Comcast: Best Foot Forward


Talk about optimism. Cable giant Comcast (CMCSK) recently bumped up its second-quarter earnings announcement to Aug. 1 from Aug. 7. That's rare these days, when most company CEOs would rather get a root canal than face shareholders with disappointing earnings.

Naturally, Comcast had good reason to step up the timetable. Analysts and others expect the company to report very respectable earnings, even as most companies are barely meeting estimates that have been revised downward. Wall Street foresees solid growth in the cable division's operating cash flow and 10.8% revenue growth, to $1.3 billion. That estimate points to an operating margin of 43.8%, above the industry average of 40%.

Another reason for the date change might be a strategic move by Comcast to convince AT&T's board and shareholders to reconsider its $58 billion offer to buy AT&T Broadband. On July 19, the day after the offer was made, AT&T flat-out rejected Comcast's entreaty for Ma Bell's cable division.

Chief Executive Michael Armstrong, after consulting with his board, felt the offer failed to take into account the division's true value. In a rare television appearance, he touted AT&T Broadband's 13.7% gain in second-quarter cable revenues and its operating margin of 23.4% -- far below the industry average, but better than what it did a quarter earlier.

PREACHING TO THE CHOIR. Many analysts believe Comcast moved up its earnings announcement to highlight what it has to offer: a stellar management track record. Over the past 10 years, Comcast has delivered shareholders a compound annual growth rate of 25%. Compare that with the cable composite index, which grew 20% a year. The Standard & Poor's 500-stock index rose 12% during the same period. "This is a battle for the hearts and minds of AT&T shareholders," says Mike Goodman, a cable analyst with the Yankee Group.

Meanwhile, some of the other possibilities for AT&T Broadband that have received wide speculation -- including a merger with AOL Time Warner's cable division -- aren't nearly as attractive for regulatory and strategic reasons. In the end, AT&T's board is likely to conclude that a deal with Comcast is the company's best bet, especially if it's sweetened.

Many of AT&T's shareholders will likely agree. Of the 693 institutional investors who own shares in Comcast, 80% also hold shares of AT&T, according to Thomson Financial/Carson. If Comcast wants to solicit proxies from AT&T shareholders, the company will find itself in the enviable position of soliciting many of its own shareholders. "It's an intelligent move for AT&T to try to get other bidders, but I don't see how they can walk away from Comcast's offer. It's a very good deal," says Jeff Wlodarczak, a cable analyst at CIBC World Markets.

AOL'S DOWNSIDES. What about AT&T's ongoing discussions with AOL, which both companies have acknowledged? The problem is, many insiders think an AOL deal would face serious regulatory challenges. A united Time Warner Cable and AT&T Broadband would be able to reach 44 million homes, or 44% of all U.S. households.

Although there are no formal rules restricting cable ownership, that's above the 40% FCC Chairman Michael Powell has suggested is a reasonable ceiling. In contrast, a deal with Comcast give the combined company potential access to about 30 million homes, or 30% of U.S. households.

A multibillion dollar purchase of AT&T Broadband would also make it harder for AOL to meet its aggressive long-term growth goals, especially during an economic downturn. While the company's merger with Time Warner was predicated on the move to broadband -- which a bigger cable system would enhance -- the combined entity would still rely heavily on AOL's dial-up Internet service provider subscription fees.

Whereas 94% of Time Warner's cable systems can now carry high-end digital services, about 70% of AT&T's cable lines still need to be upgraded. That means big capital outlays and more pressure on the bottom line.

MICROSOFT'S AGENDA. Then there's the Bill Gates factor. "Microsoft is doing everything it can to make sure that AOL doesn't get a hold of this," says Wlodarczak. The company does have a material interest, besides thwarting an archrival.

Microsoft sunk $1 billion into the Philadelphia-based cable company in 1998. It also invested $5 billion in AT&T in 1999 to ensure that its interactive TV platform would be deployed across AT&T cable systems. With AOL in control, Microsoft might think that's money down the drain. After all, AOL is aggressively pushing its own platform, AOL TV. Of course, for now, Microsoft and AOL aren't talking about AT&T.

To be sure, AT&T could still try to go it alone. AT&T Broadband's results were the highlight of AT&T's quarterly earnings. That doesn't, however, obscure that the business is still struggling.

BREAD AND BUTTER. AT&T Broadband's revenue growth was driven by "advanced services," such as high-speed Internet access and telephone service over cable lines. The number of basic subscribers -- the bread and butter of the cable business -- declined 0.6% in the first half of 2001. That's not promising for a company trying to show shareholders it offers maximum value as a stand-alone entity.

What's more, look at how Comcast has already improved performance in AT&T systems. At the July 9 conference announcing its bid for AT&T, Comcast President Steve Burke noted the company had increased revenue a hefty $7 per subscriber in systems acquired from AT&T early in 2001. How? By effectively marketing premium channels such as HBO and Starz.

Moreover, while AT&T spends 5% to 6% of sales on marketing, Comcast's spending averages about 3%. "Comcast has done a more effective job in marketing, selling, and managing. If that's not a testament to why AT&T shareholders would benefit from a Comcast buyout, I don't know what is," says the Yankee Group's Goodman.

Most likely, Comcast will end up sweetening its bid a bit to win over the shareholders and the board. Analysts believe it might go as high as $70 billion, although some believe that's $5 billion or so too high. Many observers insist there will be a long round of negotiations over price and control before a final deal is struck between the two. Comcast, however, isn't likely to make any new offers -- yet. Instead, it is just trying to get the word out that it's the most capable to make a success of AT&T Broadband. Strong earnings from Comcast on Aug. 1 are one more step in that direction. By Jane Black in New York


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