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Diller makes hay while on hold

Jun 11, 2001  •  Post A Comment

Barry Diller’s defining advantage in the marketplace morphing around him is his potential Achilles’ heel as well: being so far ahead of most companies in convergence and interactivity that he must wait for them to catch up so he can reap the full economic benefits.
It is a waiting game that Mr. Diller may not be able or willing to play, despite having neatly positioned his USA Networks for 20-percent-plus annual cash flow growth over the long-term.
Part of the dilemma is that while Wall Street and the media industry at large readily embrace the company’s branded program holdings–led by USA Network, the Sci-Fi Channel and Studios USA–they’re just beginning to appreciate and use the eclectic interactive and electronic retailing operations that are the jewels in USA’s crown.
Although USA thinks of itself as a convergence company, with 65 percent of its revenues generated from transactions and 20 percent from subscriptions, about 62 percent of its cash flow remains dependent on its mainstream entertainment operations.
“We believe entertainment and information and direct selling are continuing to converge
and that linking those historically disparate areas is our way of competing in a consolidated world, where on the traditional media side, we’re certainly a second-tier company,” Mr. Diller told Electronic Media in a recent interview. “But in information services and electronic retailing, we’re very much first-tier. We have scale. We have dominance.”
High-level sources said USA’s traditional media holdings could get a boost from an alliance with John Malone’s Liberty Media Group (which holds a 21 percent USA stake).
Once Liberty is spun off from AT&T Corp. in July, Mr. Malone will be free to strengthen his Discovery Communications (which includes Discovery Channel, The Learning Channel, The Travel Channel and Animal Planet) through a deal with USA that could combine their program assets into a new and powerful publicly traded program company they would co-own, said those sources. USA and Liberty declined to comment.
Never overpay
Such an arrangement would be an alternative way to fortify and extend the value of USA’s entertainment holdings, since Mr. Diller has refused to overpay for existing scarce program properties such as Rainbow Media Group and Fox Family Channel.
However bright USA’s long-range outlook, the company’s ability to aggressively grow revenues and profits–which are only 15 percent dependent on conventional advertising, tied mostly to its better known cable program services–could be hindered by the slow albeit steady rollout of electronic transactions and other forms of interactivity, analysts warned.
“Barry Diller has established a beachhead in many important areas of electronic commerce, which cannot be effectively used until there are more transactions online and there has been a complete convergence of the TV and the PC,” said Christopher Dixon, veteran analyst at UBS Warburg. “It is an extraordinary interactive platform. It’s just that less than 10 percent of all U.S. homes have high-speed Internet access.”
But make no mistake about it. Even now, because he is so far ahead of the pack, Mr. Diller has the upper hand, with options for forging USA’s future that are as numerous as they are varied.
“Whatever opportunity comes, we’re prepared,” Mr. Diller said in his Manhattan office next to Carnegie Hall. “We’ve got fantastic cards to play. The next year or so, I expect certain things will happen.”
Mr. Diller declines to elaborate, leaving industry analysts, investors and peers to assess USA’s growth options.
In a more stable stock market, any of USA’s recently restructured core businesses–information and services, electronic retailing and entertainment–could be publicly spun off or more closely aligned with big strategic partners such as AOL Time Warner, Yahoo!, Microsoft Corp. or NBC–any of which can make full use of the order processing, direct marketing, customer database and other interactive infrastructures that are too expensive and extensive to replicate.
Such moves could boost the core business units’ worth well beyond their current sum-of-the-parts valuation, while bolstering USA’s overall $20 billion market capitalization, creating new stock to be used as deal currency and providing USA with much-needed scale.
Even rapidly growing individual operations such as HSN International–valued today at only about $300 million, with strongholds in France, China, Japan and Italy and on its way to a targeted $1 billion annual revenues–could become a publicly traded entity such as Ticketmaster and Hotel Reservations Network, analysts say.
A.G. Edwards estimates the public value of USA’s USA Network at $7.8 billion, Sci-Fi Channel at $3.9 billion, Studios USA at $660 million, Home Shopping Network at $3.9 billion, Ticketmaster at $830 million, the Hotel Reservation Network at $1.4 billion and its teleservices business at $855 million.
Internet commerce assault
The stand-alone valuations underscore another of USA’s dilemmas: commanding investor support for its unique interactive portfolio. Mr. Diller has achieved scale in the Internet commerce world, where he plans to increase his 3 percent share of the business to as much as 20 percent in short order. USA’s Internet commerce operations, at $130 million in online profitability, are second only to eBay.
