Navigating the Twists and Turns of the AT&T-Excite@Home Link

Investors have to watch AT&T flip-flop on its open-access strategy. But there's a way out of the mess, Seymour says.
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Boy, AT&T (T) - Get Report really has put itself in a wringer in this open-access mess. Say one thing, do another, plot a third. And no easy way out, no matter what. I'm long AT&T and still believe in the company and, especially, its leader (a word carefully chosen) Mike Armstrong. So watching AT&T dig this hole, jump in and then shovel dirt on top of itself hasn't been pretty.

But it is an instructive episode about the twists and turns that cross-technology efforts are taking in the Internet Era, and about the perils of casual assumptions in acquisitions. It also holds big lessons for other companies and investors as well.

It's hard to put together a brief summary of this, but let me give it a try. Gather 'round the fire, kids, and keep your seat belts buckled because the twists and turns will be fast and furious.

When AT&T acquired the cable-systems business of

TCI

last year, it looked forward to being able to deliver both local phone service and fast Net access over one wire into customers' homes. This was a nice way around those pesky, uncooperative regional Bell operating companies in solving the "last mile" problem for AT&T's residential phone-service aspirations. That a nice chunk of what is now known as

Excite@Home

(ATHM) - Get Report

came along too, was gravy: That meant AT&T could premium-price that Net-access service, since it would be delivering Excite@Home's content over the Net-access channel, too. AT&T (and, we presume, TCI), assumed that those local contracts for the TCI cable franchises around the country would be easily and quickly transferred to AT&T, and the business would take off.

But it didn't work out that way. In Portland, Ore., Multnomah County commissioners declined to make that automatic transfer. In response to community outcries about an AT&T monopoly in Net-connection content in the form of Excite@Home, they demanded that AT&T open its service to other content providers as a condition of approving the transfer. AT&T said no and dug its heels in; the matter went to court.

Shortly afterward, another public board in Broward County, Fla., took the same stance.

Meanwhile, the

Federal Communications Commission

was unhappy about all these incursions onto what it considers its rulemaking turf. Chairman

Bill Kennard

went on the road with a stump speech about how cable plus Net -- and maybe plus telephony, too -- just aren't the same as cable alone, and that the narrow view of these local meddlers, in declaring the new AT&T offerings the same as TCI's former offerings -- that is, a "cable is cable is cable" position -- was wrong. Everyone else should keep his or her mitts off this decision, thank you.

A heavy-hitting coalition formed against the AT&T move. Led by

America Online

(AOL)

and having many other ISPs and content providers on board, it hired big-time lawyers. AT&T responded with its own brand-name lawyers. Recent combatants in other Washington-based matters, including

l'affaire

Clinton

, found themselves sitting somewhat uncomfortably on the same side of the table in this one ... staring at other odd-couple lawyer pairings on the other side.

AT&T took a public stance that this interference by local boards was illogical and counter to the public interest. Moreover, AT&T said, offering carriage to other content providers on its system was technically impossible. AOL and its followers took the stance that AT&T was trying for a stealth land-grab on a scale not heretofore seen in this century: owning the primary content source in the fat pipe into America's homes.

Things got

very

noisy.

And then the cracks began to appear. Leo Hindery, the AT&T exec in charge of its new cable businesses, is widely understood to believe that AT&T will do a lot better long term if it opens its pipes to others and sells them access. But AT&T's contract with Excite@Home gives Excite@Home exclusive carriage on AT&T's cable systems into 2002. AT&T does not have a majority stake in Excite@Home and is thus unable to act unilaterally to change that contract. (AT&T has only about a fourth of Excite@Home, and any move to disadvantage Excite@Home through reducing the length or exclusivity of that contract would face a firestorm of opposition from other big, mean, well-financed holders of sizable stakes in Excite@Home, including

Comcast

(CMCSK)

,

Cox Communications

(COX)

,

Cablevision

(CVC)

and fund manager

Janus

. To say nothing of the screams from the many small holders of Excite@Home.)

AT&T has to be sensitive, too, to the value of its 25.9% share of Excite@Home because that represents about $4 billion of AT&T's assets at recent prices. But the market has not been unaware of AT&T's machinations: Excite@Home has lost about a third of its market value since mid-June, when T's waffling on this problem began to appear.

AT&T spokesmen do say that the company will honor that Excite@Home contract, but you can almost hear the unspoken but hanging-in-the-air clause that follows: "unless we can do something about it."

Meanwhile, the FCC filed a friend-of-the-court brief in Portland earlier this month, asking the court hearing the Multnomah matter to back off because the FCC believes this is clearly the FCC's turf. It also asked the court to recognize the special nature of this call and to make any decision narrow and local.

