TCI, Bell Atlantic deal puts feds on the spot for new-age regulations

With the banner of competition waving high in a warm autumnal breeze, U.S. Commerce Secretary Ron Brown showed no fear last month as he prepared to plunge into the alligator-infested swamp that lies between Washington and the electronic superhighway.

The Clinton administration “is perfectly situated now to realize its vision of the National Information Infrastructure,” Brown said while addressing an audience of telecommunications executives at the Networked Economy conference in Washington, DC. “My job, my goal, is to transform the United States government into a responsive and productive ally of yours.”

Brown, as well as other Clinton administration strategists, indicated that they were prepared to unveil proposals that would eliminate many barriers to telephone company operations while also establishing a single set of rules for cable and telephony alike. “Communication must flow easily and inexpensively both ways, out of as well as into homes, small business and new industries,” Brown said.

“We are looking for ways to promote competition, particularly in the local loop,” said Mike Nelson, senior advisor for science and technology policy at the White House, who also spoke at the conference. “We are preparing to testify on this and will soon have an answer to questions such as how quickly can RBOCs get into cable and how quickly cable can get into telephony, and we’ll address questions about restrictions on inter-LATA (long distance) competition as well.”

But, having said all that, Nelson hastened to add what Brown left unsaid: “It’s easy to say we should get rid of the regulations we have now. It’s much harder to say what we should replace them with.”

Indeed, the widely accepted prescription of competition as the cure to all ills is likely to quickly lose its luster on deeper analysis, leaving policymakers with a much more intractable set of problems than they bargained for. Yet to be answered in the crucible of public debate, for example, are questions such as these:

• What are the cost and public benefit justifications for creating two or more information highways of infinite capacity?
• How does government go about ensuring universal access and open standards?
• To what extent can control over content and facilities or networks be mixed without inviting monopoly abuse?
• How far can the federal government go in pre-empting traditional state and local control over network operators?

TCI AND BELL ATLANTIC NOW UNDER THE HOT LIGHTS

The first test of the competition hypothesis is now underway with the government’s examination of the proposed Bell Atlantic/TeleCommunications, Inc. deal. Ray Smith, Bell Atlantic chairman and CEO, appeared on Capitol Hill late last month to address senator Howard Metzenbaum’s (D-OH) charges that the agreement was an anti-competitive “mega-monster.”

Smith noted that with Bell Atlantic’s commitment to divesting all TCI cable systems within its telephone operating territories, the deal did not represent concentration in any one marketplace. Instead, he said, it put the cable company in the position of having the wherewithal to mount a significant challenge for the long haul against entrenched telephone monopolies outside Bell Atlantic territories.

As for Bell Atlantic’s existing telephone operations, Smith noted, the company faces competition from cable everywhere it looks, given its commitment to getting into video transport. And those cable companies are likely to benefit from the same type of capital infusion from third parties that Bell Atlantic is providing to TCI in other telcos’ territories.

“No one will control entry into the home,” Smith said a week earlier at the Networked Economy conference in Washington. “The notion of a single transport medium into the customer premises is part of an archaic view of the past.”

Mr. Smith will prevail. Early betting in the press was that Smith’s arguments would prevail in Washington. Indeed, a source close to the Clinton Administration said the signals from the Justice Department suggested the deal would easily pass muster there, despite the launch of a formal review.

But Metzenbaum’s challenge was soon to be echoed by one from Ed Markey (D-MA), chairman of the House telecommunications subcommittee, who also was planning to hold a hearing on the deal. In addition, Markey said he had ordered the FCC “to assess the potential technological and market bottlenecks created by mergers, acquisitions and alliances among cable, telephone and computer companies.”

The credibility question. Bell Atlantic’s credibility on the issue of supporting competition will be crucial to regulatory approval, given the anti-competitive image TCI has acquired over the years. But, early on, the RBOC was having some trouble on this score.