USA’s electronic retailing (comprising mostly HSN) posted 12 percent growth in pro forma 2000 cash flow on a 20 percent rise in revenues. Its Information and Services Unit (which includes Ticketmaster, CitySearch, Match.com, Hotel Reservations Network, Styleclick and Precision Response Corp.) posted 33 percent growth in pro forma 2000 cash flow on a 38 percent rise in revenues.
By comparison, USA’s entertainment operations reported a 26 percent gain in pro forma 2000 cash flow on a 17 percent rise in revenues.
On the entertainment side of the ledger, where it most lacks scale, growth through acquisition has been limited by high prices. And the internal development of new services has been slow.
USA’s acquisition and development of three lesser-known special-interest program networks–Trio (an art service that is being revamped beginning this week), Crime and News World International–are indicative of the cost-effective, organic way Mr. Diller prefers to expand. The most successful example is Sci-Fi’s three-year turnaround.
Although Mr. Diller told analysts during the company’s most recent earnings call that maintaining control is a major issue for him in the case of a merger or an alliance (“When you ask me issues about control, you see me vibrate like a tuning fork.”), he is not excluding an outright sale of USA in which he could step aside.
“I would if that’s the best way to get growth for this company. It would not be my most desired path, because I think this company can grow independently in a way that is in the best interest of shareholders,” Mr. Diller said.
“But should an opportunity come along that is compelling, then I would absolutely take it for the company and for the shareholders. If I could no longer be in control of it, and that was the best course for the company on a long-term basis, of course I would do it,” he said.
Mr. Diller also said he is prepared to temporarily dilute USA’s rebounding stock and rack up debt if it means pursuing an exceptional growth opportunity.
“Sure we would. Absolutely. For the right opportunity, we will jump the bar,” he said. “Of course, we have to become bigger. You know the companies that are on the line. We’re not going to talk about them other than to say we are in a wonderful position in a number of ways. Our basic businesses are sound and growing. We have an excellent balance sheet. We have extremely strong cash flow, even in difficult times. And we are alert and energetic. So that will make for its own brew.”
Potential buyers abound
Prospective alliance and acquisition partners run the gamut from Yahoo! and NBC, to Walt Disney and Sony Corp., to USA’s 43 percent owner Vivendi Universal. USA also could
be courted by hybrid media giants such as AOL Time Warner, Viacom and News Corp., which could realize endless synergies with USA’s interactive and entertainment operations.
Although USA’s choice electronic retailing, interactive and entertainment operations make it a takeover target in a rapidly consolidating world, those who know Mr. Diller well insist he is an unlikely seller.
“Barry made a promise after he left Fox that he was only going to work for himself and build a company for the future, and he’s closer than ever to that reality,” said one close associate. “But he might have to think twice if someone offers him a premium of $65 a share or $75 a share for the company.”
Bear Stearns analyst Victor Miller is among those who believe that USA will find a way to scale up on the interactive and entertainment fronts over the next several years to remain competitive.
“On the entertainment side, he could engage in a smart deal with a company such as NBC or Yahoo! that can provide it more scale,” Mr. Miller said. Goodwill accounting rule changes and a change in the leadership of corporate parent General Electric could be just the impetus NBC needs to pursue the kind of grand alliance that it almost struck with USA in 1997. A deal with Yahoo! could mirror Mr. Diller’s foiled efforts to merge with Lycos in 1999. However, sources close to Mr. Diller said he is not about to buy Yahoo!
“Unlike other media companies such as Disney and NBC that have had disappointing roll-ins of their Internet activities, USA is steady in its approach to the Internet because it does not meander far from its core competencies,” Mr. Miller said.
“Home Shopping Network has been proficient in retail commerce for more than 20 years, Ticketmaster has been selling tickets for more than 25 years, and Hotel Reservation Network is based on the time-honored practice of third-party booking. These are traditional businesses that have been given an extended life online with interactivity,” Mr. Miller said.
On that basis, Mr. Diller also can opt to stay the course, organically growing each of his businesses at stellar rates that have won him deep support on Wall Street, while using his strong balance sheet to selectively acquire distressed Internet companies that fit into its unique electronic retailing and interactivity portfolio.
