AT&T'S Mike Armstrong Hypes Wall Street -- But Can He Deliver?

How Armstrong's magic math adds two and subtracts one, and appears to get five.
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It's really great that AT&T (T) - Get Report has triumphed in its bid to become the eye of the needle through which more than half of America will soon be watching TV ... and making phone calls ... and logging on to the Internet ... and all that other stuff that makes you feel so healthy and alive from sitting around all day getting wide while interfacing with the digisphere.

But before we get totally carried away with how swell it is that a company dismembered by Federal court fiat 17 years ago should now be effectively reconstituting itself as if it were made of that blob-stuff from

Terminator II

, let us ponder a question that somehow seems to have escaped consideration amid all the excitement: Is AT&T really worth $21 billion more than it was barely a week earlier, simply for having overpaid by around 30% to acquire a Colorado cable company that itself spurted by $12 billion at the sound of the barking by the Big Dog?

I don't think so.

AT&T, we may all agree, is certainly worth a lot of money, no matter how you look at it. And in a similar spirit, I suspect we will find further agreement that the ruling by

U.S. District Court

Judge

Harold Greene

back in 1982 that forced the breakup of the Bell System into AT&T and seven regional "Baby Bell" companies has spawned all sorts of welcome competition in the telecommunications industry. But it does not automatically follow that AT&T will now be worth even more money to its shareholders simply because it is now looking to merge with money-losing

MediaOne Group

(UMG)

of Englewood, Colo., one of the most Balkanized business horror stories of the age.

If you think it is difficult to figure out who did what to whom to start all the ruckus in Kosovo, believe me when I tell you that the Yugoslavian Question is a "See Spot Run" story compared with the story of MediaOne Group -- a company that was ripped from the loins of AT&T by Judge Greene back in 1982.

Thereafter, the company wound up with a phone business in the Rockies, cable operations in Japan, Georgia, France and God knows where else, a 25% stake in

Time Warner

(TWX)

media operations, a directory publishing company in Britain, part of a paging service in New York, and various sorts of goings-on in the Czech Republic, Hungary and Russia. And now the thing seems ready to be absorbed right back into the loins of the ur-beast that gave birth to it in the first place.

So confusing did the business entanglements of the company become that in 1995, the brass concluded it was no longer possible to sort out anything anymore and said, in effect, the hell with all of it and broke the company in two. One part held onto the company's original name,

U.S. West

, and consisted (I think I've got this right) of all the phone company stuff related to the Baby Bell business -- that is, more or less, $14 billion worth of poles, wires, switches, phone lines and that sort of thing.

The other part took the name MediaOne Group and consisted of all the stuff the company picked up, or inherited, or found, or stumbled upon, following the 1982 breakup. Today, this seems to amount to $4 billion worth of cable systems, wire phone operations, programming services and whatnot-and maybe $11 billion worth of overpayment "intangibles" spent to have acquired the stuff in the first place.

It is the MediaOne operation that AT&T has now offered to buy for $58 billion in cash and stock. Thus we may rightly ask, for starters, whether $58 billion is a reasonable price for this business when a full $20.1 billion of it is coming in the form of cold, hard cash.

On a cash basis alone, the deal puts a value on MediaOne of 36 times trailing cash flow from continuing operations when a cable outfit like

Cablevision Systems

(CVC)

, which has a number of competing products and which AT&T happens to own a third of anyway, is currently selling for only 31 times trailing cash flow. In other words, the whole rest of the AT&T offer -- that is, the stock part, which is worth $38 billion at current prices -- might fairly be said to amount to nothing more than a freebie deal-clincher.

Why would AT&T want to pay up so steeply? To answer that, we've got to look at what has caused the escalation in cable prices -- most recently thanks to a Philadelphia-based cable operator,

Comcast

(CMCSK)

, which also wanted to buy MediaOne and in March offered $49 billion in stock to that end. The cause: broadband mania.

Broadband is -- well, actually, I'm not sure what it is except that everyone now wants to have it. This much I know: Broadband gets into your house through a big fat cable TV wire instead of a little skinny telephone wire. Apparently because the wire is big and fat instead of little and skinny, it is said that you can use broadband services to make phone calls, log onto the Internet, watch TV and maybe even have a sexual experience, for all I know.

Anyway, in the same sense that paper will beat rock, and scissors will beat paper, we may say that broadband will beat normal phone service every time. Which is why AT&T agreed to pay $32 billion in June 1998 to acquire the second largest cable company in America: Dr. John ("The Evil One") Malone's

Tele-Communications

.

The idea behind that deal was (and remains) to use the Evil One's broadband resources (those miles and miles of big fat wires) to scoot around the Baby Bells. With broadband connections, you could pick up the phone in your kitchen and make a call across the street (or across the country) by, in effect, speaking over your cable TV line instead of a phone line.

