close.

Regional Bell operating company stocks also took some hits, although Bell Atlantic and other RBOCs immediately argued that the deal would create a big new local-phone competitor, and that it should prompt regulators to speed the Bells'entry into the long-distance business.

Bear Stearns & Co. telecommunications analyst William Deatherage said in a report that the AT&T-TCI deal should make those approvals easier to get, adding, "The sheer size of the [AT&T-TCI] combination" makes it hard to argue against approving the pending SBC Communications Inc. merger with Ameritech Corp.

Kent Gibbons

Kent has been a journalist, writer and editor at Multichannel News since 1994 and with Broadcasting+Cable since 2010. He is a good point of contact for anything editorial at the publications and for Nexttv.com. Before joining Multichannel News he had been a newspaper reporter with publications including The Washington Times, The Poughkeepsie (N.Y.) Journal and North County News.