February 28, 1996

A Baby Bell Presses to Be a Cable Power

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    If you listened hard enough Tuesday, you could almost hear the crack of a starting gun.

    Four weeks after Congress passed a bill intended to unleash a free-for-all among communications companies, U S West said Tuesday that it would acquire Continental Cablevision Corp. for $5.3 billion in cash and stock, and the assumption of $5.6 billion in debt.

    The deal would be the first big transaction of the deregulated era, and the choice of partners underscores -- figuratively and literally -- U S West's ambition to grow from a regional Bell telephone company into a continental company with a powerful presence in both phone service and cable television.

    "This is a defining day for U S West," said Chuck Lillis, the chief executive of the U S West Media Group, the division of U S West that plans to acquire Continental.

    Continental, which is based in Boston, is the nation's third-largest cable operator with 4.2 million subscribers in 20 states from New Hampshire to California.

    By adding Continental to its own 500,000 subscribers in the Atlanta area and its existing cable alliance with Time Warner Inc., U S West will have access to 16.3 million households, the widest reach of any cable operator in the country.

    Continental chairman and chief executive Amos B. Hostetter Jr. said Tuesday at a news conference in New York that he decided to sell because he believes that only giant companies will survive in the rapidly consolidating world of telecommunications.

    "We know for damn sure that U S West has more financial muscle to bring to bear than we ever could," said Hostetter, a zealously private individual who founded Continental 33 years ago with a fraternity brother from Amherst College. As the largest single shareholder in the company, Hostetter stands personally to make $1.2 billion from the deal.

    Continental has hashed out potential deals with U S West for the last three years, but cable executives and analysts were still startled that Hostetter would accede to an outright sale.

    The 59-year-old Hostetter will continue to manage Continental's cable systems, as well as U S West's Atlanta cable systems.

    For U S West, which is based in Englewood, Colo. and provides local phone service to 25 million customers in 14 Western states, the deal is a resounding affirmation of its cable strategy.

    In 1993, U S West became the first Bell company to break into cable -- acquiring a 25 percent stake in Time Warner's cable division and film studio for $2.5 billion.

    But that strategy has been under a cloud since September, when relations between U S West and Time Warner deteriorated into a barrage of lawsuits and name-calling after Time Warner arranged a deal to acquire Turner Broadcasting System without informing U S West.

    Now, U S West seems to be returning the favor. Lillis said the company only briefed Time Warner about the Continental deal late on Monday, just hours before the U S West and Continental boards voted to approve it early Tuesday.

    U S West had received Time Warner's authorization to resume talks with Continental last May, but Time Warner executives had remained largely out of the loop since then.

    Whatever the resolution of the problems between Time Warner and U S West, some analysts said that the Continental deal indicates that other phone companies may look to the cable industry as a means to expand beyond their regions and into new businesses like television or high-speed data delivery.

    "This is a precursor to telephone companies buying back into cable," said John Waller, the chairman of Waller Capital, a New York brokerage firm that specializes in cable deals.

    U S West's original investment in Time Warner prompted a raft of deals between telephone and cable companies that culminated when Bell Atlantic Corp. tried to buy the nation's largest cable operator, Tele-Communications Inc., later in 1993. But that deal -- and others like it -- collapsed after the government placed strict new regulations on cable rates.

    With the passage of the Communications Act of 1996, though, those rate regulations are largely gone. And Lillis said that it once again made sense for U S West to invest heavily in cable.

    He said Continental was a perfect match for U S West because its systems -- like those of Time Warner -- are clustered in big markets; Continental's biggest systems are in Boston, Los Angeles and Chicago.

    By upgrading Continental's and Time Warner's cable networks to carry telephone service, U S West could offer combined television and local telephone service in 66 of the top 100 cable markets -- drastically expanding its reach from the vast but sparsely populated Rocky Mountain region in which it now provides telephone service.

    Lillis said that Continental and Time Warner would upgrade 80 percent of their cable networks for phone service by the end of 1998.

    Yet, for every cable bull like Lillis, there are bears. Several analysts noted that no other Baby Bells have jumped into cable even since that industry's outlook has brightened -- preferring to husband their resources for long-distance or new forms of wireless technology, like personal communications services.

    Ivan G. Seidenberg, chairman of Nynex Corp., the New York-based regional Bell, said, "They are gambling that they will get a quicker return from the cable business than we will get from long distance or wireless."

    Moreover, the communications bill will enable local and long-distance phone companies to lease capacity on each other's networks at favorable rates. So some analysts wonder why U S West needs to make a huge capital investment in Continental's coaxial-cable networks.

    "They're putting an awful lot of money into physical infrastructure at a time when the wisdom of these infrastructure investments is being questioned," said Eli M. Noam, the director of the Institute for Tele-Information at Columbia University.

    Analysts also said that U S West is paying a full -- though not excessive -- price for Continental. Under the terms of the deal, U S West will pay shareholders of Continental $1 billion in preferred equity, which converts into common stock of the U S West Media Group, the Baby Bell's separate class of shares for its cable, wireless and overseas properties.

    In addition to the preferred stock, Continental shareholders will receive $1 billion to $1.5 billion in cash and $2.8 billion to $3.3 billion in common shares of U S West Media Group. Investment bankers who worked on the deal said that the transaction essentially guarantees Continental's shareholders $30 a share in cash and stock.

    In addition to Continental's cable subscribers, U S West would receive its stakes in Turner Broadcasting System; Prime Star Partners, a direct-broadcast satellite company; Teleport Communications, a Staten Island company that provides corporate clients an alternative to local phone companies in providing access to long-distance networks and assorted overseas cable properties.

    The on-again, off-again negotiations between U S West and Continental were led by Pearre Williams, a mergers-and-acquisitions lawyer for U S West, and Timothy P. Neher, the vice chairman of Continental. Executives involved in the deal said the breakthrough came when U S West agreed to guarantee the $30-a-share valuation for Continental.

    Meeting on Super Bowl Sunday at the New York apartment of Continental's investment banker, Steven Rattner of Lazard Freres & Co., Williams and Neher agreed that were U S West Media's shares to drop to less than $20.825, U S West would either inject more cash or stock into the deal or give Continental the option of calling it off.

    U S West Media Group's shares fell 50 cents, to $21.625, on the New York Stock Exchange on Tuesday. Shares of U S West Communications, which reflect the performance of the company's telephone operations closed at $33.50, down 37.5 cents.

    If the deal falls through completely, U S West has further pledged to invest $282.5 million in Continental for a small equity stake.

    In fact, it was Continental's hunger for capital that drove it to do the deal. The company is already investing hundreds of millions of dollars to upgrade its coaxial cable network to carry telephone traffic. But the local phone business is proving a tough nut to crack for even the largest and best financed cable companies.

    What is more, Continental and its cable brethren face fierce competition in their core business from Bell companies like Nynex and Bell Atlantic and long-distance carriers like AT&T and MCI Communications, which both recently made big investments in satellite television.

    In the wake of the Continental deal, analysts predicted that other large cable operators would likely sell themselves to phone companies. But as Lillis noted Tuesday, the roster of large, independent cable companies has already dwindled sharply.

    Hostetter seems to be casting his eye on at least one other player: Cablevision Systems Corp., which has 2.5 million subscribers in the suburbs of New York City. U S West already has a potent New York-area presence through its alliance with Time Warner.

    And Hostetter said Tuesday that he hoped U S West would be able to "integrate" Cablevision's systems -- if not through a deal than through a joint venture.

    Cablevision chairman Charles F. Dolan said Tuesday that he was receptive to new partners but preferred to remain independent. "Independence does not mean isolation," he said.

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