The great divide

AT&T decides the sum of its parts are better than the whole

The dream of being a global communications player that serves as a one-stop shop for business and residential telephone, cable, wireless and Internet services may have been broken last week. AT&T, the former Bell Telephone Co. that was disbanded by a federal court in 1984, split along the lines of its four operating units.

On the premise that each piece of AT&T's business could be worth more to Wall Street than their sum, AT&T Chairman and CEO C. Michael Armstrong announced a two-year deconstruction plan. The plan eventually will create three independent publicly traded companies: AT&T Broadband, AT&T Wireless - currently a tracking stock - and AT&T Business. AT&T Consumer will be spun off from AT&T Business as a tracking stock.

AT&T Business will be the legal owner of the AT&T brand and will house AT&T Network and AT&T Labs, which will service the other companies under commercial contracts.

Freed from the encumbrance of being part of a $70 billion global communications conglomerate hurt by the price decline in consumer long-distance, each independent company should "achieve value transparency" and "establish a currency that will enable them to participate in industry consolidation and expansion," Armstrong said. "If you work for these companies, the fruits of your efforts will not be shrouded by the enterprise."

Armstrong portrayed the move as the natural evolution of the strategy he set when he joined AT&T in 1997, and some Wall Street analysts applauded it, saying the four businesses could perform better on their own. "The theory underlying the acquisition of the cable properties was premised on the ability to weave together a national footprint through acquisitions and alliances, and this could not be achieved," said Frank Governali, analyst at Goldman Sachs. "As a result, the connection of the cable operations to the rest of [AT&T] is tenuous at best."

Others saw the move as an attempt to boost AT&T's sagging share price and appease Wall Street. "I see this as a desperation death rattle of a dying company being positioned by a very skillful showman," said Donald Luskin, lead fund manager of OpenFund and CEO of MetaMarkets.com, who became infamous for shorting AT&T stock but no longer holds a position in the company.

Some said AT&T should combine the consumer and broadband units. "On the positive side, you get a fully independent AT&T Wireless, but we're still concerned about splitting the [consumer] cash flow from the cash needs of the broadband business," said Michael Hodel, stock analyst at Morningstar.com.

Indeed, the breakup itself leaves unsolved the execution problems that underly AT&T's problems and contributed to the company's 12% decline in third quarter earnings. In the short run, the breakup could even exaggerate them, said Nicholas Economides, professor of economics at New York University's Stern School of Business. "[The split] creates significant upheaval, and the company will spend a lot of time thinking about itself rather than the market," Economides said.

Two effects of the breakup could be the concentration of more power in the hands of the RBOCs and a slowdown in the rollout of broadband services.

"It really represents the failure of the Telecom Act of 1996," Economides said. "Local markets were not open to competition quickly and reasonably, and AT&T responded by buying cable companies to get into the local exchange."

Because AT&T Broadband's entry into high-speed data markets may be significantly delayed now that it is not funded by long-distance, consumers could suffer from a slackening in DSL service offerings by the RBOCs, Economides said. The cable modem threat forced RBOCs to introduce DSL services much faster, he said. "If that threat is eliminated, we might see a slower expansion of the RBOCs into DSL." AT&T's consumer long-distance business could even be a takeover target of the RBOCs.

The breakup also could signal a shift away from the trend of carrier consolidation in which companies aim to offer enterprises and consumers every product worldwide, said P. William Bane, vice president of Mercer Management Consulting. "AT&T got stared down by the management complexity of such a gargantuan task," Bane said. "Maybe all products to all people everywhere is not in the cards."

The immediate reaction of AT&T investors was evident in the drop in its share price, which fell 13% the day of the announcement and almost 2% the following day. Two undetermined aspects of the plan are contributing to the anxiety on Wall Street: the individual companies' stock dividend policies and the portion of the AT&T debt load each business will carry. Through its acquisition spree, AT&T accumulated about $61 billion in debt, costing the company about $2 billion per year in interest.

AT&T said the separate units would pay a lower combined dividend than the company does now. The consumer unit is expected to allocate a greater portion of its earnings to dividends, while the broadband and wireless businesses likely will reinvest profits.

The consumer unit will get a "nominal" debt level, said Charles Noski, chief financial officer of AT&T. "That's troubling because the consumer business generates a steady amount of cash flow, so it has the ability to pay down debt," Hodel said. "It sounds like a lot of the debt might be passed on to the broadband segment."

The company hopes new investors will boost share prices to lessen its debt load.

Armstrong said preliminary discussions with the FCC indicated the plan would not encounter any regulatory stumbling blocks, but FCC Chairman William E. Kennard said federal regulators must ensure the breakup will not hurt competition, service quality or the integrity of the telecom network.

"I will continue to closely question the company about today's announcement and will insist that consumers' interests are protected," Kennard said.

AT&T Wireless prepares for independence After announcing spinoff plans from parent AT&T and strong third quarter results, AT&T Wireless is being upgraded by some financial analysts.

Currently in the market as a tracking stock, the carrier has two years to become an independent company with asset-based stocks. In the interim, officials will monitor the nation's financial progress.

"We are planning to keep a watchful eye on what happens with the national economy," said John Zeglis, AT&T Wireless Group Chairman and CEO, during a press conference last week. "We still are working through our [current] fall commitment process, but will be working out the dynamics of spinning into a full-fledged independent company."

Working out the dynamics might take longer than two years, said Larry Swasey, vice president of communications research with Allied Business Intelligence. "There still are a lot of wireless decisions to be made. They still don't know how data will play out."

Enhanced data rates for GSM evolution technology will not be deployed throughout its network for another two years, which means applications will have to wait until third generation gains presence, Swasey added. Regardless, the company will become independent by 2002.

"It is a great idea because it is the only thing that unlocks value," said Patrick Comack, an analyst with Guzman & Co. "I would like to see them keep things simple... and avoid rushing into any mergers."

The merger question surfaced during AT&T's announcement, but AT&T Chairman and CEO C. Michael Armstrong refused comment. Previously, discussions between AT&T Wireless and Nextel Communications reportedly had died.

An independent AT&T Wireless could become a buyout target, Swasey said.

"This [breakup] might not allow AT&T Wireless to become a large entity that can go after other companies," Swasey said. "Pre-spinout, AT&T Wireless could not be touched. Now Nextel could come in as a prudent purchaser."

A Nextel merger would be a good long-term fit for AT&T Wireless, but such decisions should be based on operational benefits, not the whims of investors, said Elliott Hamilton, senior vice president and director of The Strategis Group's global wireless group.

"Sometimes the market overreacts," Hamilton said. "AT&T Wireless stock has been hammered in the marketplace, but on the consumer side, [the carrier] has the most well-known brand name in telecom."

Revenue for AT&T Wireless during the third quarter increased more than 36% to about $2.8 billion, driven by high growth in mobility service revenue, which increased by more than 34% to $2.5 billion.