Financial Implications of AT&T Comcast Merger For Mile Hi Cable Partners, L.P.

Report Prepared for Dean Smits, Director Office of Telecommunications for the City and County of Denver

by Ronald J. Rizzuto, Ph.D.

Professor of Finance University of Denver

June 5, 2002

Financial Implications of AT&T Comcast Merger For Mile Hi Cable Partners, L.P.

Table of Contents
Page 3 5 6

Executive Summary Scope of Work Overview of Merger Financial Profile of AT&T Comcast After Completion of the Merger Financial Ability of Mile Hi Cable Partners To Satisfy Franchise Commitments

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Exhibit 1 Financial Profile of AT&T and Comcast Before and After the Merger

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Exhibit 2 Summary Credit Statistics of Selected Cable Companies Exhibit 3 - AT&T Comcast Free Cash Flow Analysis Base Case Assumptions Exhibit 4 - AT&T Comcast Free Cash Flow Analysis Synergy Case

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15

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Executive Summary
The purposes of this report are to access: 1) AT&T Comcasts debt levels, profitability and ability to sustain its current levels of capital spending after the completion of the merger, and 2) whether Mile Hi Cable Partners will have sufficient capital resources to complete its upgrade of the cable system in the City and County of Denver. It is the opinion of the author of this report that AT&T Comcast will be financially healthy after the merger and the likelihood of a capital crunch will be quite low. Although debt levels for AT&T Comcast will be $38.1 billion when the merger closes, the company will delever significantly during 2003. Debt will be reduced by approximately $10 billion as the company converts convertible and exchangeable debt into common stock. AT&T Comcasts debt ratio (Debt/EBITDA) will be 6.4 when the merger closes. This is in the middle of the debt ratio range for the industry. If AT&T Comcast performs as expected in 2003, it will have a debt ratio that is among the lowest in the industry. In all likelihood, AT&T Comcast should be rated an investment grade credit, and, consequently, have reasonably good access to the debt market. AT&T Comcast should have the capital resources to execute its business plan in the near term. Sufficient internally generated funds, together with external financial resources, should be available to sustain capital expenditures in the $5.5 - $5.8 billion range.

AT&T Broadband management provided Denvers Director of Telecommunications and the author of this report a proprietary and confidential briefing on the status of the upgrade for the City and County of Denver. At this meeting it was disclosed that Mile Hi Cable Partners needs additional capital allocations from AT&T Comcast to complete the upgrade in the City and County of Denver. Some of these funds have already been allocated for 2002, however, the remaining capital needs to be approved as part of AT&T Comcasts Capital Plan for 2003. This capital approval process will not be completed until the fall of 2002. All indications are, however, that the necessary capital will be provided. There is some probability that MHCP will not receive the necessary capital appropriation by AT&T Comcast; however, this probability is quite low. Mile Hi Cable Partners capital needs are likely to be among AT&T Comcasts highest priorities because of: the franchise requirement to complete the upgrade by 2003 competitive pressures AT&T Comcasts opportunity to generate incremental revenue from new services.

II. Scope of Work

This report focuses on the following two key aspects of the AT&T Comcast merger. First, it considers the financial condition of the parent company, AT&T Comcast, after the merger. In particular, this report focuses on AT&T Comcasts debt levels, profitability and ability to sustain its current levels of capital spending after the completion of this transaction. Second, the report addresses whether Mile Hi Cable Partners will have sufficient capital resources to complete its upgrade of the cable system in the City and County of Denver.

III. Overview of Merger

On December 19, 2001 the AT&T and Comcast board of directors approved a definitive agreement to combine AT&T Broadband and Comcast. This agreement concluded more than a year long effort by AT&T to restructure its ownership of AT&T Broadband. AT&T Corporation began 2001 with the intension of spinning off AT&T Broadband into a separate, publicly held corporation. However, in July, 2001, Comcast made an unsolicited offer for $58 billion to purchase AT&T Broadband. AT&T rejected the offer as too low, but eventually decided to sell AT&T Broadband instead of spinning it off as a separate company. Several bidders (i.e. AOL Time Warner, Comcast and Cox Communications) submitted bids for AT&T Broadband. AT&T agreed to sell its broadband unit to Comcast for an estimated $72 billion.1 The $72 billion is broken down as follows: $47 billion stock swap value $20 billion debt assumption $5 billion assumption of QUIPS (Quarterly income preferred securities) obligation to the Microsoft Corporation. The merger between AT&T Broadband and Comcast is complicated by several factors. First, AT&T Corporation needs to spin-off the Broadband Division to AT&T shareholders. Each AT&T shareholder will receive one share of AT&T Broadband for each AT&T Corporation share that they own. Second, AT&T Broadband and Comcast will merge to form a new company AT&T Comcast. Each AT&T Broadband shareholder will receive
1

