In Strategy Shift, AT&T; to Split Into 3 Firms

In a dramatic signal that AT&T;’s three-year effort to remake itself into a one-stop telecommunications marketplace has failed, the company said Wednesday it will disassemble itself into three separate companies--its third major restructuring in 16 years.

The move underscores Wall Street’s doubts about the strategy of AT&T; Chairman and Chief Executive C. Michael Armstrong, the former Hughes Electronics executive who took over at the company in October 1997.

It also calls into question the idea that deregulating telecommunications would foster new competition in local and long-distance service. Consumer advocates say the experience of AT&T;, which tried to compete in all sectors of the industry, proves that the idea is flawed.

Investors did not view AT&T;’s new plan as a cheering solution to the company’s ills. AT&T; stock fell $3.50 to close at $23.38 on the New York Stock Exchange after the announcement. Telecommunications analyst Anna-Maria Kovacs of Janney Montgomery Scott issued an almost unheard-of “sell� recommendation on AT&T;’s stock, citing concerns that the massive restructuring presages a long period of operational turmoil at the company.

“Morale, which is already low, can only plummet further,� Kovacs said in a report.

Armstrong’s master plan was to turn Ma Bell into an integrated provider of local, long-distance and wireless phone calling, along with cable television and Internet services. Over the next two years he spent about $100 billion to buy two huge nationwide cable systems to carry most of those services into the home.

But he could not realize the benefits of this strategy fast enough to outrun the decline in its traditional businesses such as long-distance calling, where proliferating competitors have engaged in ferocious price-cutting. Since the beginning of this year AT&T; stock has lost 54% of its value, or $105 billion in market capitalization.

The company’s answer to this free fall is to break in three: wireless, cable TV and long-distance phone and corporate services. The main fragment, which would retain ownership of the AT&T; brand and Armstrong’s services as CEO, would include its consumer long-distance unit and the unit that serves business customers. At some point, consumer long-distance and AT&T;’s WorldNet Internet service provider would be spun off to AT&T; investors as a “tracking� stock--one whose assets would be owned by AT&T; but report its revenue and earnings separately.

AT&T; Wireless, a successful provider of mobile phone services that exists as a tracking stock, will be spun off as a separate company by next summer, subject to regulatory approvals and market conditions. And AT&T; Broadband, comprising the company’s cable, video and high-speed Internet services, will become a separate company by summer 2002, subject to the same caveats.

When the process is finished, the communications giant Armstrong envisioned will consist instead of three stand-alone companies and a fourth tracking stock, consumer services.

Gone from the AT&T; tradition, meanwhile, would be one of its enduring distinctions: Its healthy cash dividend of 88 cents a year per share, or $3.3 billion annually. The company said Wednesday that the dividend, which is largely drawn from the long-distance service’s huge but deteriorating cash flow, will be “substantially reduced� as the reorganization takes hold.

Wednesday’s plan bears the fingerprints of AT&T;’s largest individual shareholder, John C. Malone, who gained his 28 million shares by selling his Tele-Communications Inc. cable system (TCI) to AT&T; in 1999, but has lost an estimated $1 billion on them this year. As a board member, he pressed Armstrong to issue tracking stocks, arguing that this best enables investors to evaluate businesses with different growth rates--such as cable and long-distance calling--within a single company. AT&T; long resisted the idea, but its restructuring seems to have closely followed Malone’s blueprint.

Among the concerns for AT&T; investors is that the restructuring opens a Pandora’s box for the company’s over-stressed management. Executives may be preoccupied for years with executing details of the breakup and spinoffs--including how to apportion AT&T;’s billions of dollars in debt and its 164,000 employees--while facing competitive challenges in the marketplace. Some of the restructuring will raise tax and regulatory issues requiring months of analysis and negotiation.

Armstrong on Wednesday insisted that the reorganization does not mean AT&T; is abandoning its strategy of providing customers with everything from local and long-distance to Internet and video services.

But he also acknowledged that it will be “quite a task to implement successfully what we’ve outlined today.�

Many investment professionals argued that AT&T;’s fundamental problem is not the way its various pieces are assembled, but the poor performance of each piece.

