Washington-Last year, AT & T Corp. officials thought they could glide their merger with MediaOne Group Inc. past the Federal Communications Commission with few, if any, conditions. It didn't work out that way, but AT & T said it is still pleased.

As expected, the FCC last week approved the $50.7 billion deal, which would make AT & T the largest U.S. cable operator after picking up 5 million MediaOne subscribers.

But the agency, alarmed by the merger's impact on ownership diversity and cable competition, insisted that AT & T undergo a serious revamping within one year.

The FCC gave AT & T three choices: Divest MediaOne's 25 percent stake in Time Warner Entertainment; sell Liberty Media Group, a minority stake in Rainbow Media Holdings Inc. and MediaOne's programming networks; or sell 9.7 million cable subscribers.

AT & T has six months from the date of the MediaOne closing to inform the FCC of its election, and until May 19, 2001, to carry out the plan.

If AT & T fails to meet the May 19, 2001, deadline, the assets it has designated for sale would be placed in an irrevocable trust. The FCC would sell the assets in the trust, a commission source said.

"AT & T's application, as originally filed, was inconsistent with the public interest," FCC chairman William Kennard told reporters. "That application has been modified significantly."

AT & T general counsel James W. Cicconi maintained an upbeat posture despite his prolonged and tenacious effort to gain FCC approval of the deal as originally proposed.

Speaking to reporters during a conference call, Cicconi said he was "delighted with the decision," pledging full compliance and disavowing any interest in taking the FCC to court.

Even though AT & T was once optimistic about getting through unscathed, Cicconi dismissed notions that the company had been dealt a serious setback.

"I don't think it's a stark reversal. We have been dealing with this for quite some time, and there have been a lot of factors in this," he said.

AT & T's hopes were heightened when the FCC changed its ownership rules in October. The agency allowed AT & T to own more cable subscribers by changing the standard from 30 percent of cable homes passed nationally to 30 percent of pay TV subscribers.

It also modified its attribution rules with regard to limited partnerships, which sent some the message that AT & T would not have to sell any assets in order to buy MediaOne.

"I think they thought they were just going to sail through here-that they were not going to get rid of anything," an FCC source said. "When the rules were redone in October, they were jubilant, and they thought they were going to have their cakewalk on their merger."

Although Cicconi said he expects AT & T to close the merger no later than Aug. 4, he offered no guidance on how the company intends to comply with the FCC's order. "I am not ruling out any of the three options here," he said.

The Aug. 4 deadline would coincide with the expiration of a noncompete clause in Media-One's original agreement with TWE. As part of that agreement, TWE has the right to block any merger concerning MediaOne until Aug. 3.

But just when AT & T would seek to close the deal is another contentious point. Although the company said publicly that it wants to close the deal by Aug. 4, industry sources said it is likely that the closing could stretch out well into the fourth quarter, mainly due to AT & T's sluggish stock price.

The MediaOne acquisition includes a $51.30-per-share collar, which would trigger an additional $3.5 billion cash payment to MediaOne shareholders should AT & T's stock fall below that level at the time of closing. AT & T shares-hurt this week by a controversy over raising long-distance calling rates-closed at $35.25 each June 8.

Cicconi said more than once that AT & T has not been working behind the scenes to set up the sale of Liberty, the cable-programming division under the semi-autonomous control of John Malone, an AT & T director who is also its largest individual shareholder.

"We have never had any intention, either at the time of the [Tele-Communications Inc.] transaction, nor do we currently have any intention of spinning out Liberty," Cicconi said.

Cicconi's reluctance to divest Liberty could be more due to the possible tax implications of a Liberty spinoff than a desire to keep the company. AT & T could face a stiff tax bill-as much as $5 billion to $7 billion-if it merely expresses an intention to spin off Liberty before March 2001, the second anniversary of the acquisition.

Although some analysts believe a Liberty spinoff is the easiest route to compliance, others said a TWE restructuring could be more attractive.

The Yankee Group senior analyst Michael Goodman said AT & T could use TWE as a bargaining chip in negotiating a telephony deal with Time Warner Cable.

"If you look at AT & T, what does it want most? It wants a telephony deal with Time Warner," Goodman said. "Time Warner has been upfront that it wouldn't mind getting that 25 percent [of TWE] back, so what you have is the basis for a beautiful relationship."

Finalizing a Time Warner telephony deal could also be the catalyst for other MSOs to reach telephony deals with AT & T, Goodman said.