Smith repeatedly stressed at the news conference following the announcement of the agreement with TCI that Bell Atlantic would divest itself of all cable properties within its telephone operating territory, ensuring there would continue to be two-wire competition in those areas.

Spinoff and buy-back. However, details of the agreement made it clear that this divestiture amounted to a spinoff to TCI’s existing shareholders with the intent of entering into an agreement with those shareholders to buy the properties back “on a deferred basis when applicable restraints are eliminated.”

Moreover, filings with the SEC suggested Bell Atlantic anticipated that TCI cable systems in its operating territories would become clients of its video dialtone network, accounting for an anticipated 50 percent of the revenues projected for the telco’s video systems in those territories.

Did Smith “misspeak”? Two weeks later, on the eve of his confrontation with Metzenbaum, Smith sought to undo the impression that Bell Atlantic was less than forthright in its claims. Talking to reporters, he said that the previously arranged provisions were no longer operative. Instead, all in-territory TCI properties would be sold or traded for out of territory cable systems, with no possibility of later purchase by the RBOC.

More worrisome to opponents of the deal, however, was Bell Atlantic’s plan to acquire TCI’s programming holdings. Here, too, there was a credibility problem with regard to how quickly TCI networks would become open platforms, which is important to Smith’s point that Bell Atlantic will own only a fraction of the programming it carries.

NO SPECIAL TREATMENT FOR TCI’S PROGRAMMING, BELL CLAIMS

TCI is presently awaiting regulatory approval of a merger with Liberty Media, the company it formed and spun off two years ago. Liberty Media was formed to serve as TCI’s shelter for its programming interests when TCI officials were concerned that the government would act against its concentration of cable and programming ownership. TCI is reacquiring the programming interests in the wake of FCC definitions of concentration that proved less restrictive than originally anticipated.

Smith and TCI CEO John Malone sought to assuage concerns about Bell Atlantic’s control over programming in a variety of forums in the weeks following announcement of the deal. Smith, at the Oct. 26 press conference, stressed that program holdings, including a 22 percent stake in Turner Broadcasting System and majority control of several other networks, would be placed in a separate subsidiary that would operate independently from the telco and would be treated like any other entity seeking entry onto the telco’s platform.

Malone, speaking at the Networked Economy conference, said, “We are building a fully interactive platform based on the concept that anyone who can afford the pennies to have shelf space will have access to the consumer. The software (programming) we have an interest in will comprise a very small percentage of the totality on the platform.”

He added, “This transaction virtually guarantees multiple providers in the marketplace. Government won’t have to impose access rules, because we’ll adopt open access as a matter of first priority.”

Left unsaid, however, was the fact that TCI today is a long way from operating the type of switched broadband network that would accommodate such open entry. Indeed, the cable tycoon has made his reputation and fortune playing hardball with programmers to whom access to TCI’s 10 million subscribers over its limited-channel networks is crucial to survival.

THE $15 BILLION NETWORK UPGRADE WAS ALREADY BUDGETED

Smith gained a lot of unquestioning publicity in The New York Times and elsewhere by announcing Bell Atlantic would spend $15 billion during the next five years on upgrades of TCI and Bell Atlantic networks, leaving the impression that TCI would quickly become an operator of switched, open platforms that would support entry by all comers. This capital infusion represented a 20 percent increase over previously planned spending by the two companies, he said, claiming the figure served as a clear indication of why the deal was a boon to the U.S. in its pursuit of infrastructure development.

Committed to spending. But a Bell Atlantic spokesman, who said he hadn’t been provided figures on how the spending would break down between the two arms of the new Bell Atlantic, acknowledged that Bell Atlantic has been spending between $2.1 and $2.5 billion per year on its networks for the past nine years and had already committed to significant accelerations in spending in New Jersey and Pennsylvania, its two largest operating territories.

Assuming this translated into an ongoing spending program at the high end of the nine-year average, the already established spending projection for the company over the next five years would be in the range of $12.5 billion.

