The Humongous Hookup At&T Goes Cellular in a Big Way -- and Steals Yet Another March on Its Rivals

By THOMAS McCARROLL

It was a highly personal kind of deal, done in a quiet hallway of a New York City hotel, man to man. The place was the Waldorf Astoria, and the players were Robert Allen, chairman of AT&T, and Craig McCaw, head of McCaw Cellular Communications. In the middle of an edgy negotiation, they had left their factotums, emissaries and lieutenants behind and paced the corridor together for just 20 minutes before shaking hands on a transaction in which the largest U.S. telephone company would buy the No. 1 provider of cellular service for $12.6 billion in stock. In the process, Craig McCaw would become a billionaire and his three brothers (Bruce, Keith and John Jr.) all centimillionaires.

The AT&T-McCaw merger, which ranks as the fifth largest in U.S. corporate history, raises the ante in an industry that is being radically reshaped by emerging technologies, falling regulatory barriers and a series of powerful partnerships and alliances. It comes only weeks after phone giant British Telecom spent $5.3 billion for a 20% stake in MCI Communications, the second largest U.S. provider of long-distance service, and it closely follows U S West's $2.5 billion investment in media conglomerate Time Warner. Although the merger is praised by consumer groups because it could lead to lower phone rates and innovative products, many analysts predict that it will ring up even more industry turmoil as it reduces the boundaries separating long-distance and local telephone service. It will also bring AT&T into close competition with local telephone carriers, including the seven former Bell System companies, collectively known as the Baby Bells.

"This is going to set off another round of deals as everybody scrambles to find a dancing partner," says Peter Huber, a telecommunications consultant in Washington. "Competitors cannot afford to let this powerful alliance go unanswered."

Together, AT&T and McCaw will give rivals plenty of reason to fret. They are expected to strengthen each other's hold on their respective markets. By linking its own computerized telephone grid with McCaw's advanced cellular network, AT&T is expected to develop a broad menu of customized services. It could, for instance, bundle telephone handsets, long-distance and cellular service in a single package. With AT&T, Craig McCaw moves one step closer to realizing his biggest dream: building the first nationwide cellular-telephone network.

The merger turned out to be the richest -- and luckiest -- deal in McCaw's life. The two companies had first spoken of the arrangement last November when AT&T agreed to acquire 33% of McCaw Cellular of Kirkland, Washington, for $3.8 billion. Negotiations stalled, however, over the issue of how to divvy up strategic decisions and future profits. The solution of buying all of McCaw, rather than just part of it, might not have been possible a few months ago. Fortune intervened, however, when the value of AT&T's stock rose 46%, or $26.5 billion, between November and two weeks ago. Since the purchase price would be in the form of AT&T stock, the telephone giant could afford to splurge.

McCaw is itself the product of a series of acquisitions. The company grew out of a string of cable-television businesses that was put together in the 1960s by J. Elroy McCaw. After their father's sudden death in 1969, Craig and his brothers built a cable empire that they finally sold in 1987 to Jack Kent Cooke for $755 million. The McCaws had switched their focus to cellular, becoming initial bidders for cellular-telephone licenses after the Federal Communications Commission opened up that business to competition in the early 1980s. McCaw's big break came in 1986, when the company acquired the cellular business of MCI for $120 million. A year later, it bought the Washington Post Co.'s cellular business in Miami for $240 million. By 1988, McCaw was the largest cellular-telephone operator in the country, with 132,000 subscribers.

But the most valuable commodity of McCaw Cellular is Craig McCaw. Soft- spoken and unassuming, McCaw is a demanding chief executive who drives a 10-year-old car and wears a $30 plastic digital watch. A licensed pilot, he relaxes by flying his De Havilland-Beaver seaplane to remote lakes in the Pacific Northwest. The McCaw family, including Craig and his brothers, owned 20% of their company's stock. When the AT&T purchase is completed, their holdings will be worth a combined $2.8 billion, making the McCaws AT&T's largest independent shareholders. Craig, who will become an AT&T board member, will receive shares valued at $1.01 billion.

The cost of McCaw's visionary expansion is a staggering debt load of nearly $5 billion and losses of $715 million in the past two years. Even with that burden, McCaw is expected to play a crucial role in AT&T's quest to conquer the emerging field of wireless communications. Almost all calls now originate or terminate on conventional wall-jack telephones (even if they are cordless within the home). But analysts predict that cellular-type phones will gradually replace hard-wired sets. That could mean trouble for local telephone companies, whose monopoly depends on phones remaining tied down to a small area.

McCaw could turn out to be the Trojan horse that lets AT&T into the rigidly fortified local telephone business. Under the terms of the 1984 court-ordered breakup of the Bell System, AT&T is barred from re-entering that market. But with McCaw in hand, AT&T could skirt the restrictions, bypassing the local telephone network completely to provide long-distance cellular service directly to customers. If it succeeds, AT&T can sharply reduce the access fees it must pay the local carriers for the right to connect to their networks. Last year it paid $14 billion to the Baby Bells for that privilege.

The Baby Bells are worried about losing prime customers. Pacific Bell, for instance, relies on 10% of its high-volume customers for 50% of its residential toll revenues. If AT&T helps this kind of customer bypass the network, the Baby Bells claim, they would be left with higher-cost, less profitable customers, which would invite rate increases. Says William Ferguson, chairman of New York-based local phone company NYNEX: "Consumers could end up paying for this deal."

Although Ferguson will try to shoot down the deal, the AT&T-McCaw merger looks as if it may fly. While the Justice Department has yet to give the two companies the go-ahead, the FCC has in the past looked favorably at such transactions. If the agency does not approve, it can expect to be swiftly inundated with demands from the rest of the industry to be saved from the competitive behemoth that technology has spawned.

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CREDIT: [TMFONT 1 d #666666 d {Source: Cellular Telecommunications Industry Association}]CAPTION: LARGEST U.S. CELLULAR OPERATORS