Copyright 2000 The Washington Post
The Washington
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October 29, 2000, Sunday, Final Edition
SECTION: FINANCIAL; Pg. H01
LENGTH: 2549 words
HEADLINE:
AT&T's Big Bang Theory; Company Talks of Strategy, but Many Hear Death Knell
BYLINE: Peter S. Goodman , Washington Post Staff Writer
BODY:
As the word resounded last
week with word that AT&T Corp. plans to break itself into four pieces, it
signaled a shift in the basic geography of the telecommunications world and
provoked a reconsideration of the merits of sheer size.
AT&T, a
corporate icon once synonymous with the telephone system, had been one of a
handful of behemoths expected to emerge from a spiraling wave of consolidation
in a position to thrive. Though its shape and strategy often seemed a work in
progress, its stature and dominance rarely appeared in doubt.
Now, over
the next two years, AT&T plans to dismantle its patchwork empire, spinning
off its parts into four separate companies--cable, wireless, consumer and
business--that will compete with one another and, indeed, the rest of the
crowded telecommunications field.
Three years ago, AT&T gambled that
it could turn cable television systems into the raw fiber of a new full-service
communications network--one that would carry high-speed Internet connections and
entertainment as well as telephone service. At the end of this admittedly
wrenching transformation, AT&T hoped to stand among the new century's
dominant enterprises, the equal of global telecommunications giants as well as
new-economy leaders such as Microsoft Corp. and the proposed AOL Time Warner
Inc. Instead, AT&T's mandarins aborted the mission. They opted to blow up
the works, hoping the parts would amount to more than the whole.
"Regardless of size and current position, regardless of financial might,
regardless of marketing might, the laws of business physics and economics always
prevail," said Pascal Aguirre, an analyst with Adventis Corp. in Boston.
"Inefficient scale will never beat out focused smaller companies. You have to
disassociate sheer size with management effectiveness."
In the accounts
now circulating, AT&T's story was a potent version of an increasingly
familiar tale: A once-solid corporate leader loses its footing in an unsteady
terrain being reshaped by the Internet, technology and unforeseen competitors.
It amounted to disaster on an unprecedented scale, as an examination of the
company's stock price shows.
When Iridium LLC, a venture backed by
Motorola Inc., landed in bankruptcy last year, opting to allow $ 5 billion worth
of satellites to burn up as they fell from orbit, it occasioned talk of cosmic
failure. But in the past year alone, AT&T has seen the stock market
extinguish nearly $ 160 billion of its worth.
Though AT&T officials
packaged the breakup announcement as a rejuvenation, it was widely greeted with
funereal tones.
"It's the last twitch of the corpse," said Donald L.
Luskin, manager of the $ 30 million Open Fund, a San Francisco-based mutual
fund, who accused AT&T of coming late to the realization that the
Internet--not voice telephone service--would drive future growth. "This company
is dying."
Forces of Antitrust
But many analysts
say the forces that culminated in AT&T's breakup were set in motion long
before its bet on cable, and before the emergence of the Internet. They took
shape 16 years ago in a landmark antitrust case in which AT&T submitted to
the federal government's demands that is split apart.
The old Ma Bell,
once the basic telephone provider for 80 percent of the nation, was divided into
long-distance and local telephone arms. AT&T recognized the value of owning
the local franchises: direct links to the customers. But it did not see keeping
the local telephone business in one piece as politically tenable.
"The
problem with the Bell System was it was too big and everybody beat on it," said
Howard Trienens, who served as AT&T general counsel through most of the
1980s. "Congress would have screamed, and it wasn't even clear that the judge
would have approved it."
So, in the consent decree AT&T signed with
Justice, the local business was broken into seven regional fiefdoms, the Baby
Bells. AT&T walked away with the long-distance business and AT&T's
national communications network--the web of wires carrying telephone calls and
computer data across the nation--as well as Ma Bell's research labs.
"That's where the innovation was, that's where the future was," Trienens
said. "The local companies were restricted to be local companies, and AT&T
was not restricted. We were free to get into the computer business and
manufacturing."
Thus, with a pen stroke, AT&T relinquished its
direct connections to its customers. Some analysts now criticize that decision
as a mortal mistake. The emergence of the Internet raised the value of direct
links to customers exponentially. Local telephone service was now merely one of
many services that could be sold over the wire.
