Cable Operators

Break Up To Make Up

3/20/2005 7:00 PM Eastern

Frustrated with a stock market that it can't seem to please — though heaven knows, they've tried — cable operators and programmers are finding solace in their own version of the classic breakup song.

In the past four months, two MSOs — Cox Communications Inc. and Insight Communications Co. — turned their backs on the public markets by buying up their shares and going private. Last week, a pair of programming giants, Liberty Media Corp. and Viacom Inc., initiated plans to split their operations in two.

Liberty Media Corp. set the stage early last week with its proposal to spin off its 50% interest in Discovery Communications Inc. and its 100% stake in television production arm Ascent Media Group Inc. into a separate publicly-traded company, called Discovery Holding Co.

Anatomy of a Breakup
Viacom said last week that it is considering splitting itself into two separate entities. Here's a snapshot of what they could look like:
Source:Multichannel News research
MTV
President and COO: Tom Freston
MTV Networks 17 cable networks including: MTV: Music Television; Nickelodeon, Nick at Nite, VH1, Comedy Central, SpikeTV and Noggin
Paramount Pictures (movie studio)
Paramount Home Entertainment (distributor of home video)
Paramount Parks (five regional theme parks)
Famous Players and United Cinemas International (1,700 movie screens nationwide)
Simon & Schuster (publisher)
CBS
President and COO: Les Moonves
CBS (No. 1 broadcaster in U.S.)
UPN (broadcast network reaching 86% of U.S. homes)
Viacom Television Stations Group (39 TV stations)
Paramount Television (one of largest suppliers of television programming for broadcast, cable and syndication)
CBS Enterprises (television production and syndication, includes King World TV syndication)
Infinity Broadcasting (185 radio stations, most in top 50 markets)
Viacom Outdoor (outdoor advertising)
Viacom Consumer Products (entertainment licensing)

Viacom followed, noting that it's considering cleaving itself into two separate units. One, including assets like MTV Networks and Paramount Pictures, would be run by co-president and co-chief operating officer Tom Freston. The other, consisting of more mature properties like the CBS Television Network, radio's Infinity Broadcasting Corp. and outdoor advertising, would be led by co-president and co-COO Les Moonves.

Viacom chairman Sumner Redstone would become chairman of both new entities.

Both deals fall in line with the media sector's newest mantra: unlocking the value of undervalued stocks.

“We believe that a separation of our businesses into distinct and strong operating entities would allow us to optimize our capital structure and create unique investments that are more appealing to investors with different objectives,” Redstone said in a statement.

Viacom's decision came merely hours after influential Merrill Lynch & Co. media analyst Jessica Reif Cohen issued a report suggesting that a split-up could create more shareholder value.

Whether this will become a trend in the media sector still remains to be seen, although several analysts speculate that Time Warner Inc. may be the next media giant to follow the deconsolidation route.

Time Warner is expected to spin off its cable properties into a separate entity if it's successful in winning the auction for Adelphia Communications Corp.

Last December, Cox Enterprises Inc., which owned 62% of Cox Communications Inc., completed an $8.5 billion buy out of the remaining 38% public float of the MSO. And earlier this month, Insight chairman Sidney Knafel and CEO Michael Willner teamed up with private-equity house The Carlyle Group to purchase the remaining 86% of the MSO for $650 million. That deal is still pending.

But for other media giants, like The Walt Disney Co. and News Corp., holding on to their asset base or supplementing it with new holdings appear to remain the strategies of choice.

Most observers said that while Disney could spin its ABC Television Network and ESPN cable networks into a separate entity, it would lose more than it would gain in such a separation. Many analysts believe that ABC and ESPN already make up the bulk of Disney's stock price now.

Though Disney could spin off its radio business or its theme parks, most analysts believe that is unlikely because those units wouldn't receive an attractive valuation.

For its part, News Corp. has been making moves to consolidate its businesses, not break them up.

Last year News Corp. proposed buying in the remaining interest of Fox Entertainment Group it doesn't already own in a deal valued at about $6 billion. That deal was expected to be approved late last week.

Most analysts also expect News Corp. to eventually consolidate direct-broadcast satellite powerhouse DirecTV Group Inc. (in which it already owns a 34% economic interest) into the parent within the next few years.

LANGUISHING STOCK PRICES

While Liberty and Viacom shares have shown decent returns in the past 10 years — they've risen 315.4% and 58.3% between 1995 and 2005, respectively — lately the stocks have languished. Liberty shares have dropped 52.2% in the last five years and Viacom is down 32% in the same time frame.

ACT II Partners general partner Dennis Leibowitz said the motivation behind the moves is simple — frustration with their stock prices.