So what's AT&T to do? Its guy in charge wants to do what the opponents want, but it can't take a dive. It can't disadvantage -- or

appear

to disadvantage -- Excite@Home's position. But any reduction in the term or exclusivity of that contract would certainly have that effect.

Meanwhile -- ah, the twists and subplots here! -- AT&T is having trouble hitting its internal target dates for getting its phone-over-cable service out there with "lifeline" quality-control standards; it's watching third-party vendors prove that opening its pipes to others isn't all that hard, let alone impossible; Excite@Home has stumbled so badly in the San Francisco Bay area that AT&T is giving 1,000-plus Excite@Home customers five months' free service; AT&T is widely reported (and believed) to be negotiating with AOL for "someday" access to the AT&T systems; and the value of its Excite@Home holding has been declining sharply (though it was buoyed a bit by the

FOMC

announcement Tuesday afternoon).

What to do, Brain? The same thing we do every day, Pinky. We're going to continue to try to take over the world.

How? AT&T's larger interest certainly isn't promoting the success of Excite@Home, but of AT&T in general. With two big steps, it could advance that cause -- and I'm convinced you'll see those moves shortly.

First, AT&T has to back away from its "no sharing" decision and allow access and preferred position -- for what could be very substantial fees -- to other content providers. By folding its tent in these legal wars around the country, it backs away from the bully-boy image it's getting -- at exactly the moment it can't afford that reputation, if it's to persuade American consumers to accept AT&T as their primary in-home communications provider.

And second, it has to divest itself of its Excite@Home stake in a way that allows it to wiggle out of that exclusive-carriage contract. The only way I see to do that is for AT&T to offer to sell its stake to other shareholders at a discount, rather than the usual premium, to Excite@Home's market value. A condition of the sale, of course, would be the cancellation of that contract.

AT&T has to walk a fine line here: It can't give some Excite@Home holders preferential treatment. A quick, easier-to-do deal that transferred AT&T's Excite@Home stake to a few of the big Excite@Home holders would invite shareholder lawsuits from others not offered such a bargain.

But it can be done. Mark the price of its Excite@Home stake down 50%, and I'm convinced other Excite@Home holders would bite -- and accept the contract cancellation.

If that means AT&T eats, say, a $2 billion markdown, that's a cheap price to be freed of the Excite@Home problem. (It's also a small fraction of the $100 billion-plus AT&T has spent assembling this cable empire.) And remember that at least some of the cost of a discounted sale of the Excite@Home stake would be quickly recouped through new deals selling access to AT&T's systems to the likes of AOL.

Mike, there just isn't any other way. Listen to Leo. Open the system. Get out of a bad deal. Quick.

I said there were a number of lessons here. The biggest one of all is the horrible cost of getting caught in the war between content and connection: Are companies bringing fast access to market selling a connection or proprietary content bundled with that connection?

In presidential terms,

it's the connection, stupid

!

I can't believe how many companies still have their knickers in a twist over this. They like to point to AOL and say "See, see?

They

combine proprietary content and an ISP connection! See how well they're doing?"

What an inapt comparison. There's just one AOL, and there's never gonna be another. AOL owes its position and success almost entirely to timing, to its legendary early position in the market. It was, for many, the only choice and a pretty simple one; we are a people confused by things even modestly technical, so a substantial number of us stay with an incredibly feeble service rather than changing. Period.

When we go out looking for a fast-access connection, we want exactly that:

a fast-access connection

. We don't give a hoot about the watery bilge pumped down that pipe by the people from whom we buy the connection. We understand that we can get that stuff -- far better stuff -- all over the Web. Which is, in fact, why we want the fast connection to the Web.

Severing the connection from the content is key to making money. I've thought and said for a long time that Excite@Home -- a content-only player that must piggyback atop someone else's wires -- is one of those stocks sitting there waiting for bad things to happen. Said that again just a couple of weeks ago on a

Yahoo!

chat, and I got whacked for it in a pile of emails later from Excite@Home loyalists.

Look, folks, content is the hardest sell on the Net. But fast connections are -- at least for now -- an incredibly easy sell, for which demand outstrips effective supply by a hundred times.

It's going to be fun -- except, maybe, for those who, like me, are long AT&T -- watching it flop back and forth here, wrestling a thousand invisible demons.

But I'm convinced Armstrong's leadership, with Hindery's strategies pushing him, will lead AT&T to divest this Excite@Home stake and that nettlesome exclusive-carriage contract. Tom Jermoluk and George Bell at Excite@Home won't like the outcome and will kick and scream, no matter how fat the AT&T offer is.

But Excite@Home will go away; AT&T will open its system; and I'm betting AOL will be one of the big winners.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Seymour was long AT&T, although positions can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.