07/14/97 AT&T: DIALING FOR DIRECTION

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AT&T: DIALING FOR DIRECTION
It's scrambling once more for a local-phone strategy
The collapse of AT&T Chairman Robert E. Allen's breathtaking plan to merge with Baby Bell SBC Communications Inc. is more than just an embarrassing gaffe. Sure, Allen's bizarre public spat with Federal Communications Commission Chairman Reed E. Hundt--a bitter exchange in the news media over the ramifications of a deal that AT&T never officially acknowledged --leaves AT&T image-makers working overtime to repair the damage. But the real harm is that AT&T is once more scrambling for a strategy to get into the local-phone business and give itself a chance to survive the accelerating market-share losses that deregulation is expected to bring to its core long-distance business.
So far, AT&T has launched a half-dozen local-phone strategies--from simply reselling services bought from local incumbents to pioneering a new system for ''fixed wireless'' residential service. It dramatically increased its capital spending this year from $6.6 billion to $9 billion to accommodate $1 billion slated for building local networks. Still, none of the approaches--save the now defunct SBC merger option--appears to have the potential to get AT&T into the $100 billion local market in a big way any time soon. Says Jeffrey Kagan of Kagan Telecom Associates: ''They're not anywhere near where they wanted to be or where analysts expected them to be.''
So, what next? Sources close to the company say that, despite the SBC debacle, AT&T execs are talking about pursuing another acquisition. The most likely targets: GTE Corp. and Southern New England Telephone Co.--companies with which AT&T has talked merger in the past. Although AT&T has not yet restarted talks with either, ''they've pretty much said they want to do a deal,'' says one source.
Another potential partner is Teleport Communications Group Inc., which provides local service to businesses in large cities, in competition with the Baby Bells. BellSouth Corp. and Ameritech Corp. have also been mentioned as merger candidates at various times, but such deals are unlikely unless the FCC drops the objections it has voiced about a theoretical AT&T-Baby Bell combination.
TIN-CAN ALLEY? For now, the long-distance giant will pursue less ambitious options--such as marketing deals with small companies that compete with the Bells, usually by linking business customers to long-distance networks. In the next three months, AT&T plans to announce franchise agreements under which it would receive royalty payments and the local company could use the AT&T brand to sell service. ''We want to leverage our brand name and save on the amount of money we have to invest in local infrastructure,'' says John C. Petrillo, AT&T's executive vice-president for corporate strategy and business development. Likely partners include McLeod USA Inc. in Cedar Rapids, Iowa.
Such deals will never make AT&T a local power, though. ''It's like stringing tin cans together and tying it with a knot,'' says Gary Miller, chairman and CEO of Aragon Consulting Group in St. Louis. And stitching together dozens of partnerships will be costly. ''All I can see is a network that's getting complex, and complexity to me means expensive,'' says Daniel E. Zito, vice-president at Legg Mason Wood Walker Inc.
Another easy option for AT&T is a strategy Allen has resisted--reselling service provided by the local Baby Bell. AT&T contends that with the 18% to 20% off of retail calling prices that the Bells typically offer, it can't afford to market and sell local service. In long distance, there's a thriving resale business, but the discounts range as deep as 70%.
Allen, in fact, has been an outspoken critic of what he says are intentional strategies by local-phone companies to foil new competitors (page 26). The company stopped marketing in Sacramento earlier this year because it said that Pacific Bell was slow to connect its customers. In Rochester, N.Y., AT&T exited the resale business because Frontier Corp. offered only a 5% discount. Still, AT&T continues to pursue resale markets in several states, mainly to build customer loyalty by providing a full bundle of phone services.
The net result: AT&T's efforts in local calling have yielded little. A recent Yankee Group Inc. study shows that AT&T has won about half of the households that have chosen an alternative to the local phone company--but that's only about 200,000 customers. Just last year, Allen was boasting that AT&T would take one-third of the local market.
There is a costly, long-term approach that could produce bigger numbers: AT&T can speed up plans to build local connections, such as it is currently pursuing in Chicago where it's testing new wireless technology. A nationwide system, however, would cost as much as $100 billion, and Wall Street, which already went on a rampage over this year's increase in capital expenditures, is unlikely to sit still for any effort that places such a drag on earnings.
Regardless, AT&T has no choice but to come up with a local-phone strategy soon--particularly because the Baby Bells are so intent on getting into long distance. Just days after their merger talks broke off, in fact, SBC was suing in federal courts in Texas and Washington, challenging the FCC's right to keep it out of long distance until it opens up local calling in its markets. ''AT&T has to get into the local-service business,'' says Guy W. Woodlief, telecom analyst at Prudential Securities Inc. ''It's their best opportunity for growth.'' Allen, who has scheduled his retirement for next May, has little time to seize that opportunity.
By Peter Elstrom in New York

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