As for TCI, Malone late last year said the company would expand spending to $750 million per year. This year, officials said, the figure had climbed to close to $1 billion, with 1994 likely to come in at the same level. Assuming the lower figure projected over five years, the already established spending target for TCI would come to $3.75 billion.

The altar of growth. In other words, Smith’s $15 billion offering on the altar of infrastructure growth appears to be at or under already scheduled spending levels for the two companies. “I haven’t been able to find out what the baseline was on (Smith’s) calculation,” the Bell Atlantic spokesman said.

WHAT OF THIS DEAL IS REAL, AFTER THE SPIN IS GONE?

Aside from illuminating how lightly some of the deal promoting spin on future plans should be taken, the figure suggests that TCI will continue on its anticipated track for some time to come; that is, it will invest in network upgrades to accommodate channel expansion into the 750 MHz range (110 analog channels) throughout its systems during the next several years.

When, it must be asked, does Bell Atlantic get to its wide open, switched access platform and away from the bottleneck control over content that has been TCI’s hallmark? Apparently, sometime after 1998.

Milking the cable cow. That leaves a lot of time to continue to milk the cable cash cow from both the content and facilities sides of the business. And it leaves a lot of time to nurture proprietary new advanced services into being through the TCI gateway well ahead of potential competitors who will have to wait for the infinite platform to open up.

SOMEDAY, EVENTUALLY, ALL BECOMES OPEN — MAYBE

All of this represents a translation of the upside scenario posited by Smith and Malone. It may take to the end of the decade, but, yes, everything becomes open and, as Malone put it, everybody eventually has access onto the platform for “a few pennies” — even if they’re getting on after Bell Atlantic’s proprietary versions of the interactive TV and multimedia cornucopia have had several years lead time in which to establish brand identity and loyalty in the marketplace.

But there are no guarantees that even this more realistic version of the upside scenario painted by Smith and Malone will prevail. Several speakers at the Networked Economy conference alluded to the downside, although the general tenor at the meeting was supportive of the deal as promoting faster development.

A massive reordering. Eli Noam, director of the Columbia University Institute for Tele-Information, expressed concern that megadeals like Bell Atlantic/TCI, which are pegged to projections under the current regulatory regime, were triggering a massive reordering of the way business is done in a way that could invalidate the projections.

While Noam said he was confident the Bell Atlantic deal would foster competition, he added, “I wonder if they are opening the business structure in a way that could undermine their own deal.”

Jonathan Solomon, executive director for strategy and corporate business development at the British firm of Cable & Wireless, was more skeptical.

The deal is the new bottleneck. “Technology is creating an environment of super abundance,” Solomon said, noting silicon, light and brain power are the resources on which computing and communications are based. “As a result, true costs are relentlessly being driven to zero.”

At the same time, Solomon continued, the costs of the megamergers are building in costs that ultimately could limit availability of services. “The bottleneck is supposed to be going away,” he said, “but what if the deal structures themselves become the source of a new bottleneck? It’s quite worrying.”

NETWORKS AS A UTILITY COULD OBVIATE THE CONTENT ISSUE

In a phone interview, Steven Rivkin, visiting fellow for the Progressive Policy Institute, the research arm of the Democratic Leadership Conference, noted the Clinton Administration’s policy “is trending toward facilities competition and is heedless of what kind of hellish situation could emerge with this sort of overkill.”

Rivkin suggested the only sensible course was to establish a regulatory regime that makes the facilities a public utility, with content providers competing over the infinite highway, possibly using the wherewithal of power utilities to further drive spending on network development.

Lifting cross-ownership rules. But, as Rivkin noted, the mood in Washington is to support the idea of facilities competition. In an interview, Rep. Rick Boucher (D-VA) asserted that “by this time next year, we’ll have legislation” along these lines. His bill aimed at lifting the cross-ownership restriction (H.R. 1504) now has more than 70 cosponsors, he said.