Analysts forecast that this year USA will continue its pro forma growth in earnings before interest, taxes, depreciation and amortization of about 27 percent to more than $1 billion, supported by a healthy 13 percent gain in cable network and studio cash flow, a 16 percent increase in electronic retailing cash flow and a 15 percent increase in ticketing cash flow. Revenues should rise nearly 16 percent to $5.4 billion.
Mr. Diller said he could spend about $1 billion this year (or the proceeds from USA’s recent sale of television stations to Univision) acquiring as many as one dozen distressed dot-com companies that could enhance his strength in call centers, customer databases, electronic ticket sales and travel and destination information.
Golden investment touch
His track record for such acquisitions is impressive. HRN has appreciated more than sixfold to $1.4 billion from when USA acquired it for $250 million in May 1999. USA’s 61 percent interest in Ticketmaster, which it acquired for $850 million in 1997, has swollen to more than $3.4 billion.
What formerly were Seagram’s domestic TV assets (including USA Network, Sci-Fi Channel and Universal’s domestic TV group) have more than tripled in value to about $13 billion since Mr. Diller acquired them in February 1998. The 15 acquisitions Mr. Diller made for $750 million over the past five years have appreciated to more than $7 billion in value. Overall, Mr. Diller said USA is growing two to five times faster than his largest media peers.
Still, some analysts are betting that Mr. Diller will make some of his best moves over the next year, leveraging existing assets and relationships.
Leveraging Liberty and Vivendi
The more intriguing scenarios for securing USA’s future are those that have Mr. Diller leveraging his powerful alliances with Mr. Malone’s Liberty Media Group or Jean-Marie Messier’s Vivendi Universal.
High-level sources close to the parties said it would not be surprising if USA eventually became a core interactive platform for Sky Global, the worldwide satellite service being built by Liberty and Rupert Murdoch’s News Corp., or for the music-downloading enterprises Vivendi is building with its acquisition of MP3 and its Duet partnership with Sony and Yahoo!
Then there’s the Discovery-USA merger scenario that sources said could result in a separate publicly traded cable powerhouse once Liberty is free of AT&T.
Liberty also could prove helpful in more closely aligning USA’s interactive interests with those of major cable operators such as AT&T, Time Warner, Cablevision Systems and Comcast, in which Liberty is a shareholder. The next-generation digital set-top boxes will showcase the kind of electronic retailing and interactive activities in which USA specializes.
Gordon Hodge, analyst at Thomas Weisel Partners, points out that some of Liberty Digital’s interactive television properties also have “a natural synergy” with USA’s electronic fulfillment infrastructure–which processes orders for goods and services, provides customer service and manages customer data. USA’s information and services assets are the company’s crown jewels, although their “value and potential are probably the most difficult for investors to appreciate,” Mr. Hodge said.
An autonomous Liberty Media’s “focus may shift, and its vision of USA Networks may shift with it,” Mr. Hodge said. For example, industry sources said Liberty could seek to align its part-owned and struggling Priceline.com with USA’s interactive retailing assets. Liberty declined comment on such speculation.
In another possible move, Mr. Diller also could rely on Liberty’s clout to buy out Vivendi’s 43 percent ownership stake in USA, which Vivendi has promised to expand to at least 50 percent by 2002. Mr. Diller, whose 73 percent voting control of USA can protect it from unwanted takeover, said he welcomes Vivendi’s increased ownership stake as long as it means “assured growth” for USA.
Better than it looks
As it stands, USA is penalized by its complex ownership structure in which Liberty and Vivendi own their stakes through subsidiaries. If a more conventional ownership structure had been in place and those stakes had been converted to common stock, USA last quarter would have posted an overall profit of $11.6 million, or 2 cents a share, instead of a loss of $7.7 million, or 1 cent a share. So an ownership restructuring, involving other prominent shareholders such as Microsoft co-founder Paul Allen, could occur.
Ironically, Mr. Diller’s right of first refusal on any attempted USA buyout, even by Vivendi, could be used to set off a bidding war for the company or at least effect change to Mr. Diller’s liking.
For instance, one possible complex transaction some analysts support could involve Liberty swapping its 21 percent stake in USA for Vivendi’s 23 percent stake in News Corp.’s BSkyB in the United Kingdom, on the condition that Liberty and USA can combine and co-own their choice cable program assets and engage in other joint ventures.
It is one of endless examples of how Mr. Diller can leverage a portfolio of companies related through interactivity and direct selling, which is why a number of savvy industry analysts are not counting out France’s Vivendi as the major force in USA’s future.