This purchase price was based on Comcasts share price of $38 at the time of the agreement. The actual purchase price will vary depending on the final Comcast share price when the deal closes. In addition, the actual number of shares exchanged may change as well. 8

approximately .35 shares of AT&T Comcast for each Broadband share. Each Comcast shareholder will receive one share of AT&T Comcast for every Comcast share. Third, Microsoft will swap its $5 billion QUIPS (quarterly income preferred stock) investment in AT&T for 115 million shares of AT&T Comcast shares. Fourth, AT&T Comcast is creating a shareholder voting structure where a disproportionate percentage of the common shareholder votes are controlled by AT&T Comcast Class B shareholders (i.e. Surel LLC controlled by Brian Roberts). Once this transaction is completed, the AT&T Comcast organization will have the following ownership people: Preferred Structure*2__________ Number of Economic Common shares Voting % Ownership (millions of shares) AT&T Comcast Class A 66.7% 61% AT&T Comcast Special Class A 0% 38.6% AT&T Comcast Special B (Surel LLC) 33.3% .4% Total 100.0% 100% * The Preferred Structure will need to be approved by shareholders. 1433.5 907.1 9.4 2,350

In this preferred structure, existing AT&T Broadband shareholders will own 54.8% of the economic interest and have 60.6% of the voting interest.

If the Preferred Structure is not approved, then AT&T Comcast Class A shareholders will control 5.1% of the common votes. AT&T Comcast Special Class A will have no vote. AT&T Comcast Class B will still have 38.6% and an AT&T Comcast Class C group will be created an they will have a 61.5% voting stake. 9

IV. Financial Profile of AT&T Comcast After Completion of the Merger

As Exhibit 1 illustrates, AT&T Broadband and Comcast are comparable sized companies in terms of revenues - $9.8 billion vs. $9.7 billion, respectively.3 However, Comcast is more profitable (i.e. Earnings Before Interest, Taxes, Depreciation and Amortization [EBITDA] of $2.7 vs. $2.0 billion)4 and has less debt. At the end of 2001, Comcast had $12.2 billion in debt as compared to AT&T Broadbands debt of $23.2 billion. These debt levels translate into a Debt/EBITDA of 4.5 for Comcast and 11.4 for AT&T Broadband. The merger of AT&T Broadband and Comcast at the end of 2002 will create a combined entity, with revenues of $21.5 billion, EBITDA of $5.96 billion and a debt level of $38.1 billion. As Exhibit 1 illustrates, during 2002 both companys revenues, EBITDA and debt levels will grow. However, on a relative basis, the EBITDA will grow faster than the debt so that the combined Debt/EBITDA will decline from 7.5 to 6.4. Although debt levels for AT&T Comcast will be higher in 2002, the borrowing will drop significantly during 2003. AT&T Comcast debt will decrease from $38.1 billion to $28.5 billion as the company converts convertible and exchangeable debt into common stock. The debt ratio for AT&T Comcast will decline from 6.4 to 3.7 during this time period. This reduction in leverage is primarily the result of 1) improvement in margins at AT&T Broadband, 2) conversion of debt to equity, and 3) growth in revenues for the combined companies.
3

Comcasts total revenues include its electronic retailing business (QVC) as well as cable revenues. If one considers only Comcasts cable revenues, then Comcasts 2001 revenue is $5.2 billion. Comcasts EBITDA from only its cable operations was approximately $2.1 billion. 10

A review of the debt ratios and debt rating of cable companies in Exhibit 2 indicates that AT&T Comcast with a Debt/EBITDA ratio in 2002 of 6.4 will be in the middle with respect to the debt ratios in the industry. That is, Charter at an 8.9 Debt/EBITDA ratio is the highest and AOL Time Warner is the lowest at 3.2. If AT&T Comcast performs as expected in 2003, it will have a debt ratio that is among the lowest in the industry (i.e. 3.7 AT&T Comcast vs. 3.2 AOL Time Warner and 3.3 Cox). Currently, Comcast and AT&T Corporation long term debt are rated investment grade by Moodys.5 Comcast is rated Baa3 while AT&T is rated Baa2. AT&T Corporation debt rating was downgraded on May 29, 2002 to Baa2 from A3. Comcast is currently under review by Moodys for a possible downgrade as a result of the AT&T Broadband merger. Moodys is also reviewing the status of AT&T Comcast. Financial analysts who follow the cable industry are optimistic that AT&T Comcast will be rated investment grade (i.e. Baa2). On March 4, 2002, Fitch Ratings assigned indicative ratings of BBB to the senior unsecured debt obligations of AT&T Comcast. As Exhibit 3 illustrates, AT&T Comcast is projected to have to raise external capital during 2002 and 2003. In 2002, the company is projected to have a negative $2.548 billion free cash flow (i.e. cash flow after payment of all interest, taxes, capital expenditures, working capital and minority interests). Free cash flow will still be a negative $ .989 in 2003. In 2004 and beyond, AT&T Comcast is projected to be free cash flow positive, and, hence, not be in a capital raising mode. Given that AT&T Comcast needs to raise capital in the 2002 2003 time period, then it is possible that the company could experience a capital crunch and have to scale back its capital spending.
5

