AT&T Out Of Business

Had AT&T defined itself differently, AT&T could have easily been one of the world’s biggest companies instead of being out of business.”

It finally happened … AT&T is gone.

My career as a stock analyst was launched with a ludicrous prediction: that AT&T would soon go out of business. It happened. Last month AT&T agreed to sell out to SBC for a measly $16 billion, less than half the amount its one time spin-off, AT&T Wireless, garnered from SBC two years ago. (And, it’s the AT&T Wireless deal that really explains SBC’s purchase, as I’ll explain in a minute…)

The essential reason AT&T failed isn’t hard to find. And it wasn’t hard to see in 1999 either – but back then nobody was willing to listen.

AT&T Out of Business: The Problem

AT&T, over the course of several decades, made a fundamental business error: it became a company of process and not of function. AT&T defined itself as a voice long distance company. It had numerous opportunities to choose another path, but it chose to be America’s “long distance” company. And by that it meant circuit switched, dedicated voice. It was a company about a process: the process of switching dedicated circuits. That business came to an end with the Internet, which uses packet switching, not circuit switching. No more dedicated circuits, no more AT&T.

Had AT&T defined itself differently, AT&T could have easily been one of the world’s biggest companies instead of being out of business. Don’t believe the hype that the 1996 Telecom Act destroyed AT&T or that the breakup of AT&T in 1984 is responsible. The worst choices AT&T made, it made all by itself. It always perceived communication as something that happened on its circuits, rather than something that happens between people, whatever the medium. Had AT&T perceived its mission to be empowering communication, many things would have happened differently.

AT&T Out Of Business: AT&T’s Mistakes

For example, it was at AT&T’s Bell Labs that the transistor was discovered. The transistor, as the basic building block of an integrated circuit and the heart of every computer chip in the world, is undoubtedly the greatest invention of the last century. Next to electricity and perhaps the pathology of bacteria, the transistor is the greatest scientific development in the history of mankind. AT&T developed the transistor as a way to amplify long distance calls and it never realized any other significant value from the invention. In 1956, in order to keep its long distance monopoly, AT&T agreed to give away, for free, its license to the transistor, placing its designs in the public domain.

You might make an argument that back then AT&T didn’t know what it had – but that’s simply not true. Texas Instruments, General Electric and Fairchild all spent $25,000 buying licenses to AT&T’s transistor patents before they became public. Lots of people in engineering knew how important transistor technology would, and did, become.

Besides, the transistor wasn’t the only time AT&T dropped the ball. Another great example is the cell phone, which as you will see, led directly to the sale of the company.

As with the transistor, it was Bell Lab researchers who developed the concept of a portable phone whose calls could be passed from tower to tower (from cell to cell). But, in 1983, before AT&T was broken up, when the FCC was figuring out how to dole out licenses, AT&T chose not to bargain for cell phone licenses. AT&T’s CEO at the time, Charles Brown, decided cell phones were a strictly for local calling. It wasn’t until 1993 – ten years later – that AT&T realized how badly it missed the boat.

That year it spent $14 billion acquiring McCaw Cellular. It paid too much and bought too late. McCaw cellular was built on obsolete, analog technology, using something called TDMA technology, which wasn’t very efficient. Even after spending billions to upgrade the network to digital service, AT&T wasn’t going to be able to offer the high-speed data services – the so-called “3G” services – at any reasonable price on this obsolete network. Its competitors, Sprint and Verizon, could cheaply upgrade their networks, which were built with CDMA technology and which are extremely spectral efficient. AT&T bought a lemon, in other words. I didn’t even believe how bad the situation was until I saw the numbers: AT&T spent $10 billion more on AT&T Wireless than it made in operational profits during the five years running up to 2001, when it went public. That’s two billion dollars a year, down the drain.

AT&T’s cellular business – instead of being a global triumph – was a complete disaster that could have driven AT&T bankrupt.

AT&T Sells Out:

To raise much needed cash, AT&T sold 24% of the business to Japan’s top wireless company, DoCoMo, for $9.8 billion in 2000. Unbelievably, AT&T kept $4 billion of this cash for its wire line business. Meanwhile, it left AT&T Wireless with all of the obligations of the deal (more about these obligations in a second). But, in less than a year, even more capital was needed. AT&T then sold the rest of AT&T Wireless to an unsuspecting and ignorant public. It picked the grandiose three letter symbol: “AWE.”

