Some of the Rule Breaker's stocks have got them Old Uncertainty Blues. First, Amgen (Nasdaq: AMGN) got beaten down last week after Merrill Lynch issued a downgrade in its long-term outlook because of potential short-term volatility brought on by the Epogen patent dispute. You can get a Foolish take here, or better yet, check out a real, long-term research report on Amgen, penned by the Fool's own Zeke Ashton.
Today, many of our fellow investors in eBay (Nasdaq: EBAY) fled the scene because of the FUD (Fear, Uncertainty and Doubt) surrounding a recent Justice Department subpoena. Jeff Fischer offered some thoughts on the situation in this post.
But I'd like to talk about the FUD engulfing Excite@Home (Nasdaq: ATHM) this week. The price shot up Wednesday on the news that the company had signed extended distribution agreements with its cable partners, but the bears have since emerged to drive Excite@Home back down to its starting point.
It's not surprising that this deal, like AOL's (NYSE: AOL) deal with Time Warner (NYSE: TWX), brought short-term volatility to the stock. It's complex. All the fine points have not been resolved. Still, this Fool's smiling about the whole thing like I just found $10 in my brother's pocket. Woo-hoo!
Let's puzzle through some of the changes this deal will bring to Excite@Home.
Distribution: Excite@Home will be the provider of platform/connectivity services used by its principal cable partners in delivering their high-speed Internet services. Keep in mind that platform services and connectivity services are mutually exclusive, and that the deal with AT&T (NYSE: T) differs from the deal with Comcast (Nasdaq: CMCSA) and Cox (NYSE: COX).
First, AT&T, with its 26 million homes passed (assuming that the MediaOne acquisition goes through), has agreed to use Excite@Home's platform services through 2008. That means that AT&T will be free to offer its own connectivity service or those of any third-party Internet Service Provider (ISP), after the current exclusivity deal expires in June 2002. Remember that Excite@Home collects a toll from every ISP that uses its platform. Tom Jermoluk, chairman of Excite@Home, calls this a great wholesale opportunity.
In addition, AT&T will offer Excite's connectivity service a featured spot on its home page with other ISPs through 2008, so long as Excite@Home offers compensation commensurate with that of other portals. That's not as strict a commitment as I would have liked, but the importance of appearing on the start page cannot be underestimated. This game is about getting market share early. Once an ISP nets a customer and integrates them into its system, it gets harder and harder to pry that customer away.
Comcast and Cox, who estimate that they will have 13 million and 10 million homes passed respectively in 2002, have agreed to similar conditions, but the deal expires in 2006. Furthermore, they have the right to end the exclusivity provisions (which also run through June 2002 under current agreements) and may also terminate the entire distribution arrangement beginning in June 2001. Note that Comcast has had the right in the past to end exclusivity, but hasn't done so. The deal provides incentives to maintain agreements, which I'll discuss in a moment.
In a nutshell, then, this agreement gives Excite@Home exclusive rights to the platform services for 50 million homes, as well as featured placement for connectivity through 2006. They also retain their exclusive connectivity agreements through mid-2002, and the three cable partners have agreed not to try to "remarket" any of the customers Excite@Home will have signed up by then. George Bell, Excite@Home's president and CEO, said that Excite could essentially "rope off" all of its customers at the end of exclusivity.
How many customers will that be? It's anyone's guess, but as of the end of 1999 subscribers totaled 1.1 million, with 24 million cable-ready to take on services. Last quarter, Excite@Home increased its subscriber base by 36%. If it can maintain a 25% rate through the end of exclusivity, Excite will have about 10 million customers by June 2002. At $50 per month, that's not small potatoes.
Ownership and Governance: The deal provides for an immediate change in governance at Excite@Home, once the companies get shareholder approval. Comcast and Cox will forfeit their seats on the board of directors at Excite@Home, together with certain veto rights. Excite@Home will also convert about 50 million of AT&T's Series A shares into Series B super-duper shares, each of which has 10 votes. This will boost AT&T's voting majority from 56% to 74%.
Because of this, Forbes.com pronounced the deal "AT&T's Stealth Takeover of Excite@Home." Stealth? These folks haven't been paying attention. The B shares were invented in June 1998 by TCI's John Malone -- a man with more than his share of vision -- in order to give his company a 72% voting majority in @Home. Lack of voting control over its own company is nothing new to Excite@Home or its shareholders.
I don't really have a problem with that, so long as the folks on top have a vested interest in the company and a vision of the future. I think that C. Michael Armstrong, AT&T's chairman, and John Malone have a very good idea of the possibilities that await Excite@Home. In that sense, I'd rather have them in control than a bunch of institutions and individuals who are upset that their shares haven't appreciated this week.
But there's more. AT&T has agreed to give Comcast and Cox the right to sell their shares in Excite@Home to AT&T for a minimum price of $48 a share after January 1, 2001. The price may be higher, but AT&T won't buy more than $3 billion worth. Comcast and Cox each own approximately 30 million shares, or about 8 percent, of Excite@Home.
Furthermore, Comcast and Cox will each receive warrants to purchase two shares for each home its system passes. At current estimates, that means 46 million shares. These warrants will vest in installments every six months beginning in June 2001, and be fully vested in June 2006, if Comcast and Cox have elected to continue their extended non-exclusive distribution agreements through that period. This provides the incentive for Comcast and Cox to stick with Excite@Home, rather than exercise their right to cancel their agreements.
AT&T will also have the right to purchase up to approximately 25 million Series A shares and 25 million Series B shares through 2008. The strike price for the warrants is just under $30. AT&T currently owns about 81 million shares.
This opens up a lot of uncertainty about the capital structure. Still, Excite@Home investors have seen the company cede huge numbers of shares and warrants to its cable partners since the beginning. That's not to mention that Excite@Home also granted 65% of its revenue to the cable guys very early on. That arrangement will not change.
These are noteworthy concerns, and we'll talk more about them in the future, but they can't be allowed to obscure the big picture. A major product transition will take place in Internet connectivity during the next decade. Broadband will become, if not an absolute necessity, at least as much a fact of life as the telephone or the television. In fact, it may well be the telephone and the television. That is the capability that AT&T, America's telephony and cable giant, is creating, and it wants Excite@Home to help it achieve its vision.
Excite@Home remains the best-positioned company to accomplish this transition, but it has to do so in concert with AT&T. With the governance of the company clarified and AT&T firmly in charge, Excite@Home is free to pursue deployment of its services. If they can become the dominate players in broadband, investors in both companies will flourish. If Wednesday's announcement helped clear the path to that goal, and I think that it did, I'm all for it.
-- Brian Lund, TMF Tardior on the boards.
P.S. The Fool's most recent Jester Award, which goes to an excellent book related to business and investing (and what isn't related!?) went to Genome, a superb book for any investor interested in biotechnology.