In the same spirit of trying to capitalize on AT&T's dreams of sticking it to the Baby Bells, Comcast made its bid to acquire MediaOne, hoping, it would seem, that once the deal was completed AT&T would come along and pay some preposterous sum to acquire them both. But what happened instead was that AT&T, in the person of its deal-a-minute chief executive,

C. Michael Armstrong

, looked at the situation and said "Why wait?", simply unfurling a clear-the-decks offer for MediaOne alone, which Comcast could not match.

Now he's got the prize, if we can call it that. But the price of his triumph has been steep, to say the least. If we take the combined financials of AT&T and

TCI

(the merger was finally completed on March 9), we come up with a company that is currently trading at roughly 28 times Wall Street's consensus forecast of $2.19 per share in 1999 earnings.

But merging MediaOne into the company changes everything. If the two were merged together as of Jan. 1, 1998, overall revenue for the whole of 1998 (pro forma, $63 billion) wouldn't have been much more than about 5% greater than AT&T has actually proved to be as a stand-alone company. But if you take out MediaOne's frantic trading-around of its assets and just look at its operating income, the company lost $239 million in 1998, which means net income for the combined operation would have dropped by about 6%, to somewhere around $3.5 billion. Meanwhile, of course, AT&T's total shares outstanding would have increased by more than a third, to $2.3 billion.

Drop to the bottom line. If this deal had been in effect on Jan. 1, 1998, we might say on the evidence to date that the combined company would have reported roughly $1.47 per share in 1998 net income instead of the $1.94 AT&T actually declared. In other words, at AT&T's current price of roughly $61 per share, the combined company would be selling for nearly 41 times trailing earnings instead of 31.

How rich is 41 times trailing earnings? Think of it this way: Forty-one times trailing earnings makes AT&T roughly 8% more valuable, as an income-generating machine, than

General Electric

(GE) - Get Report

, arguably the most successfully managed company in the history of the

Dow

industrials. If an investor had put $1 into each of these two stocks 10 years ago, the GE stock would today be worth more than $8 while the AT&T stock would be worth barely $3.60 -- with most of that gain coming only since Armstrong caught broadband-itis.

And when you get down to cases, what is AT&T, anyway? It has none of the monopoly benefits enjoyed by the Baby Bells; it's really just a long distance carrier that any two-bit reseller can compete against. It doesn't even make phone equipment for the industry anymore; that lucrative business was spun off in the form of

Lucent

(LU)

. In short, this is a company that hasn't gone anywhere in 10 years.

Now, we know that no one cares about balance sheets anymore -- and for AT&T's sake, that is probably a good thing. Let's face it, folks, this company isn't the Ma Bell that sold for years at $150 per share and paid $9 per share a year to all the widows and orphans in America. Would you believe that, until a recent notes offering in March, the company's current liabilities exceeded current assets by $1.3 billion? As for its vaunted $10 billion in cash flow, forget it. Nearly 80% of the cash gets eaten up yearly by capital expenditures.

In other words, what you are looking at in AT&T is a company with no bankable cash flow, no growth in the business, no reliable earnings trend, no balance sheet -- and no hope for propping up its $60 stock price except to convince Wall Street that it's transforming itself into the ultimate Internet business.

I know an old-timer in this game who says the stock is probably not worth more than $10, and I think he's right. As my friend

Andrew Tobias

pointed out more than 20 years ago in his eternally readable book

The Only Investment Guide You'll Ever Need

,

Coca-Cola Company

(KO) - Get Report

fell 70% in the 1970s bear market slide,

Avon Products

(AVP) - Get Report

fell 87%, and

Merrill Lynch

(MER)

and

Walt Disney

(DIS) - Get Report

each dropped 86%. AT&T is primed for just such a reversal if and when the current bull market comes unstuck.

Whether AT&T's current run-up will continue in the meantime no one can say. But when a stock as widely held and traded as AT&T jumps in a week's time by more than 20% to $61 per share on news that it plans to buy a money-losing business with organizational and management problems pouring out every window, you have to assume that the new owners will be able to do better -- a lot better -- than those who came before.

If there is evidence that this is a reasonable assumption when it comes to AT&T, I am unaware of it -- no matter how many cable companies Armstrong runs around buying, or how much Wall Street cheers him on. When a company gets as big and closely watched as AT&T, earnings become ultimately the only thing that matters. Right now, investors are swooning over the revival of this long-struggling stock. But unless Armstrong can turn the $58 billion acquisition of MediaOne into bottom-line results for his shareholders, they will not be swooning forever.

You can reach me by email at

cbyron1@home.com .

Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. Byron holds no positions in any of the stocks discussed in his column. While he cannot provide investment advice or recommendations, he welcomes your feedback at

commentarymail@thestreet.com.