Wall Street is expecting John Malone to re-emerge this week with both barrels loaded to execute a broad array of media deals in the United States and abroad as his Liberty Media Corp. finally breaks free from AT&T Corp.
But how much and how fast he and Liberty move could be shaped by the Securities and Exchange Commission and its determination of whether Liberty is an investment company or an operating company under the Investment Act of 1940.
Liberty maintains it is not an investment company and that it does comply with the law. But it declines to elaborate, saying the matter is too complex to explain. Sources close to the company said Liberty is not concerned and will do what it must to maintain compliance with SEC law.
Still, the matter-if it remains unresolved-could become critical as Liberty prepares to exercise its long-awaited autonomy to engage in investments and acquisitions, and to rearrange its assets in ways that it was not as free to do as a tracking stock of AT&T, the largest U.S. cable operator.
For instance, an SEC determination could make the difference between Liberty spinning off, selling or partnering its valuable Discovery Communications to more fully realize shareholder value from the asset.
Creating value
Although Liberty has indicated no such plans, there has been industry speculation that Liberty could, among other things, continue to own and merge Discovery with other related assets of affiliated companies such as Barry Diller’s USA Networks to create a potent, separately traded new entity. None of the companies will comment on the scenario, which exemplifies the value creation Liberty and Mr. Malone do best.
The fact that Liberty is heading into its independence without resolution of the SEC-related matter is troublesome to Sanford Bernstein analyst Tom Wolzien because of the uncertainty created around Liberty’s stock price, stake in publicly held companies and future deal-making.
Liberty could become an independent company Aug. 10 without hearing from the SEC. If the SEC eventually determines that Liberty is an investment company that must comply with certain restrictions, Liberty would have up to one year to seek exemptions, take action to comply or otherwise challenge the ruling, sources said.
New limitations
“Even if Liberty is in compliance now, it certainly could have more limited flexibility than it previously enjoyed as a tracking stock of either AT&T or TCI, when it was inhibited in other ways,” Mr. Wolzien said. “As an independent, Liberty could be limited in taking any further partial, noncontrolling ownership positions. Liberty maintains it has ways of looking at all of this that are in compliance but won’t explain what those are.”
While Mr. Wolzien wrote in a July 20 report to clients that he has no reason to doubt the company’s ability to operate under the law, he said investors should be “highly concerned if it is not clear that significant progress has been made” toward resolving the issue by year-end.
Sanford Bernstein took the unusual step of hiring three independent lawyers versed in SEC law to study public documents on file and make their own determination. They concluded Liberty is not in compliance with the law because among other things it has no obvious ownership or operating control of about 55 percent of its overall holdings.
Some of the holdings considered at risk are among Liberty’s most powerful and lucrative: its 4 percent stake in AOL Time Warner, 18 percent stake in News Corp., 43 percent stake in QVC, 21 percent stake in Sprint PCS Group, 21 percent stake in USA Networks and 4 percent stake in Gemstar-TV Guide International. Collectively, those stakes alone are valued at upward of $31 billion.
There also is a public perception that Liberty is more an investment portfolio manager than an operating company, which the SEC also will consider, sources said.
“If Liberty were to be found [to be] an investment company and forced to register under the Act, it would be subject to extensive restrictions on operating methods, management and capital structure, rendering the company unable to operate its business as it had in the past,” Mr. Wolzien said.
The worst-case scenario is that Liberty would be subject to SEC-imposed monetary penalties or injunctive relief from the courts. If it becomes involved in litigation, the courts could toss out Liberty’s existing contracts with affiliated companies, throwing the company and its valuation into some chaos, Mr. Wolzien said.
In addition to a potential forced liquidation of assets, Liberty could be prevented from rolling up smaller companies into its fold and then selling them to larger companies in exchange for stock that can be monetized. The operating pattern is one that has heavily contributed to Liberty’s wealth creation over the years and its current $46 billion market capitalization. That’s about half of the estimated $70 billion Mr. Wolzien believes Liberty’s sprawling portfolio of assets and stakes are really worth.
Tweaking the formula
Certainly Liberty could make adjustments to its extensive public and private assets and investments in order to more clearly qualify as an operating company. However, a source close to the company said that if Liberty considered such precautionary adjustments necessary to settle the matter, “It would likely have already have done it.”
“We figure Liberty either needs to acquire $13 billion or sell $5 billion in assets that it owns or controls to change its current ratios and qualify as an operating company under SEC law,” Mr. Wolzien said.
The fact that Liberty and Mr. Malone’s investment tentacles are potent and pervasive make such matters as this tricky to contemplate.
Things are further complicated by the fact there could be control, ownership or operational options and conditions in confidential contracts Liberty has with any of its affiliated companies-that aren’t a matter of public record-that could further impact the situation.
The only things we can be sure of is that Liberty Chairman Mr. Malone and Liberty President Dobb Bennett have been brilliant strategists and investors who are unlikely to do anything to jeopardize their unmatched portfolio.
That normally has been good enough to bet on them both.
But for now, the implications of the Investment Company Act “are a legitimate overriding concern,” Mr. Wolzien said.
“I think there is value in Liberty’s stock. I think the company will get this worked out. But I’m also leery that if we don’t understand the basis of Liberty’s assumption, or we don’t see some resolution because there is insufficient public information, then I think it becomes a problematic investment,” he said.
In characteristic close-to-the-vest fashion, Liberty will mark its tax-free split off from AT&T on Friday by moving into its newly constructed headquarters outside Denver. Mr. Malone returns to Englewood, Colo., from his prolonged summertime vacation in Maine to begin preparing for trips to Germany and England, where buying, building and operating pre-eminent cable systems have become Liberty’s new passions.
Replicating the TCI consolidator model, Liberty has more than $55 billion invested to become the largest cable provider outside the United States.
Liberty recently announced its $4.7 billion acquisition of Germany’s Deutsche Telekom regional cable network of 10 million subscribers, and sources say Liberty and its UnitedGlobalCom/United Pan-Europe Communications subsidiary have been talking to Deutsche Bank about acquiring its cable subsidiary Tele Columbus with 2.2 million subscribers for more than $1 billion.
The road ahead
Since Mr. Malone first identified Liberty’s ultimate independence as a goal when he sold his TCI to AT&T two years ago, he has been itching to take Liberty in new directions.
Anything Liberty would acquire outright and operate, such as its pending $5 billion German cable buy, would only help its SEC situation. So would an acquisition of AT&T Broadband, although analysts consider that unlikely.
While no one is sure of Liberty’s wish list o
f deals, sources say it will continue to make acquisitions, particularly outside the United States, rearrange and even spin off some of its existing holdings and sell or swap some assets or stakes. This steady action will unfold as the economy and stock markets strengthen.
Liberty and Mr. Malone will elaborate on their plans in a quarterly earnings call Aug. 14 and a Sept. 7 investors’ meeting in New York.
Mr. Malone and Liberty predictably prefer to monetize assets, engage in tax-free, noncash transactions and leverage its strategic stakes in companies.
But anyone who has closely tracked Liberty and Mr. Malone since Liberty was last completely independent-which was at its inception in the early 1990s-knows the only sure bet is that Liberty and Mr. Malone will continue to find enterprising ways to dramatically reshape and command the media landscape.