“There is a general frustration with the fact that media stocks have been poor performers,” Leibowitz said. “All last year the media sector was down and this year they are down as well.”

Leibowitz added that Viacom, in particular, has been stagnant, despite Redstone's efforts to goose the shares through an $8 billion buyback authorization last year. So far, Viacom has repurchased about $3 billion of its own stock and has seen little response in its stock price.

But splitting Viacom in two appears on the surface to be a lot of effort and money to achieve what could be only a short-term lift to the stock. While Liberty has a long history as a holding company, Viacom's plan seems less appealing.

“Liberty's a little different — you've always had a spread between public and private values,” Leibowitz said. “So, [Liberty chairman] John [Malone] has become more active in trying to do things that will actually close the spread.”

Leibowitz added that Liberty's moves to split off its international cable assets into Liberty Media International Inc. last year are an example of how the media giant has created value. LMI, which began trading last June at $38.50 per share, closed at $45.64 on March 17.

Viacom stock did get an initial lift after the March 16 announcement of the split-up — it rose 8% ($3.04 per share to $37.33 in two days — but it fell back to $37.03 as investors began to wonder just how the two companies will look.

Still uncertain is who will be CEO of each company. While Freston and Moonves will run the respective entities, Redstone has said in published reports that he will be CEO of both. And the break-up also seems to fly in the face of the reason for doing its $44.4 billion merger with CBS in 2000 in the first place.

“I'm skeptical on the Viacom side, because I don't really know from a business standpoint what it accomplishes,” Leibowitz said. “I don't know if Viacom the broadcast company and MTV the cable company are going to sell in such a way that the two parts are going to be at a big premium. Is one plus one equal to more than two here?”

One concern is that Viacom's cable networks could lose some clout with operators because they would not be able to use CBS as a sledgehammer — through retransmission consent — to force distributors to accept higher carriage fees or take on new networks.

Viacom got into a heated public fight with EchoStar Communications Corp. last year regarding carriage fee increases. EchoStar pulled Viacom cable networks and 15 CBS broadcast stations from Dish Network in 16 of its markets, but relented after less than two days.

Despite that concern, American Cable Association president Matt Polka believes Viacom will find a way to use retrans consent to launch new networks.

“I'd have to see it to believe it, the day when Viacom wouldn't tie [cable] programming to broadcasting,” Polka said.

While the MTV spinoff would likely be the growth stock, Leibowitz said Viacom could position the CBS entity as a more stable investment that returns steady cash to investors.

“The key is, is it a dividend stock?” Leibowitz said. “One thing that can make a difference, at least financially if not operationally, is to make the broadcast company a high dividend return to shareholders. That could get the stock price up because even if you don't grow very fast, the free cash flow is so high that if you paid a lot of it out, you could support the stock or increase the stock price that way.”

In a research report, Banc of America Securities analyst Doug Shapiro said the split may present a short-term benefit, but probably won't fundamentally unlock the value of the assets.

Shapiro wrote that while the split could solve succession issues at Viacom, make it easier for both entities to make accretive acquisitions and is more tax-efficient than selling non-core assets, its major drawbacks are the loss of synergies between the cable and broadcast divisions and the inability of the high-growth assets to access low-cost capital from the more mature cash-flowing properties.

“We don't believe just breaking up the assets makes them worth more,” Shapiro wrote.

The Discovery spin is a little different. For the separation to be effective, Liberty will most likely need Discovery's other partners — Cox and Advance/Newhouse Programming Partners, each with 25% of the network — to contribute their stakes to the spinoff.

WHITHER DISCOVERY PARTNERS?

While Malone expressed optimism that Cox and A/N would join in, he added that Liberty has had only preliminary discussions with both partners.

On a conference call with analysts, Malone said the two could contribute their interests into Discovery Holding, or Liberty could eventually sell its 50% stake to Cox, Advance/Newhouse, both or someone else.

“There are lots of ways this can evolve,” Malone said. “I would put a fair amount of money on the table that Cox and Newhouse will want to merge into this vehicle.”

Cox spokesman David Grabert said the MSO is evaluating the Liberty proposal, but it's still too early to tell whether the company will participate.

Malone also said on the conference call that more spinoffs could be forthcoming, adding that Liberty is currently looking at all of its assets to determine which ones could stand on their own.

“They don't have to be huge, but they should be assets that can become, when separated from the portfolio, leaders in their field, and sort of the black hole, if you want to call it that, that consolidates other assets around them and becomes a very strong growth asset that our shareholders would own directly,” Malone said.

Linda Moss contributed to this report.

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