Bonds rated Ba and below by Moodys are considered junk bonds. The practical importance of investment grade as compared to junk bond are 1) junk bonds bear a higher interest cost, and 2) there is sometimes less capital available in this market.

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Such a capital crunch is not likely for the following reasons: 1. Numerous synergies have been projected to result from this merger.6 If these occur, then free cash flow may become positive more quickly. Exhibit 4 provides estimates of possible synergies for 2003 2007. In this forecast most are projected to occur in the 2005 2007 period. However, if they materialize sooner then free cash flow may be less negative in the near term. 2. AT&T Comcast will have significant investments that it may sell to get the cash needed to finance itself in the 2002 2003 period. These investments include AT&T Corporation stock, Sprint PCS stock, and Time Warner Entertainment. These assets are valued in excess of $12 billion. AT&T Comcast should have the capital resources to execute its business plan in the near term. Sufficient internally generated funds, together with external financial resources, should be available to sustain capital expenditures in the $5.5 - $5.8 billion range.7

The following synergies have been identified in the AT&T Comcast merger: Annual EBITDA Impact (millions) Programming cost savings $ 250 - 450 Continued Operating Efficiencies $ 200 300 National Advertising Platform $ 100 200 New Products $ 100 200 Comcast telephony $ 600 800 Total $1,250 1,950

Comcast executives have indicated that the combined companies may be able to trim between $200 300 million annually in capital expenditures as a result of economics of scale and efficiencies. 12

V. Financial Ability of Mile Hi Cable Partners To Satisfy Franchise Commitments

Mile Hi Cable Partners, L.P. (MHCP) is a limited partnership and originally included the P & B Johnson Corporation as general partner and Community Cable Television (CCT) and Daniels Communications as limited partners. The P & B Johnson Corporation owned 21% interest in MHCP. CCT had a 78% share and Daniels Communications had a 1% interest. In 2000, CCT purchased P & B Johnsons interest and now owns 99% of MHCP. With the AT&T Comcast merger, CCT will remain a 100% owned subsidiary of AT&T Broadband Corporation. CCT and MHCP will be dependent on capital allocations from AT&T Comcast to complete the upgrade of the City and County of Denver franchise.8 AT&T Broadband management provided Denvers Director of Telecommunications and the author of this report a proprietary and confidential briefing on the status of the upgrade for the City and County of Denver. At this meeting it was disclosed that MHCP needs additional capital allocations from AT&T Comcast to complete the Denver upgrade. Some of these funds have already been allocated for 2002, however, the remaining capital necessary for the completion of the upgrade needs to be approved as part of AT&T Comcasts Capital Plan for 2003. This capital approval process will not be completed until the fall of 2002. All indications are, however, that the necessary capital will be provided.
8

CCT and MHCP were legal entities originally created to finance cable operations in Colorado and Michigan. Although these entities are technically responsible for the financing of cable operations in Denver, in reality the parent company, AT&T Comcast, will advance the funds necessary for the upgrade. The only complication in this situation would be if either CCT or MHCP were obligors on any debt instruments. In this case there might be some financial jeopardy for MHCP. Legal counsel for AT&T Comcast has offered assurances that CCT and MHCP are not obligors on any debt instruments. In effect, these entities are debt free. 13

There is some possibility that MHCP will not receive the necessary capital to complete the upgrade in Denver. AT&T Comcast could experience a capital crunch and/or other corporate priorities may take precedence over MHCP needs. The probability of a capital crunch is quite low as noted in the previous section of this report.

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MHCP capital needs are likely to be among AT&T Comcasts highest priorities because: 1) 2) 3) The franchise requires the upgrade to be completed by the end of 2003. Competitive pressures from DirecTV, Echostar and Wide Open West dictate improvements in products and services. An upgrade will allow AT&T Comcast to generate new revenue streams from the additional services that can be provided with an upgraded plant (i.e. high speed data, telephony, video-on-demand and interactive services).

