Let me explain. The AT&T-TCI deal, unveiled with great fanfare last June, featured the creation of a fancy new security to help AT&T’s stock-market value. Staid AT&T was joining the designer-stock crowd. The new AT&T security, called a tracking stock, was to be tied to the performance of AT&T’s consumer long-distance and wireless businesses and to the cable-TV business it was buying from TCI. But there’s nothing about the tracking stock in the mailing, which went to TCI’s holders as well as AT&T’s. That’s because AT&T and TCI decided late last month not to issue the stock.
Why talk about a stock that’s not being created? Because the tale of this on-again, off-again security offers insights into the thinking of two of America’s sharpest dealmakers: AT&T chairman C. Michael Armstrong and TCI chairman John Malone. And because it also shows how Wall Street and the real world intersect. Neither company would comment because their deal is in SEC registration, so I’ve had to sleuth around and deduce facts from documents and indirect sources.
The idea of combining AT&T and TCI is simple. But doing that without eviscerating AT&T’s per-share profits was excruciatingly difficult. AT&T, the nation’s biggest long-distance company, wants to use TCI’s cable wires to bypass local phone companies (and the fees they charge) and offer customers telephone and Internet services directly. But buying TCI would clobber AT&T’s earnings per share because AT&T would issue about 435 million new shares to TCI holders and would be hit by noncash accounting charges of $735 million a year. AT&T’s stock has historically been very sensitive to reported profits; thus, lower per-share profits were likely to mean a lower stock price. Elementary.
So dealsters Armstrong and Malone came up with a solution: the aforementioned AT&T tracking stock. They figured they could offload some or all of the accounting charges onto the tracking stock, which they hoped would trade like a cable-TV stock: on the basis of profits before interest, taxes and noncash charges. Accounting charges wouldn’t reduce its price. What’s more, some AT&T shareholders would swap some or all of their AT&T shares for tracking shares, which would reduce the number of AT&T shares outstanding and help per-share profits.
Isn’t this easy? What’s more, owning tracking stock, which unlike regular AT&T stock would pay no cash dividends, appealed to Malone, a legendary taxophobe.
But there was a problem translating the concept into reality. AT&T and TCI came to realize that AT&T’s residential long-distance business would be by far the most important element in the tracking stock. And it’s a mature business that shows fat profits, unlike the cable and wireless businesses. So then they tried to create a tracking stock with just wireless and cable TV, but ran into all sorts of accounting, operating and personnel problems. In other words, Plan A worked operationally but not financially. Plan B worked financially but was an operational nightmare.
Then the stock market solved the problem. In December AT&T’s stock price took off. Individual stockholders were selling out; institutional investors like mutual funds and pension funds and hedge funds were pounding in. Institutions’ stake in AT&T has reportedly risen to about 60 percent from about 40 percent when the deal was announced. The goal had been to raise AT&T’s stock-market value. The goal had been met. So why mess around with tracking stock? Around Christmas, the plug was pulled.
The deal description, which became public on Jan. 8, showed that owning TCI would have cut AT&T’s 1997 per-share earnings by 41 percent, and by 35 percent for the first nine months of 1998. Yet the stock stayed strong. Without having even consummated their deal, let alone showing results, Armstrong and Malone convinced Wall Street that AT&T is a go-go stock and per-share profits don’t matter. How did they accomplish this? That, my friends, is a mystery worthy of Sherlock Holmes.