Forging new links to
customers required rolling out new wires to homes and businesses, a messy and
expensive process, whereas getting into long-distance was far less complicated
because the traffic ran over a single network. Upstart providers such as Sprint
Corp. and MCI, since absorbed by WorldCom Inc., began taking increasingly
sizable chunks of the business.
Not least, along with their local
monopolies the Baby Bells walked away with rights to use the airwaves for
wireless communications--a modern-day gold mine.
"That was a monumental
misjudgment by AT&T," said Scott Cleland, an analyst with the Precursor
Group in Washington. "The AT&T research and development people thought
wireless would be a niche service by 2000. No more than a million customers.
They were only off by 50 million."
Not until AT&T spent $ 11.5
billion in 1994 to buy wireless network McCaw Cellular Communications Corp., an
industry pioneer, did the company find its way into that business.
The Telecommunications Act
For more than a
decade after the breakup, AT&T counted steady profits and paid out handsome
dividends in its incarnation as the nation's long-distance company, even as its
competitors forced prices lower and claimed market share.
But all the
while the Baby Bells lobbied for the right to expand into the long-distance
business. AT&T successfully quashed such efforts for years, arguing that the
Bells would gain an unfair advantage by being able to leverage their direct
links to customers. But the dam broke in 1996 with the passage of the federal
Telecommunications Act.
AT&T did succeed in claiming something
significant in the debate: The landmark law forced the Bells to open their
markets to competition for local service and lease to rivals the parts of their
networks needed to reach customers. But those caveats amounted to the best
possible salvage of a wholly problematic situation.
When C. Michael
Armstrong, the Harley-riding executive, took control of AT&T in November
1997, he found: The long-distance business--source of some 80 percent of the
company's revenue--was under attack from the upstarts. The specter of Bell
competition loomed. The company would have to forge new links to the customers,
taking on the Bells with its own wires into homes while expanding into new
Internet businesses. If not, it would wither away.
So Armstrong launched
into cable. He snapped up Tele-Communications Inc. and MediaOne Group Inc. for a
combined $ 115 billion. The old Ma Bell became the nation's largest cable power.
At first, the bet earned him plaudits as a visionary. Armstrong's
beaming visage decorated seemingly every glossy magazine on the rack.
AT&T would turn cable into the plumbing for a panoply of lucrative
services--high-speed Internet links and interactive television, plus local
telephone service and games. The computer data, sound and video would be carried
over AT&T's wholly owned network, meaning AT&T would no longer have to
pay fees to local phone companies to connect the calls. The Bells would no
longer sit between AT&T and its customers.
The trouble was, the two
cable companies brought AT&T only 16.2 million customers and a network
within reach of about 25 percent of U.S. households.
Federal rules
limiting how many cable systems one company may own prohibited AT&T from
amassing more--rules AT&T is now seeking to kill, both in Congress and in
court. More than a decade earlier, AT&T had surrendered--for free--copper
telephone wires reaching 80 percent of the homes and businesses in the nation.
Now it was handing over monumental sums to regain a fraction of those links.
What happened next has been well chronicled: AT&T sunk billions into
upgrading its cable systems, a slow and difficult process. AT&T's
residential long-distance business continued to erode, losing customers and
revenue at an 11 percent rate in the most recent quarter. Bell Atlantic
Corp.--since combined with GTE Corp. and renamed Verizon Communications--last
year gained the right to sell long-distance service in New York and has since
signed up more than 1 million customers. It is awaiting permission to enter the
market in Massachusetts. This year, SBC Communications Inc. entered
long-distance in Texas, where it, too, quickly reached the million-customer
mark. Last week, SBC filed for permission to sell long-distance in Kansas and
Oklahoma.
If the erosion of AT&T's residential long-distance was
expected, investors were not prepared for the trouble that developed in
AT&T's business services division--its most profitable arm. As word broke
that customers were departing because of service problems, the stock sank
further. Today AT&T is worth less than the day Armstrong took over.
Armstrong became convinced that AT&T's stock would never perform
well as long as the company's faster-growing operations--cable and its national
wireless business--were stuck on board the sinking ship of long-distance. He
sold the breakup to investors and his governing board as the best way to
highlight the good news from cable and wireless while deemphasizing the plight
of AT&T's ailing core.
"The value of our equity in the market has
been shrouded by the enterprise complexity and systemic decline of
long-distance," he said in an interview last week.
