Let's make a deal: FCC OKs MediaOne merger - if AT&T slims down

To satisfy the urge to merge with MediaOne, AT&T must decide what it needs least: leverage with rival Time Warner, a corporate relationship with John Malone's Liberty Media, or almost 10 million of the cable subscribers to whom it hopes to sell local phone service.

That's the cost of leaping the last regulatory hurdle to the deal, said FCC Chairman William Kennard. One of those assets will have to go by May 19, 2001, if the carrier wants to acquire the 5 million cable customers and highly upgraded network now controlled by MediaOne.

"In approving this merger, we are imposing non-severable conditions that will prevent the company from serving as a bottleneck in the video programming marketplace," Kennard said. Under the plan, AT&T must divest its 25% stake in Time Warner Enterprises, the programming side of Time Warner; end involvement in programming activities by selling Liberty Media and Rainbow Media; or sell more than 9.7 million cable customers, bringing its total of owned and operated subscribers under the FCC's recently reinstated 30% market cap.

AT&T has until six months after closing the $54 billion merger to pick an option. The company plans to complete the MediaOne deal no later than Aug. 4.

Selling cable customers seems the most unlikely choice for AT&T. "It's counter-intuitive to spend that much and wind up with a smaller number of cable subscribers," said Drake Johnston, first vice president with Davenport & Co. "It just doesn't suit the company's plan for becoming a power in local telephony over cable." MediaOne's subscribers would give AT&T direct control of 23.7 million customers; a sell-off would bring that figure down to 16 million.

The FCC's 30% cap also is involved in a court challenge, and AT&T has hopes that it will be overturned - perhaps a further disincentive to sell subscribers.

Getting rid of Liberty Media seems to involve the least pain for AT&T. Liberty is a holding company for assorted high-tech investments, including a stake in IP voice provider Net2Phone and investments in companies that sell programming to Time Warner. The biggest obstacle appears to be a tax issue: AT&T acquired Liberty when it purchased TCI Communications on March 1, 1999, at which time it agreed to hold the assets it bought for two years. An early sale could present AT&T with a tax bill of $5 billion or more.

"It is not our intention, nor has it been our intention, to spin off Liberty," said James Cicconi, AT&T general counsel. That may cut some ice with the IRS, which can take the carrier's intentions at the time of the TCI deal into account in determining tax penalties.

Selling the carrier's interest in Time Warner Enterprises is perhaps the most convoluted option because of the tangled motives of AT&T and Time Warner. AT&T has been in stalled negotiations to sell local phone service to Time Warner cable customers, and retaining an interest in a Time Warner property might be a strategic holding should those discussions regain momentum.

"I really don't think that, in the long run, AT&T wants to hold 23% of Time Warner," said Patrick Comack, a senior analyst with Guzman and Co. "It just wants to use this ownership as a bargaining chip to get a telephony deal, which is really crucial for AT&T's penetration of the local loop." If the carrier can reach a telephone deal with Time Warner before the FCC's May 2001 deadline, it may be willing to sell its Time Warner Enterprises holding.

Time Warner parent-to-be America Online also wants to get its Internet access service onto AT&T's cable network and may be part of a multiple-ISP access test that AT&T has said it will launch in its Boulder, Colo., system this November.

AT&T might "insulate" Time Warner Enterprises without spinning it off, Cicconi said. "I'm not sure the complete sale is the only way to provide the appropriate insulation," he said. "It's certainly the easiest way, and it's probably what the FCC is considering. But we want to take a close look at all our options to see if the required insulation could be arrived at through any options that might be available."

That view seems at odds with the one expressed by Kennard, who said proper insulation would come only with complete divestiture of programming interests.

In March, AT&T submitted a memo of understanding pledging that it would not influence Time Warner Enterprises programming in any form.