A Merger That Might Make Sense

Two years late, the Telecommunications Reform Act of 1996 has finally given birth to a deal that might actually break local phone-service monopolies, as AT&T today announced that it was going to be acquiring cable giant Tele-Communications, Inc. in a deal valued at close to $48 billion. For all of the promises of lower costs and increased competition that accompanied the Telecom Reform Act, in practice it has translated into little more than carte blanche for Regional Bell Operating Companies (RBOCs) to merge and for cable operators to raise their rates.

The fundamental problem that telecom reform has always confronted has been the so-called “last mile” problem. While long-distance carriers like AT&T or Sprint can offer lower rates or connections that provide for the transmission of data and voice simultaneously, access to consumers has been, for the most part, controlled by the RBOCs, since they own the lines that enter our houses. Small competitors like Teleport and RCN have sprung up in many regions, but they too have been forced either to purchase access from the RBOCs or build their own local networks, which entails enormous sunk costs and requires zoning permission that is often hard to come by. The RBOCs, meanwhile, have done an excellent job of making it as difficult as possible for consumers to switch local carriers.

What TCI offers AT&T, then, is that crucial wire into the home. In an earlier column about TCI’s recent resurrection, I pointed to the patience company chairman John Malone exhibited through three years (1995-1997) when the cable industry looked to be on its way out. Malone always recognized the long-term leverage that TCI’s network of coaxial cable gave the company, and the AT&T deal represents the culmination of his long quest to turn TCI into an all-purpose information carrier. If Malone and AT&T chairman Mike Armstrong are to be believed, AT&T will now become the Citigroup of the telecom industry, offering its users one-stop shopping for everything from digital telephony to cable TV to high-speed Internet service. Malone, in his inimitable fashion, even suggested that users would be able to order Viagra while watching their “favorite entertainment” (wink, wink) with a simple point-and-click.

Interestingly, on yet another big day for stocks, the market’s verdict on the deal was decidedly negative, with AT&T finishing down sharply and TCI’s main stock up only a little more than a point. The deal does merit skepticism. Although initial press accounts suggested that telephone service over the cable wire would become an instant reality, in fact it’s going to take billions of dollars and at least a couple of years before AT&T could become a serious player in the local phone-service market. In addition, AT&T is paying a premium for TCI stock and taking on $16 billion in debt, so it’s going to need a huge increase in cash flow in order to garner an acceptable return on capital.

Still, AT&T’s future was looking increasingly bleak. Its profit margins were dropping, its sales were standing still, and it really had no clear plan that would allow it to circumvent the RBOC stranglehold on consumers. Aside from the managerial and cultural difficulties created by any huge acquisition, the technological questions involved in one-stop telecom service are not easy to solve. But getting access to that last mile does materially change AT&T’s business. In the long run, this might actually be a merger that makes sense.