Starz Socked by Boffo Box Office


Liberty Media Corp. warned that increased programming costs incurred by its Starz Encore Group LLC unit will likely decrease the premium cable programmer's 2004 operating income.

In a statement, Liberty said programming costs at Starz Encore will rise between $175 million and $225 million in 2004, mainly due to the expected box-office performance of movie titles that will become available to the premium channel during that time frame from movie studios.

Programming costs for 2005 are expected to be the same as in 2004, Liberty said.

Previously, Starz had been able to pass through a portion of its programming cost increases to AT&T Broadband. But because of pending litigation with Comcast Corp. — which purchased AT&T Broadband in November — the programmer can no longer do that.

Comcast has argued that Starz should honor the agreement it had with the Philadelphia-based MSO prior to the AT&T acquisition. Starz has contended that the AT&T agreement should move over to Comcast.

"Accordingly, unless this litigation is favorably resolved, or Starz Encore is able to generate offsetting increases in revenues or reductions in other costs, these increased programming costs are expected to result in a direct reduction to Starz Encore's operating income in 2004," Liberty said in a statement.

Liberty did not elaborate on how much of an affect the increased costs would have on 2004 operating income.

The news apparently spooked investors, who drove down Liberty's stock by more than 6% (74 cents per share) in 4 p.m. trading last Wednesday to $11.11 each.

Comcast sued Liberty in a Pennsylvania court in November saying it shouldn't inherit or be bound to the 25-year programming agreement Starz had with AT&T Broadband. Starz, which said that the Comcast lawsuit was without merit, had filed its own suit against AT&T Broadband about 18 months prior over the carriage deal, which stipulated that AT&T would owe Starz about $360 million in 2003.

Starz filed that suit after AT&T refused to comply with the affiliation deal it inherited when it purchased Tele-Communications Inc. in 1999. According to that deal — reached in 1997 — TCI was obligated to pay Starz $270 million in 1998, with payments rising to $360 million in 2003. After 2003, the payments increased at the rate of inflation.

At the time TCI signed the deal with Starz, Liberty, the premium channel's parent, was a unit of TCI.

Analysts saw the most recent disclosure as having a modest negative impact on Starz.

In a report, Stifel, Nicolaus & Co. cable analyst Ted Henderson said that he had estimated programming costs were about 50% of Starz revenue. With the new disclosure, that percentage increases to 68% and 61% of revenue for 2004 and 2005, respectively.

As a result, Henderson reduced his valuation multiple on Liberty from 14 times 2003 operating income to 12 times operating income. In his report, he said the blended impact of the programming increase is a $350 million reduction in valuation.

Henderson reduced his 2004 operating income estimates for Starz to $209 million (from $389 million) in 2004 and to $328 million from $446 million in 2005. For 2006, Henderson reduced his operating income estimate from $515 million to $474 million.

Despite those changes, Henderson reiterated his "buy" rating and his $17 per share price target on Liberty stock. In his report, he stated that Liberty's recent moves toward becoming an operating company, rather than a holding entity, should compress any discount in valuation.