Residential
long-distance has become a crowded and cutthroat field. Even the upstarts are
struggling, with WorldCom this week expected to announce its own restructuring
to partition its residential long-distance business--the nation's
second-largest--from its business-oriented operations.
Failure
to Thrive
But analysts and former AT&T executives say poor
decision-making and execution, as much as the changing market, explain how the
company found itself in a position where a breakup became more palatable than
pushing on.
Many analysts contend that AT&T paid too dearly for its
cable properties. In TCI, it bought a network that was widely known to have been
in poor shape, slowing the upgrade process and increasing the costs. And the
very hype that boosted AT&T's story as it first plunged into cable served to
wildly inflate the value of its next purchase, MediaOne.
"There's no
doubt that they overpaid for TCI and effectively pumped the price up for
MediaOne," said Matthew Harrigan, an analyst with Janco Partners in Denver. "On
Wall Street, if you make optimistic forecasts for five years, you can justify
just about anything." Harrigan estimates that the two properties are today worth
$ 40 billion to $ 58 billion--as much as 65 percent less than AT&T
surrendered.
Armstrong makes no apologies, asserting that the real
purchase price was only about $ 60 billion after subtracting the value of assets
AT&T has since sold. "If somebody would have sold those companies to me for
less, I'd have paid less for them," he said. "I had to pay a premium."
Two former AT&T executives say Armstrong stymied the execution of
the cable strategy by driving away legions of talented people.
"He has a
fairly significant ego, a notch above the average," one former AT&T
executive said. "He lost talent to a point where the ability to execute was
difficult."
One of those who left, Leo Hindery, headed the cable unit
and had overseen TCI before it was acquired by AT&T. He came with valuable
industry connections and was entrusted with fulfilling a key part of AT&T's
strategy: signing deals with other cable companies to sell AT&T telephone
service over their networks.
According to the former AT&T
executives, Armstrong behaved as if the cable partners needed his brand name
more than he needed their wires into homes, alienating the clannish cable
chieftains. AT&T claims it struck no deals because the would-be cable
partners demanded unfair terms. In any event, Armstrong and Hindery clashed;
Hindery departed.
"Some good people have left," Armstrong said. "Of
course, that is happening throughout corporate America."
Even with such
struggles, many industry analysts still maintain that the cable strategy was
sound and some investors fret that AT&T pulled the plug too quickly,
succumbing to Wall Street's strident demands for immediate return.
"The
patience level deteriorated and the stock collapsed," said Trienens, the former
AT&T general counsel. "Things are so volatile and crazy today, it's hard to
be rational."
Some say AT&T was a victim of its own hype: The
company sold Wall Street on the merits of using cable to reach customers but
failed to explain that upgrading the systems was a long-term struggle, not a
snap revolution. It would take years and billions of dollars before producing
substantial returns.
"They did a pretty poor job of managing
expectation," said Brian Adamik of the Yankee Group. "This is the legacy of
AT&T--great strategy, poor execution. More often than not, they overpromise
and under-deliver."
AT&T says it has met or exceeded the goals it
established last December for signing up customers and upgrading the cable
network. It says it will push on with the cable strategy--even as its cable
holdings become a separate company with its own stock and management--by linking
the pieces via marketing agreements.
Some analysts say the restructuring
may now free the cable and wireless businesses to grow like never before,
liberating those operations from the ponderous and bureaucratized culture of
AT&T. But most concur that the race among industry players to become
one-stop providers of all services will now cool severely.
Most still
expect that a handful of giants will share a majority of the telecommunications
spoils, but the list of winners is now shorter. Out of the dust of AT&T's
deconstruction, the Bell companies emerge more powerful than ever--particularly
Verizon and SBC, each controlling more than a third of the nation's telephone
lines. Verizon boasts the nation's largest mobile-phone business, and SBC
controls the second-largest, Cingular, in partnership with BellSouth Corp.
Though the refashioning of the industry map is hardly complete, the
Bells appear poised to dominate the consumer market, as the aspirants to its
turf one by one exit that race, analysts say. WorldCom, once thought to be a
potential giant, has stumbled in the wake of its failed merger with Sprint and
is orienting itself back toward the lucrative business customers of its roots,
the same direction explored by the new AT&T.
"AT&T loses its
stature as a supercarrier," Adamik said. "The Bells are extremely well
positioned. The name of the game is who has access to the customer."
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