“We’re in serious discussions with (telecommunications subcommittee chairman) Ed Markey for the first time in four years on this issue,” Boucher said. “The gaps are narrowing rapidly,”

A THIRD COURSE TO CONSIDER: SPLIT THE TELCOS

Congressional and administration initiatives so far appear to be ignoring a third course between the status quo and all-out facilities competition which has been advocated by some state regulators, and by Ameritech and Rochester Telephone. In this scenario, telcos would split into two types of business, one facilities based and heavily regulated, the other content oriented and unregulated.

On the facilities side, the networks would be open to anyone, not just as lessees of channel space, but as users of various facilities components to provide competing services. If someone wanted to provide a competing voice service, for example, the party could lease individual lines into customer premises from the telephone company rather than building separate lines.

This “unbundling” and tariffing of all segments of the telephone network would allow competitors to configure their own networks however they wish, mixing and matching their facilities with telco facilities to maximize value and service potential. The telephone network operating entity would essentially become a utility charged with managing the system for all providers.

For now, though, facilities competition under a regulatory umbrella that applies the same rules to cable and telephone companies alike appears to be the direction things are going in. “The fact that telephone and cable companies are moving in the same technological direction makes it anachronistic to treat the two industries with completely different sets of regulations,” the administration’s Mike Nelson said.

Redefining “universal service.” But the White House might yet discover its vision of facilities competition is in conflict with another major goal — universal service. Nelson and Brown made it clear that universal service will be a key component of the regulatory regime governing cable and telcos, with an extension of the meaning of the term to embrace what Nelson called “plain old digital service” or PODS, as compared to today’s POTS (plain old telephone service).

“The Clinton administration is developing a broad, modern concept of universal service — giving all Americans who desire it easy and affordable access to advanced communication and information services regardless of income, location or disability,” Brown said.

Nelson said the framing of the universal service concept will rely on input from the general public, advocacy groups, institutions, government units and industry through a series of hearings to be conducted by an advisory group to the administration’s Information Industry Task Force.

How far should we go? Nelson said it was unclear just how far the new universal access rules would go in covering advanced services. For example, he asked rhetorically, should communications in rural communities be subsidized so that people in those localities can talk face to face over a videophone connection at costs comparable to costs for people in urban settings?

“It’s not a question we have an answer to at this point,” he said.

“We are going to have to find a different way to maintain the social goal of universal access but in a way that encourages competition,” Nelson added. “That’s not easy to do with lots of players providing services.”

WHO WILL BE THE PROVIDER OF LAST RESORT?

He voiced support for the idea of requiring network operators of all stripes to contribute to a universal service fund. But he left unsaid who would actually build that network and under what regulations.

If the telephone company is the provider of last resort, it remains, by definition, a utility and would be governed by rules different from those governing other network providers. In that event, it may well be that the Ameritech/Rochester Tel solution — splitting the telcos into content- and network-based businesses — will bubble to the surface sooner or later as Washington gains greater insight into the dimensions of the chaos that prevails on the information highway.

Fred Dawson

THE SPECIFICS OF THE BELL ATLANTIC-TCI DEAL

Bell Atlantic’s acquisition of TeleCommunications, Inc. is a cashless transaction involving a complex set of stock trades that have been variously reported to be worth $16 billion (our initial, pre-announcement guestimate), $21.4 billion and $33 billion.

While we would go with a valuation of $33 billion (in agreement with The New York Times, as opposed to the Wall Street Journal and Business Week, which opted for $22 billion), no one really knows what the deal is worth. It is tied to values that will be in play when it actually closes, some 14 to 18 months hence, and the value further depends on how TCI systems inside Bell Atlantic territories are disposed of.

Not a merger. While company representatives keep referring to the agreement as a merger, both CEOs — Bell Atlantic’s Ray Smith and TCI’s John Malone — used the phrase “the New Bell Atlantic” repeatedly in their comments at the press conference following the announcement on Oct. 13. Indeed, with Smith taking on the role of chairman and Malone assuming that of vice chairman with no direct executive responsibilities in the running of the new entity, acquisition would seem to be a better term to use in characterizing the proposed deal.