In fact, Vivendi Universal’s own fortune is tied to whether it can develop a clear acquisition strategy and a “tactical alliance with USA Networks … by aligning each company’s operations to provide more day-to-day interaction,” said Richard Bilotti, analyst at Morgan Stanley Dean Witter.
However, the symbiotic relationship between USA and Vivendi could take at least five years to develop, he said.
Due to the highly concentrated U.S. distribution market,
the alliance is more likely to focus on interactive shopping and database ventures than on television production and distribution, Mr. Bilotti said. USA’s Home Shopping Network, Ticketmaster and Hotel Reservations Networks can be introduced across Europe on Vivendi’s Vizzavi multi-access Internet portal and its SFR mobile telephony platform. Vizzavi also could expand domestically with USA’s help. “The key to the relationship is to “leverage off one another in a mutually beneficial manner to produce growth that outpaces industry trends,” he said.
Even without Vivendi’s help, Mr. Bilotti expects USA to ramp up its earnings to more than $2.2 billion annually by 2005. Last year, USA grew earnings 24 percent to $812 million.
“I’m sure there are things we can do jointly. We can talk about this. Certainly our Ticketmaster, CitySearch and other information services line up with Vivendi’s initiatives,” Mr. Diller said.
Working together
So far, Vivendi and USA are loosely collaborating on a handful of interactive ventures abroad. “It’s still early in the relationship,” Mr. Diller said. “It does take a while. People have to get to know each other and to find out about the other’s agendas,” he said.
However, analysts said they are unclear on how USA fits into Vivendi Universal’s plans for an expanded television presence in the United States and an expanded strategic alliance with Yahoo!
USA and Yahoo! already have a working relationship on Web sites such as Match.com and the Hotel Reservations Network. Mr. Diller and Chief Yahoo! Jerry Yang have always been kindred spirits in the area of interactivity. Yahoo!’s new chairman and CEO is former Warner Bros. studio chief Terry Semel, a longtime friend of Mr. Diller’s, who is expected to transform the online giant through a mainstream media deal.
Few other new or old media companies are in as good a position as USA to capitalize on Yahoo’s core strength, even though USA has covered its bases by also maintaining close ties to other major portals such as AOL and Microsoft’s MSN.
There are plenty of other ways USA can become more closely tethered to Yahoo! and other strategic online players without buying or merging with one of them. Mr. Diller’s interactive and electronic retailing assets are so advanced and deep, those parts of his company also would make a good match for eBay or Amazon.com, analysts said.
But whereas USA’s Internet commerce businesses and Amazon.com each have about $750 million in annual revenues, Amazon loses about $300 million annually, while USA makes about $130 million in annual profits. The difference is in the approach.
“We’re inherently retailers and direct marketers. It is not that we’re just interactive retailers of scale with close to $2 billion in sales and $300 million in profits on all of our electronic retailing,” Mr. Diller said. That translates into an infrastructure that annually services 1 billion telephone minutes, 75 million processed orders, 60 million credit card transactions, 40 million items shipped and a customer database of 30 million.
“I think people look at it and say that is something to pay attention to; that is something that every company relying on interactivity to generate revenues is going to have to be part of someday,” Mr. Diller said.
Mr. Diller believes that as media continues to fragment, direct selling by transactional media will become the preferred method for marketers to sell their products and services.
“When interactive television gains critical mass, media companies should be positioned to benefit from a transaction-driven model,” he said.
“We do have a unique way of approaching this convergence of direct selling and entertainment and information, and that is through the relationships we are building between entertainment and interactive assets,” Mr. Diller said.
The evolving relationship between those two assets is best exemplified today by a multi-faceted arrangement between USA and the PGA. The company telecasts the PGA tournaments on USA Network, sells tickets to PGA events via Ticketmaster, and sells related merchandise on outlets such as HSN, handling such electronic sales from start to finish through Precision Response Corp., which it acquired last year.
“Until the next stage of convergence, with smart set-top boxes with seamless point-and-click ordering, the relationships will be limited to that,” Mr. Diller said.
Misunderstood maverick
Although USA stock has appreciated as much as 30 percent so far this year (trading at about $23 a share), investors still are slow to give Mr. Diller his due as they struggle to connect the dots among his primary businesses and to understand an interactive marketplace only barely formed.
