Will This Merger Open Markets?

Robert W. Crandall
Robert W. Crandall Adjunct Senior Fellow - Technology Policy Institute

June 26, 1998

So we are finally getting competition in the local telephone sector. Or at least that is what AT&T, the country’s largest long-distance company, tells us as it buys TCI, the second largest long-distance company, tells us as it buys TCI, the second-largest cable company, for a whopping $48 billion in stock and assumed liabilities. We are told that what TCI and AT&T could not do by themselves will now be possible through their joint efforts. Having discarded Robert Allen for the more entrepreneurial Michael Armstrong, AT&T now picks up the option of one of the most successful U.S. entrepreneurs, John Malone, as it launches its newest “convergence” exercise, marrying cable, Internet and telephone services into a single enterprise.

We should all hope that this works, for more competition in the telephone industry—in both the local and long-distance sectors—is clearly good for consumers and for the entire economy. Some analysts conclude that this is, in the words of Frost & Sullivan, “a match made in heaven.” This is an apt metaphor, given that AT&T’s earlier venture into local telephony through a fixed wireless technology—which has not borne fruit—was called Project Angel. Will the gods be more kind this time, with Mr. Malone at the right-hand side of Mr. Armstrong? No one can know, but a few sobering thoughts from here on Earth might provide useful perspective.

Fumed and Fussed

Since the 1996 Telecommunications Act was signed into law nearly 2 ½ years ago, AT&T and its long-distance brethren have fumed and fussed over the lack of local company cooperation in leasing them the facilities to allow them to enter the local markets without having to make large investments. Indeed, AT&T failed to make much of a dent in the telephone markets of Rochester Telephone in New York (now Frontier) or Southern New England Telephone in Connecticut when it tried to do so by leasing the local companies’ circuits, and it has now largely pulled back from these efforts.

At the same time, efforts by Time Warner and US West to mount a competitive assault on local telephone markets in the Southeast by marrying cable service with telephony have also been a major disappointment. Indeed, even TCI’s own aggressive digitalization of its cable plant in preparation for a roll-out of a vast array of new services, including local telephony, was projected by Wall Street analysts to attract telephone subscriptions from only about 10% of the homes it passes in the next five years.

Nor have the telephone companies been successful in combining services. Large companies, such as PacTel and Bell Atlantic, once had ambitious plans to build advanced fiber-coaxial cable networks that would offer traditional cable services, video jukeboxes and telephony through the same cable, but they have now largely abandoned them. Indeed, Mr. Malone backed away from an earlier merger with Bell Atlantic that would have develped with cable telephony outside Bell Atlantic’s region.

What is the difference this time? It is possible that new technologies, such as packet switching, will allow AT&T and TCI to develop new high-speed data, Internet and voice networks that terminate over TCI’s coaxial cables. It is also possible that the lack of capital resources has restrained cable companies such as TCI, Cablevision and TCA from moving aggressively into telephony. (This surely does not explain, however, why Time Warner, the nation’s leading cable company, is not a major supplier of local telephone service.)

So what does AT&T bring to the table? The answer cannot be that TCI needs AT&T’s technology. AT&T spun off its equipment division as Lucent Technologies two years ago. Since then Lucent’s stock has increased fivefold while AT&T’s has underperformed the Standard & Poor’s 500. Nor did AT&T become a powerhouse in personal computers, automatic teller machines or point-of-sale terminals through its acquisition of NCR many years ago. It would appear, therefore, that what AT&T has to offer is deep pockets, not technology.

Does this make sense from AT&T’s perspective? Probably not—if AT&T views the TCI deal simply as a way to jump-start “facilities-based” local telephone competition (that is, competition based on separate phone lines, not just on leasing space from existing local companies). AT&T is paying $48 billion to get TCI’s cable system and other assets. By any measure, this is an expensive way to get access to local consumers. For $48 billion, it could probably build its own cable systems to cover 80% of the country, not just the 30% reached by TCI’s networks.

But AT&T’s purchase of TCI may well make sense from another perspective. Of late Mr. Malone has done an excellent job reviving TCI’s once-flagging fortunes. Thus TCI is a good business for AT&T to acquire even if it doesn’t realize any synergies and simply sticks to TCI’s operating plans. With AT&T stock soaring since Mr. Armstrong’s takeover as chairman, he probably figured this was too good a buy to pass up.

Major Bonus

Thus the AT&T-TCI deal could wind up being good for both companies. But what about the rest of us? There would be a major bonus in the deal if it led to a new surge of competition in the local markets, which in turn would force regulators to allow the Bell companies to enter the long-distance business and to drive those rates sharply lower. AT&T was still getting more than 17 cents a minute from residential customers last year, far above the cost of that service and much more than the nine- or 10-cent rates charged by many competitive new carriers. Perhaps the winds of competition will finally begin to blow, replacing the hot air of the public relations, regulatory and legal struggles that have dominated telecommunications for the past two years.