Malone’s 3-D Chess

Anyone wondering why a competing telecom executive once said that TCI chairman John Malone was “playing chess in three dimensions while the rest of us are stuck in one” just had to watch Malone’s various press appearances yesterday. Explaining the complicated structure of the AT&T-TCI deal and, in particular, the new “tracking stocks” to be created as a result of the merger, Malone seemed two or three steps ahead of his interrogators and, perhaps, a couple of steps ahead of the market as well.

Not coincidentally, perhaps, Malone is going to make out remarkably well once the deal is consummated. There are two classes of TCI stock, and shareholders of the B-class will be getting a premium over the price AT&T will be paying for the A-class stock. That’s because B-class stock, where almost all of Malone’s holdings reside, comes with super-voting rights (each B share is equal to 10 A shares), which means that it’s actually where the control of the company lies. (The fact that the more powerful shares are called B-class is baffling.)

The really curious part of the deal, though, is the creation of the three new tracking stocks. One will be attached to AT&T’s more traditional business, one will be attached to the high-powered slate of digital consumer services that AT&T expects will generate double-digit growth rates over the next decade, and one will simply be attached to TCI’s cable programming assets. If you purchase any of these tracking stocks, you won’t be purchasing the assets grouped under the company’s name–those assets will still be owned by AT&T itself. Essentially, you’ll be speculating on the growth of those assets, without actually having a stake in them.

In that sense, tracking stocks seem to be both a vestige of the old days of managerialism and the perfect invention for an era of rampant speculation. Since the owners of these tracking stocks don’t actually have any control over the company, the managers will enjoy the kind of insulation that was characteristic of most American corporations before the 1980s. And since the tracking stocks allow investors to gamble on the performance of a specific set of properties without having even the possibility of a say over what happens to those properties, they represent stock-market speculation in a very pure form.

Along those lines, one of the more astonishing things about yesterday’s Malone-Armstrong press conference was that AT&T CEO Armstrong explained to us that the AT&T Consumer Services tracking stock–this will be the hot one–will be valued according to cash flow, rather than earnings. Cash flow is a shorthand term for “earnings before interest, depreciation, taxes, and amortization” and is the number companies report when they can’t actually make a profit because of debt payments or the accounting costs associated with mergers.

Now, cash flow is an important number, since it tells you how much income a company’s operations are generating on a day-to-day basis. But surely it’s not up to Mike Armstrong to tell investors how to value a given stock. If the Street wants to value the new tracking stock on the basis of EBITDA, then it will (and it will). But that’s a choice only the market can make. It’s not the job of a CEO to tell us what a stock is worth.