Malone Has Cash, Is Yearning To Buy, Finds Pickings Slim

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New York— Flush with cash and a burning desire to lever up its balance sheet, Liberty Media Corp. is intent on bolstering its already impressive stable of television networks through acquisition this year. But what to buy?

At an investor meeting here last week, the media giant said that there are precious few properties for sale.

Chairman John Malone does have a wish list, though. He expressed a desire for National Geographic Channel — and even E.W. Scripps Co.’s cable assets — at the gathering last Thursday. Prospects for buying those networks seem remote, though, so Liberty might have to settle for small international cable properties that tie in with its existing Discovery Communications Inc. and QVC Inc. properties.

Liberty currently has about $1.5 billion in cash, $8.3 billion in nonstrategic securities and, after completing a $4 billion debt-reduction plan last year, has a leverage ratio of about 3 times annual cash flow. At the meeting, Malone told a packed Hudson Theater audience such a ratio is too low to deliver the desired returns to investors.

Beefing up its leverage will likely put Liberty at odds with the credit-rating agencies, which would likely downgrade its debt ratings below investment grade if Liberty took on a substantial amount of debt. That apparently is a risk Malone is willing to take.

“We have to be realistic in this world how we can finance things vis-à-vis the way ratings agencies want to establish credit credentials,” Malone said. “My philosophy has always been to finance businesses as close to the operations as possible.”

LMI MODEL

Malone pointed to Liberty Media International Inc., which was spun off into a separate publicly traded company last year. LMI has a debt cost of under 4%, each unit carries its own credit and its own currency, there are no parent guarantees or debt and yet it is not considered investment grade.

Malone said returns on equity for Liberty would be much better if it was levered at four or five times, like its cable peers.

“If you grow 10, 15, 20% a year in cash flow, that’s great,” Malone said. “If you’ve got leverage of reasonable cost debt at five times and you’re in a world of 10 times assets, it really does kick up your return on equity substantially.

“That’s really what wealth-building is about — return on equity accumulated over a long time frame. I think we just conclude that a number of our businesses cannot provide an acceptable return on equity capital unless they carry a substantial amount of leverage, which is beyond the leverage the ratings agencies think is appropriate for certain businesses.”

POINTS EQUAL BILLIONS

Ticking up Liberty’s leverage by two points could mean borrowing as much as $7 billion. Coupled with the cash and nonstrategic securities on its balance sheet, that leaves Liberty able to make a substantial acquisition.

Adding to Liberty’s deal-making currency is the planned spinoff of its 50% interest in Discovery Communications Inc. along with its 100% interest in Ascent Media Group into a separate publicly traded company. That deal is on track to being completed next month.

Malone said that while he would like to have the remaining interest in DCI included in the spin-off, it is unlikely that the owners of those stakes — Cox Communications Inc. and Advance/Newhouse Communications — would participate.

Keeping Cox and Newhouse away from the deal is their desire to keep DCI’s governance at 50-50 while assuming no tax risk. That, he said, would violate the Morris Trust structure of the spin, which requires the spinoff entity to retain more than 50% of the value and more than 50% of the vote.

“With the passage of time, post spin, these Morris Trust issues go away,” Malone said. “In that fullness of time, it will be much easier for the entity to accommodate the governance and ownership ambitions of Cox and Newhouse merging in. To try and do that in the short run is really a daunting challenge for the lawyers and the tax guys.”

Buying Nat Geo also has its roadblocks, Malone added. While he believes that it would be a perfect fit for Discovery, its other partners are unlikely to agree to a sale. Some analysts had speculated that Nat Geo could be sold to Liberty as part of a larger deal to exchange Liberty’s 17% voting interest in News Corp. Structured as a cash-rich split-off, News Corp. could acquire those shares for cash and a small operating asset.

But according to the rules governing such structures, Nat Geo would have to be a five-year trading asset for News Corp. (it is not) and it would have to have the blessing of Nat Geo’s other partners — the National Geographic Society, NBC Europe and British Sky Broadcasting plc.

“There would be no point in trying to buy the channel without having a strong working relationship with the Society,” Malone said, adding later that while he believes Liberty could get News Corp. to agree to including Nat Geo in some sort of resolution, it remains to be seen whether a deal could be engineered that would make economic sense.

Malone also seemed less optimistic that a deal to exchange the News Corp. stake could be reached soon. Earlier this month, News Corp. chairman Rupert Murdoch said the two were in discussions concerning the stake and that a deal could be reached as soon as August.

THEORIES TO PURSUE

“I’m glad that Mr. Murdoch’s views are that we are converging on a solution,” Malone said. “We continue to look for a win-win-win solution that good for us, good for News Corp. shareholders and good for the Murdoch family. We think we have a couple of theories that we’re moving forward on.

“That relationship is in good condition,” Malone added. “The issue comes down to third-party approvals or involvement in transactions that we’ve modeled with News Corp., but that we’re not ready to say anything about.”

But Malone later told reporters that a deal with News Corp. is “doable.” “If we can get over all the third-party issues and keep the tax guys happy, a [News Corp.] deal could be announced [by August],” he told reporters after the meeting.

Asked if the only third party issues revolved around Nat Geo, Malone replied, “There are others.”

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