“There is no question that up until very recently, our constant explanation of our strategy wasn’t doing as much good because it was not yet in evidence. It’s only been the last six months or so that people see the relationship between our interactive and entertainment assets, and how convergence is taking hold,” Mr. Diller said.
Despite a challenging economic environment, in the first quarter, USA’s cash-flow-producing assets (the cable networks, Studios USA, domestic and international Home Shopping Network properties, Ticketmaster, Hotel Reservations Network and Teleservices) grew 17 percent to $1.24 billion and cash flow grew nearly 16 percent to $269 million–exceeding analyst expectations.
If there is a sense of frustration coming from Mr. Diller, it is due to Wall Street’s attitude toward his interactive activities, which is apathetic compared to the effusive response elicited by his branded cable programming and other entertainment assets–assets that nonetheless he has been working to fortify through acquisitions of existing properties at “reasonable prices.”
Mr. Diller’s expressed interest in Cablevision System’s Rainbow Media Group triggered a bidding war from which he quickly retreated, making it possible for MGM to instead take an equity ownership stake in the choice program group.
Mr. Diller is concerned the same will occur in the scramble for Fox Family Channel that he is so far avoiding.
“These one-off assets–whether it’s Rainbow, Fox Family or even Discovery [which I am not saying is for sale]–are almost impossible to rationalize because the sellers price all of the opportunity in the purchase price. Therefore, these assets go at levels that make one-off purchases generally unsound,” Mr. Diller said.
“There are other ways,” he said. “But to be a minority partner in somebody else’s assets doesn’t make much sense for us.”
However, Mr. Diller might more readily embrace large strategic partners such as Liberty Media, Viacom or AOL Time Warner, analysts said.
“We’re quite confident that the services and assets that we have now–USA Networks, Sci-Fi Channel, our three emerging networks, our studios, our production distribution entity, our first run programming producing and distributing operations–will continue growing for us,” Mr. Diller said.
Even with Studios USA operating independently without a television station base, it is a dominant player. It has been the third-ranked producer of prime-time and first-run syndicated programming (including two of the top four syndicated talk shows “The Maury Povich Show” and “The Jerry Springer Show”), and two of the top 10 prime-time shows last season. It also produced the hit feature film “Traffic.” That contributed heavily to a 23 percent increase in first-quarter earnings to $21.5 million on a 27 percent increase in first-quarter revenues to nearly $152 million.
Despite the loss of World Wrestling Federation programming and a weak advertising market, USA Network posted a 16 percent increase in first quarter 2001 cash flow on a 10 percent rise in revenues and a 5 percent gain in distribution to 81.3 million U.S. homes. Sci-Fi Channel reported a 23 percent rise in cash flow on a 11 percent increase in revenues for the period on a 15 percent rise in distribution to nearly 70 million homes.
Two of the biggest risks faced by USA are enter
tainment related. Even with 1,500 hours of original content produced each year, the company must continue to crank out popular programs for its own cable networks and third parties and to replace the five hours of weekly WWF fare that jumped to TNN.
The missing piece
Even so, USA also must find ways to increase its distribution channels. It still lacks a major broadcast network on which to leverage its USA Network and Studios USA, which is why an alliance with NBC or even CBS remains an attractive prospect.
“We know what the challenges are. We’re not particularly worried about being marginalized at this stage,” Mr. Diller said.
Some industry executives and analysts beg to differ with Mr. Diller.
Although USA Networks has survived the loss of WWF bouts to higher bidder Viacom, analysts said it is an example of how USA can be squeezed out of critical programming by other players with more clout.
“I can now say without being defensive, that losing wrestling was best for USA Network,” Mr. Diller said.
“There’s no question that Viacom has more pots from which to compete than we do. That is a challenge. That is a challenge that a programmer can always get around. As long as you have a good enough program idea, you can always come through. But if you are in a competitive situation against a larger player in a deal where you don’t own the product yourself and you are buying it from a third party, you, of course, will be disadvantaged,” Mr. Diller said.
“I have been functioning in those disadvantages all of my business life. That does not bother me so long as other walls of the various gardens do not get so high it precludes our ability to get our message out that we have good programs for someone to see.”
That more than anything explains why television’s consummate programming wizard–who worked at ABC and gave life to Fox, feels so comfortable and in command on the interactive and electronic retailing fronts. It is a brave new converging world, and Barry Diller is conquering it bit by bit.