“Frankly, if AT&T; was performing up to its original forecasts . . .talk about restructuring would not exist,� said Jack Grubman, analyst at Salomon Smith Barney.

Sales growth in AT&T;’s business services segment is projected to be half of what was originally anticipated, in part because revenue from new advanced services has not offset the decline in traditional voice transmission. Revenue from consumer long distance, meanwhile, fell by nearly 11% in the last quarter from a year earlier, as the flight of those customers to wireless providers and other competitors accelerated.

There were a few bright spots. Wireless revenue increased by 37% in the third quarter over the same period a year ago, as subscribers jumped by 38%.

The company’s roll-out of advanced cable features, such as local telephone service, has been encouraging. AT&T; provides phone service over cable lines to 350,000 customers, up 56% from the second quarter of this year, and is on track to reach its year-end goal of 450,000 customers.

But that record is spotty. The roll-out has been slow in the Los Angeles area, where local regulators worry that the restructuring will delay it further.

“This represents a retreat locally,� said Rohit Shulka, vice president of the Los Angeles City Board of Information Technology Commissioners, which regulates local cable operators. That means competing providers of high-speed Internet services such as digital subscriber lines may respond to AT&T;’s waning presence by slowing their own roll-outs.

Although AT&T;’s wireless, broadband and consumer and business divisions will end up in separate companies, they will be bound by a web of long-term contracts to cross-sell each others’ services, leading to some suspicion that the breakup is a cosmetic exercise aimed at giving investors a clearer view of each unit’s prospects in hopes they will bid up the various shares.

Armstrong bridled at that suggestion Wednesday: “I hope to dispel the myth that this was done for any short-term purpose. . . . It’s fundamentally the next necessary step in the transformation of this company.�

Wednesday’s is the latest in a series of cataclysmic restructurings that have transformed what was once a serene monopoly reigning over the nation’s communications grid.

That stage ended in 1984 with U.S. District Judge Harold Greene’s order to break up AT&T; into a long-distance carrier and seven regional local phone companies, the so-called “Baby Bells.� Then in 1996 and 1997, AT&T; spun off its communications equipment business as Lucent Technologies and its ailing computer manufacturing venture as NCR.

The latest breakup represents Armstrong’s acknowledgment that his master plan for AT&T; is far off schedule and rife with miscalculations. For one thing, the notion that customers would relish having one bill for a wide range of telecommunications services remains unproven. AT&T; offers a dizzying 130 “bundling� options to consumers, yet subscribers keep seeking better deals elsewhere.

The drive to consolidate services within the AT&T; stable also has hamstrung the managers of each service by requiring them to work solely within the AT&T; system, even if there were cheaper and more efficient suppliers of services elsewhere.

Leaving aside whether the strategy was wise, by most accounts its execution was botched. The first mistake came with the first acquisition--of TCI for $48 billion in March 1999. TCI was among the least technologically advanced cable operators, lacking the basic infrastructure needed to provide the kind of two-way services AT&T; promised. Over the next two years AT&T; discovered it would cost more than $10 billion to upgrade TCI’s network, a task that it originally estimated at only $2 billion.

While his company was still struggling with TCI, Armstrong raised the stakes this summer by acquiring MediaOne, another huge cable operator. The deal made AT&T; the nation’s largest cable company, placing it on the radar screens of regulators concerned about cable service and potential telecommunications monopolies--producing another distraction for company executives.

AT&T;’s change of course also undermines the contention by many telecommunications companies that they must merge to survive in today’s highly competitive environment.

“What I hope comes from this is a greater degree of skepticism [by regulators] when these mergers come up for approval,� said Andrew Schwartzmann, an attorney for the Media Access Project, a Washington consumer group.

But some telecommunications experts believe that Armstrong’s fundamental vision is sound and that given time to work it will prove its value.

“This is an amazing strategic about-face for AT&T;,� said one prominent industry observer. “You have to wonder if they aren’t overreacting to their own stock slide.�

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* IMPACT OF BREAKUP

AT&T; tests nerves of investors with its plan. . . . How will the split affect consumers? C1