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News Corp. in position for another DirecTV bid

Oct 7, 2002  •  Post A Comment

As early as this week, News Corp. will resume its pursuit of DirecTV, and this time around, it will play to win because it must.
The leading U.S. satellite provider is the one choice piece News Corp. Chairman and CEO Rupert Murdoch needs to complete his global distribution puzzle to support the company’s rapidly growing and potent content resources.
“There is no question this is a critical move for us,” a high-level News Corp. official conceded.
In the year since it lost its bid for DirecTV to EchoStar Communications, News Corp. has repositioned itself for the highest future earnings growth of any media company, giving it maximum flexibility to finance new deals. Facing none of the high debt or strained asset sales plaguing many of its peers, News Corp.’s $1.5 billion in annual free cash flow will be the engine that drives a DirecTV rematch.
If, as is widely anticipated, federal regulators nix EchoStar Communications’ proposed $26 billion acquisition of DirecTV on grounds it would create a domestic satellite monopoly, News Corp. is prepared to step in with a more straightforward cash offer than the one that was abruptly rejected a year ago, just to get the strategically imperative deal done. News Corp.’s initial, more complex plans for merging DirecTV with its own diverse international satellite operations in a stand-alone public entity (worth about $80 billion) would occur later as a second phase, well-placed sources said.
Waiting for a ruling
News Corp. officials, who declined comment, could wait several weeks to renew their bid for DirecTV if regulators rule this week against the proposed EchoStar-DirecTV merger. Mr. Murdoch last week publicly acknowledged he would give DirecTV “another look” if the EchoStar transaction is rejected. But those close to him say he is prepared to do much more.
With the support of a strengthened balance sheet and the ratings and revenue momentum of new cable services, News Corp. will make a cash offer (which could include some securities) for at least General Motors’ stake in the Hughes Electronics subsidiary that houses DirecTV. GM’s 30 percent stake is now thought to be worth about $4 billion. DirecTV’s overall value has plummeted to about $12 billion from $40 billion several years ago, driven by the decline in its stock price and the rise in its operating costs.
With the backing of partners Microsoft Corp. and John Malone’s Liberty Media Corp., which is a 20 percent owner of News Corp., Mr. Murdoch could make an aggressive cash and securities offer for the entire company. The trick will be shaping a deal that is tax free to GM shareholders and that pleases GM’s frustrated board and regulators.
“We are not going to tie up this company in knots for another 18 months like last time,” one News Corp. executive said. “We learned a lot last time.”
As the only media giant that actually can lay claim to being a genuine global concern, News Corp. has learned that in a consolidating world there is no substitute for ubiquitous U.S. distribution if it wants to sell programs and advertising across what is a truly universal footprint.
Just last week, Mr. Murdoch snared the struggling pay-TV service Telepiu from Vivendi Universal for 900 million euros including debt assumption. News Corp. will merge it with its other Italian pay TV service Stream and transform the combined entity into Sky Italia, modeled after its 40 percent-owned BSkyB in the United Kingdom. It will spend $550 million during the next two years to build up the service and make it piracy-free. In order to break even by 2004, News Corp. has to add 1 million new subscribers over the next two years.
That might seem too aggressive a goal if it weren’t that News Corp. has succeeded in the face of more formidable challenges and financial losses in its other satellite ventures, including BSkyB (worth $6 billion), Star TV in Asia (worth $2 billion) and its newer JSkyB, Net Sat Brazil and Innova Mexico.
But the true value of News Corp. owning and operating a ubiquitous global satellite platform is only beginning to become evident.
In the past year, News Corp. has begun to tap its relatively new cable start-ups-Fox News, FX and Fox Sports-as well as its National Geographic Channel and 20th Century Fox’s vast film library to provide cost-effective product, promotions and advertising for its various satellite entities.
But if News Corp. layers on top of Fox’s popular content all of the interactivity that has proven so popular with BSkyB subscribers and brings it to DirecTV’s satellite platform, then Mr. Murdoch gains an instant gateway to turning U.S. viewers into interactive consumers. It is that lucrative form of interactivity that brought News Corp. together with Mr. Malone’s Liberty and Bill Gates’ Microsoft in the first place. For these partners, the DirecTV link is the big brass ring.