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Exhibit 1 Financial Profile of AT&T Broadband and Comcast Before and After the Merger
(dollars in millions)

Actual 2001 AT&T Broadband Revenues EBITDA Capital Expenditures Debt Debt/EBITDA $9,799 2,040 3,501 23,285 11.4 Comcast

Pro Forma 2001 AT&T Comcast $19,473.2 4,741.8 5,682.7 35,795.1* 7.5

Pro Forma 2002 AT&T Comcast $21,494.4 5,959.9* 5,794.5 38,084.5 6.4

Pro Forma 2003 AT&T Comcast $24,378.6 7,624.3* 5,808.7 28,492.5 3.7

$9,674.2 2,701.8 2,181.7 12,201.8 4.5

Synergies not expected in these figures

Source: Morgan Stanley

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Exhibit 2 Summary Credit Statistics of Selected Cable Companies

(dollars in millions)

AT&T Broadband 12/31/01

Comcast 12/31/01

AT&T Comcast 12/31/02 without synergies

AT&T Comcast 12/31/02 with synergies

AOL Time Warner

Cox Comm.

Cablevision Systems

Charter Comm.

Insight Comm.

Mediacom LLC

Ratings Senior

Baa2*

Baa31

Baa2/ BBB1

Baa2/BBB1

Baaa2/ BBB

Baa2/ BBB

Ba2/ BB+

B3/B+

B3/B-

Caa1/B+

Financials2 Subscribers (millions) 2001E EBITDA Total Debt & Convertible Debt Leverage Ratio Total Debt & Convertible/ EBITDA

13.6

8.6

22.0

22.0

12.8

6.2

3.0

7.0

1.3

1.6

2.0

2.7

$5.96

$6.53

$9.3

$1.6

$0.8

$1.8

$0.3

$0.3

$25.0

$12.2

38.1

$30.8

$29.6

$5.2

$5.4

$16.3

$2.5

$2.8

12.5x

4.5x

6.4x

4.7x

3.2x

3.3x

6.5x

8.9x

8.0x

8.5x

1 Both Comcast and the AT&T Comcast organization are under review by Moodys. 2 Pro forma for all announced transactions 3 Based on 2002E EBITDA. Includes $500 million in synergies * At 12/31/01, AT&T Corporation was rated A3 by Moodys. On May 29, 2002 Moodys downgraded AT&T Corporation to Baa2.

Source: Merrill Lynch and Company

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Exhibit 3 AT&T Comcast Free Cash Flow Analysis Base Case Assumptions
(millions of dollars)
Pro Forma 2002E* EBITDA Interest Expense Cash Taxes Capital Expenditures Working Capital Minority Interest Free Cash Flow $5,959.9 2,561.3 (133.1) 5,794.5 (12.9) 298.4 ($2,548.4)

2003E

2004E

2005E

2006E

2007E

$7,624.3 2,364.9 161.5 5,808.7 (55.0) 331.0 (988.9)

$9,331.2 1,937.1 520.4 5,347.8 (63.0) 360.3 $1,228.5

$10,802.6 1,950.5 838.6 4,396.8 (78.9) 391.8 $3,303.8

$12,419.9 1.989.1 1,088.9 3,686.3 (83.1) 419.0 $5,310.6

$13,973.6 1,978.1 1,614.9 3,682.8 (68.0) 446.7 $6,319.0

Pro Forma combines the companies as if they were operating as a single entity.

E = Estimated

Source: Morgan Stanley

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Exhibit 4 AT&T Comcast Free Cash Flow Analysis Synergy Case

(millions of dollars)
Pro Forma 2002E EBITDA Interest Expense Cash Taxes Capital Expenditures Working Capital Minority Interest Free Cash Flow $5,959.9 2,561.3 (133.1) 5,794.5 (12.9) 298.4 ($2,548.4)

2003E

2004E

2005E

2006E

2007E

$7,624.3 2,364.9 161.5 5,808.7 (53.0) 331.0 (988.9)

$9,331.2 1,937.1 520.4 5,347.8 (63.0) 360.3 $1,228.5

$10,874.0 1,950.5 851.1 4,396.8 (84.5) 391.8 $3,368.3

$12,575.4 1.989.1 1,116.1 3,686.3 (90.0) 419.0 $5,454.8

$14,228.9 1,978.1 1,668.5 3,682.8 (76.5) 446.7 $6,329.2

Pro Forma combines the companies as if they were operating as a single entity.

E = Estimated

Source: Morgan Stanley

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