AOL Could Play the Underdog in the Broadband Competition

AT&T's bid for MediaOne would create a giant high-speed gatekeeper.
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One day, the feds will ride their regulatory bulldozer into town and level the playing field in the broadband Internet space.

Until then,

America Online

(AOL)

will have to fend for itself against the growing menace of cable mergers.

AT&T's

(T) - Get Report

plans,

announced Thursday, to acquire

MediaOne

(UMG)

soon after its acquisition of

Tele-Communications Inc.

would solidify AT&T's role as gatekeeper of high-speed Internet service through cable systems. The long-distance phone giant has already a significant stake in the cable-modem service

@Home

(ATHM) - Get Report

.

"A bigger AT&T cable company is a bigger threat to AOL and every other Internet service provider," says Scott Cleland, analyst with the

Legg Mason Precursor Group

.

AOL hasn't yet reached any deals to deliver high-speed access through @Home or

RoadRunner

, the high-speed cable modem service co-owned by MediaOne and

Time Warner

(TWX)

. AOL is looking at alternative broadband strategies to provide access to home users. So far, that means through telephone wires, using the technology known as digital subscriber line, or DSL. Already this year, AOL has announced deals with two former Baby Bells,

Bell Atlantic

(BEL)

and

SBC Communications

(SBC)

, to market high-speed connections to its service via DSL in their territories.

"With the lack of a cable deal right now, it makes the DSL rollout more important," says Mike Wallace, analyst at

Warburg Dillon Read

. (Warburg has not underwritten for AOL.)

Yet, DSL has to catch up with cable modems; to date, there are roughly 40,000 DSL users, compared with about 600,000 cable broadband users, according to Legg Mason. The DSL deals with Bell Atlantic and SBC will give AOL the potential to reach 13 million DSL-ready homes by the end of 1999, while @Home, through its affiliates, has access to 57.3 million North American homes passed by cable (though not all of them are in areas equipped for cable-modem service.)

AOL had no comment by deadline. Previously, AOL spokeswoman Kathy McKiernan had repeated the company line: "We're firmly committed to offering our members every advanced broadband technology available in the marketplace, once it becomes convenient, easy to use and affordable enough for the mass market."

AOL isn't necessarily locked out of a deal with the cable-modem services, Wallace says. "I still expect AOL to cut a deal with @Home and RoadRunner at some point," he says. But the success of AOL's DSL service, due out this fall, will affect its power on the cable front. "If AOL is successful with DSL, it may make it less of an important issue," he says. "If not ... @Home gets a leg up on the negotiating table."

Eventually, say the pundits, the

Federal Communications Commission

or

Congress

will find a way for AOL and other Internet service providers to have open access to broadband pipelines being built by AT&T and other companies. Internet service providers argued for such access as a condition of AT&T's purchase of TCI, but the FCC declined to make such a move.

"It's my analytical opinion that a proprietary cable Internet network is not politically or regulatorily sustainable long term," says Cleland of Legg Mason.

Nancy Casey, general partner with

Valhalla Capital

, a shareholder in both AOL and @Home, says that even though the MediaOne deal extends AT&T's reach, it could benefit AOL by sparking regulation for open access. "Maybe it gives their lobbyists more fodder to go to the government," she says. "You can bet the AOL lobbyists are there today."

But it seems doubtful that such regulation could come quickly.

"We don't think

the MediaOne deal necessarily pulls the trigger that something will be done immediately about the open access debate," says Alan Harris, co-portfolio manager with the

(MNNAX) - Get Report

Munder NetNet fund, which owns both AOL and @Home.

"The fact of the matter is that cable modems are still in less than a million homes in the United States," he adds. "The FCC has historically waited until these emerging technologies become a little bit bigger before they intervene."

In the meantime, AOL has to find new partners to gain entry into the broadband party.