For example, as part of an agreement with AT & T for dropping out of the MediaOne bidding in May 1999, Comcast Corp. received the right to negotiate a telephony deal with AT & T that was no worse than Time Warner's.

Getting rid of Liberty would also mean divesting Rainbow and, most likely, AT & T's 30 percent stake in MSO Cable-vision Systems Corp., which AT & T does not want to do, Goodman said.

Cablevision CEO James Dolan would not speculate on AT & T's intentions. "We're very happy with our relationship [with AT & T] and their position [in Cablevision]," he said after last week's Cablevision shareholders meeting. "How this latest ruling affects that will be up to them."

The FCC ordered AT & T to divest assets to come into compliance with a rule that limits one cable operator to serving no more than 30 percent of the 82 million subscribers to cable, satellite and various other providers of pay television.

Adding up AT & T's wholly owned and partially owned cable-system properties, the FCC determined that AT & T would control 34.4 million cable subscribers, or 41.8 percent of pay TV subscribers-a level Kennard called "too much."

The FCC arrived at 41.8 percent by including Media-One's investment in TWE, which, the agency said, has 12.6 million subscribers, including 1.7 million wholly owned Time Warner Cable subscribers managed by TWE.

The FCC included Media-One's stake in TWE because Liberty, Rainbow and Media-One all sell cable programming to TWE. The commission will not insulate a limited partnership if the limited partner is materially involved in the video-programming activities of the general partner.

AT & T could keep Media-One's TWE investment-which the FCC figures is worth $14 billion to $18 billion-if it unloaded programming investments. But if AT & T wants to keep TWE and the other programming assets, it has to sell 9.7 million subscribers to get below the 30 percent cap.

The FCC's 30 percent cap is designed to prevent one cable operator or a group of cable operators from exercising too much power in the video-programming-acquisition market.

"We felt very, very strongly [that AT & T had] too much consolidation of power with respect to influence over programming into one company," an FCC source said. "It was always about: Can we allow them to compete in the local telephone market, and can we make certain that they don't dominate the content side of this business?"

Cicconi said he would explore whether AT & T could insulate the TWE investment from the ownership rules by means other than an outright sale of programming interests.

"I am not sure that the complete sale is necessarily the only way to provide the appropriate insulation. It's certainly the easiest way, and it's probably what the FCC is considering," he said.

A cable-industry observer said the scope of America Online Inc.'s proposed merger with Time Warner, which hit in January, probably made the FCC fear that the cable industry was becoming too top-heavy.

The source added that it was impossible to conclude, as the agency had, that AT & T controls programming decisions made by TWE, especially after MediaOne gave up all management rights last year following its deal to be bought by AT & T.

"Forget about percentages and ownership and things like that. Time Warner calls the shots [at TWE], and MediaOne relinquished any of its attributes of control," the source said. "I think [the FCC was] obviously fearful or concerned, depending on your perspective, and they acted on it."

George Reed-Dellinger, a media analyst with Washington Analysis, said it was crucial for AT & T to gain one year to divest. "In a year's time, you might have a Republican president. You'll certainly have a new FCC," he said. "So they could come back and revisit this order."

Cicconi said AT & T would carry out its responsibilities under the FCC order.

But he added that AT & T's posture might change if the company wins its court case challenging the FCC's 30 percent rule and ownership-attribution rules. Oral arguments in the case are scheduled for Oct. 17, with a decision likely to be issued before the May 19, 2001, deadline.

"I would certainly assume that if the court struck down something like the percentage limit, then I think anything that bound us to that same limit would go with it," Cicconi said. "We are operating on the assumption that there is a rule in place, and we are planning to comply with it."

The Consumers Union blasted the FCC for going too easy on AT & T, promising to take the commission to court and to ask Congress to reshape the FCC's merger authority.

CU Washington office co-director Gene Kimmelman said the FCC's decision would allow AT & T to retain an interest in 40 percent of pay TV subscribers if it sells its programming interests, calling it a huge loophole that "smacks of political favoritism for one company."

During the one-year waiver from the 30 percent cable-ownership rule, AT & T has to comply with numerous safeguards designed to prevent it from influencing programming decisions at TWE and Rainbow.

Failure to comply can cost AT & T up to $100,000 for the first offense.

One condition would bar Liberty chairman Malone from participating in any of AT & T's video-programming matters. An FCC source said the ban would prevent Malone from discussing whether AT & T should spin off Liberty.

The FCC is also ordering AT & T to name a slate of directors to the Liberty board who are not AT & T directors, officers or employees. The new directors must be approved by Deborah Lathen, chief of the commission's Cable Services Bureau.