It wasn’t as much an IPO as it was a crime.

In an era of excess and abuse of public trust, the IPO of AWE set new, low standards. And lots of people knew it too. Even Jack Grubman – the quintessential telecom prostitute on Wall Street wouldn’t praise the stock publicly unless his kids got into the best school in Manhattan. His boss, Sandy Weill, an AT&T board member, and the chief of Citigroup, which led the AT&T Wireless IPO, made it so. (See PSIA July 2003.)

Using its brandname and powerful social connections, AT&T could still dupe the rubes. But, in technology circles, the stock was ridiculed and known by the nickname: “AWEful.” Even George Gilder, who had hardly ever seen a telecom stock he didn’t love, wrote a scathing and prescient editorial in the Wall Street Journal, warning investors to stay away from AWE.

And … there’s one crowning part to the sordid tale.

DoCoMo was no idiotic individual investor, falling for the magical brand name. To get DoCoMo’s money, AT&T Wireless had to promise to build a W-CDMA network in several major U.S. cities. DoCoMo needed this network build-out to ensure the technology it was using, GSM, would work in America. (Europe adopted the GSM standard a dozen years ago, and, as a result, almost all global cell phones operate on GSM, which was not compatible with AWE’s existing TDMA technology.) The GSM build out turned into a major problem, because by the time the technology was ready, AWEful was broke. But, no matter what, AWEful had to build the network, or buy back all of DoCoMo’s shares – for $24.00 each, a $9.8 billion obligation – by December 31, 2004.

Cingular Comes In:

And this, believe it or not, is where Cingular comes in…

The only way out of the DoCoMo mess was to sell AWEful to the other major, U.S. TDMA-legacy carrier: Cingular. Cingular is a joint venture, owned by BellSouth (40%) and SBC (60%). The deal to buy AWEful made sense for Cingular only if it got a good price and if it was able to retain AWEful’s customers for a long time. Theoretically, by buying up AWE’s subscribers, Cingular could spread its network costs over a much larger audience and achieve substantial cash profitability.

That’s why Cingular agreed to pay $37 billion – roughly three times the average market value of the stock in 2003. It was a ludicrously high price to pay. Funding it, for example, required BellSouth to unload its valuable cellular monopolies in Central America. Retaining AWE’s subscribers was, therefore, a top priority.

But, the one thing I’d always found shocking about the IPO of AWEful was that AT&T sold it to the public without any rights to the AT&T Wireless brand name.

I couldn’t believe it when I read in AWE’s filings that it didn’t own its name – it only licensed “AT&T Wireless” from AT&T. Right there in the prospectus, in plain language, it explained that, in the event of a change in control, the right to the name “AT&T Wireless” would revert back to AT&T.

I don’t know for a fact that SBC and BellSouth (Cingular’s owners) weren’t aware of this issue. But I do know if they decided to spend $37 billion buying AWE without the brand name, they made a huge mistake – a $16 billion mistake actually. You see, even before Cingular’s purchase of AT&T Wireless was completed, AT&T arranged to revive the AT&T Wireless brand name.

After selling its existing wireless business for $37 billion, AT&T planned to compete with Cingular by simply reselling access to Sprint’s superior network using the AT&T brand. Rather than build its own network, the company that invented cellular technology was relegated to cheating Cingular by reselling Sprint’s service. It’s pathetic, isn’t it?

Meanwhile, Cingular couldn’t afford to compete with AT&T Wireless after spending $37 billion to buy it.

Imagine the confusion. Already it was going to be tough to explain to millions of customers why they were suddenly receiving their bills from Cingular when they’d signed up for AT&T Wireless. Cingular has to make the customers understand that it bought AT&T Wireless and that now they are Cingular customers, right? But how can you do that when there’s a brand new company, also called AT&T Wireless, that’s out there marketing a better service for a lower price.

To prevent AT&T from using the AT&T Wireless brand name, one of the two Cingular partners had to buy AT&T. BellSouth couldn’t afford it. And that left SBC. This deal isn’t about getting AT&T business customers, as you keep hearing the business press. This deal is really about saving Cingular’s acquisition of AWE.

In the end, the bitter end, AT&T got $16 billion for its dead-in-the-water business because it managed to cheat, bully, and threaten its way into a deal.

Business isn’t about process. Business is about solving problems: functions.

By Porter Stansberry

The Daily Reckoning