For News Corp., DirecTV also would give it an unrivaled economic power to sell and distribute its own and others’ content, marketing materials and advertising time across all of the world’s most important markets. It would provide Fox with secured domestic and global carriage for its own niche or new services in a digital world where shelf space is in short supply.
Even though it owns the country’s largest TV station group, whose operating margins and cash flow are being rapidly improved, the only way that News Corp. can effectively compete with cable’s 80 percent coverage of the television marketplace is to embrace a U.S.-based satellite operator such as DirecTV. News Corp. will not buy or invest in cable systems.
News Corp.’s new mantra
The move to accelerate reach and cash flow growth through more subscription-based pay-TV services is News Corp.’s new mantra. Its built-from-scratch news, sports and FX cable services already collectively contribute 20 percent of the company’s consolidated revenues and cash flow, and have plenty of room for margin improvement.
“FX exemplifies the benefits of Fox’s vertical integration strategy,” explains Lehman Brothers analyst Stuart Linde. “FX was able to build an identity of its own by leveraging synergies among Fox’s various platforms, using a mix of original programming, repurposed successful shows from the broadcast network and sports programming produced by Fox Sports Net.”
News Corp. announced last week that its StarTV would begin working closely with FX and other Fox-branded cable networks to tailor services for its subscribers that, for the most part, will utilize existing content that will generate pure profits in short order.
That is a far cry from the situation News Corp. and Fox usually are in as major content providers to other broadcast, satellite and cable operators with whom it must wage hardball negotiations and exchange upwards of $1.5 billion in annual fees. EchoStar Chairman and CEO Charlie Ergen wasted no time after winning the DirecTV bid last fall to proclaim that he would use his newfound gatekeeper’s power to negotiate the lowest possible program license fees from content providers such as Fox.
“We don’t want to be at the mercy of the gatekeepers, and we have a fair amount of confidence in the strength of our programming,” said News Corp. President Peter Chernin in an interview. “But, we don’t feel the company is in jeopardy if we don’t do something right now.”
But clearly DirecTV and its 11 million subscribers can generate billions of dollars of revenues and profits for News Corp. by making it a global satellite monopoly. Or, if DirecTV remains independent or is acquired by a competitor, it can cost News Corp. hundreds of millions of dollars in lost revenues and profits by preventing it from closing the critical U.S. satellite link.
If News Corp. gets another crack at DirecTV, the timing may actually work in its favor. In just a year’s time, the consolidating players in the U.S. cable industry have become far more vulnerable to satellite competition as their basic subscriber growth generally has slowed and the demand for new digital cable services has been hindered by uncertain and declining economic conditions.
And
there are many more distractions.
Comcast Corp. is about to close on its acquisition of AT&T Broadband, now valued at $52 billion, only to find itself steeped in two years and $2 billion of cable system upgrades before mining its enlarged 22 million subscriber footprint. AOL Time Warner is tangled in its own problems-from reinventing its AOL service and maneuvering through regulatory probes of its accounting practices to consolidating and spinning off its cable systems. Cablevision Systems, which is curiously struggling to launch its own satellite service by March, will go bankrupt Jan. 1 if it doesn’t quickly close a $1 billion funding gap with asset sales.
Ergen’s outlook
If he loses the fight of his career, Mr. Ergen will be reduced to being the second-largest satellite provider in the United States, armed with intelligence about DirecTV, whose competitive and financial momentum has been vastly slowed during the merger process. But cash-strapped EchoStar may not be financially able to make the most of what it has learned about its rival if, even as the loser, it challenges having to pay Hughes a $600 million breakup fee or pay roughly $2.7 billion to acquire Hughes’ 81 percent stake in PanAmSat.
That makes News Corp. the only financially fit and strategically sound player left to scoop up DirecTV and give it new life as a key part of a global satellite strategy. Having demonstrated that it knows how to manage a satellite company for profits, News Corp. clearly has the ability to take its own revenues and profits to the next level.