Bell Atlantic, the third largest regional Bell operating company serving about 12.5 million customers with 18 million phone lines in six mid-Atlantic states and Washington, DC, recorded operating revenues of $12.6 billion on assets of $28.1 billion in 1992, with operating income of $2.5 billion. The company also serves 698,000 cellular customers in 15 states and has telephone and cellular operations in several countries outside the U.S.

TCI is the world’s largest cable company, serving more than 10 million subscribers through its wholly owned systems in the U.S. and several million more in U.S. and overseas partnerships, and is a major stakeholder in Turner Broadcasting System, The Discovery Channel, Request Television and several other programming suppliers. It reported revenues of $3.6 billion and operating income of $956 million on an asset base of $13.2 billion in 1992.

TCI is in the process of acquiring Liberty Media, which holds interests in 17 cable companies serving approximately 3 million subscribers. Liberty is also majority or sole owner of a number of programming networks, including Encore, Black Entertainment Network, Prime Network, Family Channel, QVC, Home Shopping Network and several sports programming ventures.

ALL TOLD, A MASSIVE BASE OF CUSTOMERS

Together Bell Atlantic, TCI and Liberty wireline networks pass (as opposed to directly connect to) approximately 34 million U.S. households, representing slightly more than one-third of the entire domestic residential market.

Smith has said Bell Atlantic will divest itself of cable properties serving 1.6 million customers in Bell Atlantic telephone territories, representing household passings of about 2.6 million. The company is interested in swapping these properties for out-of-territory cable properties held by other MSOs, in which case the overall household reach of the company’s wireline networks would remain unchanged. If it sells the systems without acquiring more, the household base would drop to just more than 32 million, or slightly under one-third of the domestic residential market.

The new company’s cable network holdings will represent a significant share of the most widely distributed basic cable networks, including 11 of the 28 that reach more than 20 million households. The only pay service in the portfolio is fifth-ranked Encore, which, with 3.9 million subscribers, is only one-fifth the size of Time Warner’s HBO.

The terms of the deal. Under terms of the deal, Bell Atlantic will issue approximately 220 million Class B shares valued at $54 each in exchange for 620 million outstanding A and B shares of TCI and Liberty Media. In addition, TCI shareholders will receive shares in a new public company that will be created to take possession of TCI and Liberty properties inside Bell Atlantic’s territories.

Bell Atlantic will also assume $9.6 billion of TCI and Liberty debt, bringing the total estimated transaction value to $21.4 billion. The reported valuation of the deal at $33 billion is tied to an assumption that Bell Atlantic will end up buying the in-territory cable systems or systems of equivalent value elsewhere at a price of more than $10 billion. The $10 billion figure is based on Bell Atlantic’s projection of the eventual value of those properties.

This would be the case either if the regulatory climate shifts to permit in-territory acquisitions, now only tenuously permitted under a district federal court ruling facing appeal by the Justice Department, or if the in-territory systems were swapped for out-of-territory systems, which would then be saleable by TCI shareholders to Bell Atlantic.

Clearing hurdles. The deal must clear a number of regulatory hurdles, beginning with U.S. Justice Department and Federal Trade Commission review of the antitrust implications, if any. Beyond that, each municipal franchise authority in TCI territories will have to approve transfer of the ownership.

While this could be a snag in some areas, owing to TCI’s history of rough-and-tumble relations with franchising authorities, during the past two years the company has taken a lead among cable companies nationwide in improving service and patching up local relationships, which could go a long way toward speeding local approval.

Bell Atlantic will also have to obtain a waiver from the federal judge overseeing the modification of final judgment in the AT&T consent decree, insofar as the RBOC is banned from participating in any service that crosses local access tariff area (LATA) boundaries, including satellite-delivered cable TV services. Previous attempts at obtaining such waivers have met with long delays, though most observers believe the waiver will be granted. Moreover, the parties are hoping Congress will extend some form of relief on this issue.

Fred Dawson