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Viacom Belatedly Spins Blockbuster

2/15/2004 7:00 PM Eastern

Amid pressure from Wall Street to jettison Blockbuster, Viacom Inc. unveiled a plan last Tuesday that would spin off the video-store chain to shareholders on a tax-free basis.

In conjunction with a fourth-quarter earnings release, Viacom said its board of directors made the decision to split off the company's 81% interest in Blockbuster because it determined the video store chain would be better positioned as completely independent.

Viacom had been trying to sell off the unit — which generated $400 million in free cash flow (cash flow after interest payments and capital expenditures are made) for the media giant in 2003 — for years, but apparently didn't receive offers it considered attractive.

While Viacom left the door open to an outright sale — it said it would consider other alternatives — most in the financial community had expected the exchange offer.

Uncertainties about Blockbuster's future, as video-rental revenue has declined over the years, forced many Wall Street analysts and investors to put the pressure on for a sale.

Viacom had sold about 15% of its Blockbuster interest to the public in 1999, and told investors that it planned to sell the rest within a year.

But plans were put off, after a decline in stock prices and because Viacom chief operating officer Mel Karmazin likes Blockbuster's free cash flow.

Viacom did not release terms of the exchange, but said it would likely involve Viacom shareholders exchanging some Viacom stock for Blockbuster shares.

Viacom hopes to complete the exchange in mid-2004, which would likely result in a reduction in the number of outstanding shares of the media conglomerate.

On a conference call with analysts discussing third-quarter results, Viacom chairman Sumner Redstone called the spin-off decision a difficult one.

"We continue to believe in Blockbuster's long-term prospects, despite relentless, consistently overblown and always erroneous predictions of Blockbuster's demise," Redstone said on the call. "The fact is Blockbuster remains the No. 1 brand in home entertainment.

"But the business is evolving and moving away from our core areas of focus. Blockbuster will be far better positioned as an independent company."

Wall Street looked favorably on the decision.

"We think a divestiture is welcome news psychologically, because it will eliminate an overhang; it will increase the company's [cash flow] and [free cash flow] growth rates; and investors have been eager for a resolution," Banc of America Securities analyst Doug Shapiro wrote in a research note.

Viacom's stock price rose 96 cents on Feb 10, to $41.35.

Blockbuster overshadowed what turned out to be a mixed quarter financially for Viacom.

Overall, fourth-quarter revenue rose 11% to $7.5 billion and free cash flow topped $774 million as weak performance at it broadcast and TV station segment was offset by strong growth in its cable networks.

Cable networks reported another strong quarter – revenue rose 24% to $1.7 billion and operating income before depreciation and amortization rose 18% to $685.9 million.

Advertising revenue growth lagged that of 2002 — 6% compared to 14% — but Karmazin added that the 2002 figure included $61 million in political ads not available last year.

Full-year ad sales in 2003 outpaced 2002 by three percentage points — 8% growth in 2003 compared to 5% growth in 2002.

Cable network advertising was strong in the quarter — up 28% to — led by a 30% increase at MTV Networks and a 15% increased in ad sales at Black Entertainment Television.

Cash-flow margins (cash flow as a percentage of revenue) declined a bit, because of higher programming expenses.

Viacom also reaffirmed 2004 guidance of 5% to 7% revenue growth and 12% to 14% operating income growth.

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