Malone Has a Plan to Liberate Europe

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Maybe John Malone is both lucky and smart. While he's been trying, with mixed success, to build up a European cable empire over last two years, a financial crisis in the industry has made his dreams of patching together a big European footprint a lot less expensive — and potentially a lot more feasible.

Malone, the chairman of Liberty Media Corp., suffered a major setback earlier this year, when regulators rebuffed his plans to buy cable systems serving 10 million customers for Deutsche Telekom AG. But the same systems he originally agreed to acquire for 5.5 billion euros ($4.9 billion at that time, now $5.5 billion) are now worth only $2 billion to $3 billion.

"Malone should thank regulators for saving him billions of dollars," quipped one longtime associate.

TRIPLE WHAMMY

Much the same can be said for the other cable assets Malone has considered acquiring in the last year. Huge debts, disappointing returns and lack of capital have pushed the European cable industry into a severe financial crisis.

"This is certainly the toughest period for raising capital [for European broadband and cable assets] in the last two or three decades," said Richard Callahan, the founder of Callahan Associates, which has investments in European cable systems serving 8.1 million subscribers.

Already, the lack of capital has made it difficult, if not impossible, for MSOs to fund operations and pay off debts accumulated during the telecom bubble. A number of Europe's largest operators, including NTL Inc., Telewest plc and United Pan-Europe Communications N.V. have been forced to restructure their debts or begin talks with bondholders about a recapitalization.

Massive debts and slumping stock prices are also forcing companies to divest capital-intensive pay-TV operations.

In an attempt to cut their debt loads, DT in Germany and France Telecom have announced plans to sell off their remaining cable assets. NTL is also considering asset sales in France, Germany and Switzerland.

Vivendi Universal S.A.'s new management has also restructured the Canal Plus Group, a move that will probably lead to the sale of cable assets in France and direct-to-home platforms in Italy and Poland.

AMERICANS COMING

Many analysts and pay TV executives believe these financial troubles will produce a dramatic restructuring of the European cable industry in a few years.

"In two or three years, at least one-third of the European cable market — and maybe as much as 40 percent — will be [directly or indirectly] owned by American investors," said Henk de Goede, the president of the European Cable Communications Association and CEO and president of Casema N.V., a large Dutch operator that Liberty Media hopes to buy from France Telecom for $737.3 million in cash.

"Given the current climate, there is a real opportunity to buy some assets with a great potential at fire-sale prices," added Janco Partners cable analyst Matthew Harrigan.

Liberty executives are currently keeping quiet about their plans in Europe, and declined requests for interviews. But there is little doubt that they remain committed to building a European cable empire.

Financial problems at UnitedGlobalCom, which controls UPC, Europe's largest cable operator, allowed Malone to buy 73 percent of UGC earlier this year at a heavily discounted price.

European cable executives and people familiar with Malone's strategies stress that this deal is only the beginning, and that Malone continues to explore a number of major cable acquisitions.

While Liberty is not among the five final bidders for the DT cable assets Malone tried to buy last year, they believe that Malone will eventually buy some or all of DT's systems.

"John is a very patient man," said one. "He'll wait until he can get the right price."

In the U.K., Malone failed to gain control of bankrupt operator NTL in March. Bondholder opposition also convinced him to withdraw a bid for 20 percent of Telewest's debt.

But Malone still owns 25 percent of Telewest and 10 percent of its bonds. Sources believe he's just waiting for prices to hit bottom. At that point, he will use his leverage to restructure Telewest and then cut a deal to merge it with NTL, creating a national cable system better able to compete with direct-to-home satellite operator British Sky Broadcasting plc.

Malone is also believed to be exploring deals to buy cable systems in France, where France Telecom, NTL and Vivendi Universal are selling assets, and in Switzerland, where NTL would like to unload it's investment in Cablecom. "Everything that comes on the market passes over John's desk," said one associate.

REGULATORY POTHOLES

These sources also doubt that setbacks and delays will have much long-term impact on Liberty's European expansion.

"The market hasn't hit bottom yet," Harrigan said. "There is no shortage of mid-term opportunities and no need to hop on everything."

At Liberty's annual shareholders meeting in May, Malone seemed to be thinking along much the same lines.

"We may end up back in Germany," he said. "At the moment, what seems to be cheap gets cheaper if you wait."

But it's far from clear that Malone can overcome some political obstacles to his plans. Regulators in Europe have nixed a number of pay TV mergers in recent years, and they remain worried that Liberty will acquire too much control over a culturally sensitive industry.

Dutch regulators have already expressed concerns over the Casema deal, which would give Liberty direct and indirect control of about 60 percent of the country's cable subscribers.

"There's a fear that Malone is a cowboy who will buy and strip down Casema's assets so he can sell them for a profit," admitted Casema's de Goede. "This isn't true. Liberty understands cable. They know it is a long-term investment, and they support our business plans."

Even if the regulatory issues can be overcome, Malone will still face the difficult task of building up his cable holdings and adjusting to the peculiarities of the European multichannel business.

"Europe isn't a little America," cautioned de Goede.

Business models and regulatory regimes for the cable industry vary widely across the region.

LOW 'ARPU' COUNTS

One major difference with the U.S. market is that in Europe, monthly revenue averages are low in many territories and consumers view cable as a kind of utility. UPC gets only 13.29 euros ($13.29) a month from its subscribers across Europe, while Casema charges its customers only 10 euros ($10) for the basic TV service.

Operators have tried to make up that shortfall with new services: digital television, data and voice. But the take-up for DTV in some markets, such as the Netherlands, has been slow. Casema, for example, has 1.35 million cable TV subscribers, but only 35,000 of them have signed up for DTV.

"Consumers are not willing to pay the extra price for DTV," says Casema's de Goede.

High-speed Internet services and telephony have been much more successful, and have played a key role in bumping up average revenue per unit (ARPUs) at UPC, which now has about 600,000 subscribers for its broadband service chello.

In Western Europe, UPC's ARPUs increased 15 percent over the last year, to 19.88 euros ($19.88) at the end of the second quarter of 2002.

But time may be running out for some cable operators. Financial troubles at NTL and Telewest in the U.K. allowed BSkyB to capture subscribers from both, and both operators showed declines in their cable-subscriber rolls in the second quarter. Increasingly, BSkyB and other DTH operators are allying with companies like British Telecommunications to offer bundled packages of video, voice and data that can compete with cable's triple play of services.

"There is a danger in some markets that they will fall so far behind satellite that they'll never catch up," said Harrigan, who nonetheless believes Liberty has the operational expertise and the capital to revitalize a struggling industry.

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