Some See AOL-Time Warner Deal as a Further Sign of Cable's Broadband Edge

SAN FRANCISCO -- In the epic battle among cable, phone and satellite industries to wire the world for high-speed Internet access, the megadeal between America Online (AOL Quote) and Time Warner (TWX Quote) suggests that cable is ahead in the race -- for now, anyway.

"The market seems to believe [the deal] is a feather in the cap of cable providers and a black eye for DSL [digital subscriber line] providers," says Fritz Linkner, analyst with Husic Capital Management, which is long Time Warner.

Cable companies like AT&T (T Quote), phone companies like US West (USW Quote) and direct broadcast satellite services such as DirectTV have all been upgrading their technologies to offer high-speed Internet access.

All told, about 2 million North American consumers have access to Internet's express lanes, known as broadband. Overall, cable companies have had more success deploying broadband technology but more recently telephone companies have been stepping up their efforts. Satellite companies have been the slowest to get off the ground.

Yet now some analysts say the creation of AOL Time Warner validates cable as the premier broadband distribution channel.

"Cable is in the lead now," says Kinetics Strategies President Michael Harris. "And this deal will do nothing but cement that lead."

Until now, AOL has been hedging its bets. The online giant has entered into partnerships to offer high-speed, phone-based Net access with several Baby Bells, including SBC Communications (SBC Quote). In addition, AOL has also cut a deal with Hughes Electronics to offer satellite-based fast Net access. Although it's still too early to judge the performance of these deals, some analysts say DSL, the technology deployed by phone companies, has been long on promise and short on delivery.

"AOL has tried to go down the DSL path and it looks like they believe it wasn't the strategic way to go," says Linkner. "The rollout has been too slow."

Beyond validating cable as the broadband technology of choice, some analysts say the AOL Time Warner deal highlights the importance of content in the broadband wars as access becomes more of a commodity.

"The conduits either need to become the low-cost supplier relative to their competitors or move towards alliances with content suppliers," Morgan Stanley Dean Witter analysts Mary Meeker and Richard Bilotti wrote in a report today. "It is applications and programming that drive subscriber growth." (Morgan Stanley is advising Time Warner on its merger with AOL.)

The biggest doubter of marrying content with conduit has been AT&T, whose top executives have repeatedly stated their desire to stay out of the content-creation business. Despite the deal of the century, AT&T spokesman John Heath says the merger has not changed Ma Bell's strategy of serving as a "dumb pipe" and working with as many content providers as possible. And yet AT&T is prevented from opening up its cable lines to other content companies until its exclusive relationship with cable-modem provider Excite@Home (ATHM Quote) expires in mid-2002.

"We think the proposed deal underscores the significance of broadband distribution and reconfirms the value of AT&Ts broadband assets," says Heath. "We feel that being flexible about content is the best strategy for us." Last year, Ma Bell shelled out more than $100 billion to buy TCI and MediaOne, two of the biggest cable companies. The idea is to use the cable plant to offer a range of data and telephone services, including high-speed Net access, over the cable pipe.

Despite many discussions with both old- and new-media companies, AT&T has yet to cut any deals. And some analysts think the megadeal increases the likelihood that conduit company AT&T will need to join with content companies to compete against the giant media assets of Time Warner, which include magazines like People and Time and cable channels like CNN.

"This accelerates the whole partnership game in the cable area," says Brian Salerno, analyst with Munder Capital. Other analysts say the partnerships could take the form of either acquisitions or investments.

The merger also raises questions about the status of Excite@Home, which is controlled by AT&T. Mark Stevens, Excite@Home's head of business development, says it stacks up favorably against AOL Time Warner.

"They can focus on their 20 million homes and we can focus on our 78 million homes," says Stevens, referring to the respective reaches of Time Warner cable and AT&T's cable assets. Stevens also said the merger creates "a lot of dealmaking opportunities," though he declined to specify what types of deals.

But analysts worry about the impact of the AOL Time Warner deal. Even though the megadeal validates Excite@Home's strategy of marrying content with access, many analysts say Excite@Home needs to form more partnerships with content companies. In fact, at least one feels it's lost the game.

"[The merger] pushes them to be acquired by a larger media company," says Emeric McDonald, analyst with Amerindo Investment Advisors, which is long Excite@Home. "They're too far behind in content and not far along enough in distribution to use that as a lever."

Broadband has been the Achilles' heel of AOL, the world's most powerful Internet company. But even though its merger puts the issue to rest for the time being, some analysts say AOL must continue to pursue more partnerships with other cable companies in order to fulfill its "AOL Anywhere" strategy of reaching all consumers on all platforms at all times. Analysts estimate that Time Warner cable network reaches 20% of U.S. homes.

"AOL is not going to restrict itself to just the [Time Warner] deal," says Chris Snelling, analyst with Pivotal Asset Management, which is long AOL. "They need to reach 100% of consumers." As such, Snelling expects AOL to sign more broadband distribution deals with other cable companies, and perhaps more telephone and satellite firms.

Indeed, Munder analyst Salerno agrees that the megamerger gives AOL more leverage in its ongoing negotiations with AT&T to gain access to its cable lines, which cover almost 50% of the nation's homes. One possibility: Kinetics' analyst Harris predicts that in exchange for letting AT&T provide phone service to Time Warner's 20 million households, Ma Bell would let AOL sell its services and content over its cable lines.

"It's funny," says Harris. "AT&T [and Excite@Home] has been acting like the big kid on the block. Now the tables have clearly been turned."