Winning Bid For VUE Could Be Pyrrhic Victory

Jul 21, 2003  •  Post A Comment

No matter who wins the heated auction for Vivendi Universal Entertainment, the buyer will be hard-pressed to do more than generate modest revenue and cash flow growth, pay down debt and wrestle with integration.
Why? Because that is how even the best-planned and best-managed media mergers and acquisitions play out.
The facts provide a stark reality check after a decade of high-powered mergers and acquisitions that have transformed many industry players yet have not yielded above-average growth.
From 1998 until now the entertainment industry mustered a mere 5.7 percent in revenue growth and 5.3 percent growth in earnings before interest, taxes, depreciation and amortization. Return on invested capital at publicly traded entertainment companies during the same period averaged between 5 percent and 6 percent, and return on equity has averaged 6 percent to 7 percent, according to Richard Bilotti, analyst at Morgan Stanley.
Even Viacom, which has kept its debt low the past decade while efficiently buying and managing CBS, Paramount Studios, UPN, Infinity Broadcasting and Blockbuster, has still been able to muster only between 5.5 percent and 6 percent long-term revenue growth, and 7 percent to 8 percent long-term EBITDA growth.
In fact, Mr. Bilotti contends that as much as 10 percent of media conglomerates’ market cap generally is tied up in operations that are growing even more slowly than their core businesses. “The last decade of media consolidation has created an industry that generates a subpar return on invested capital,” Mr. Bilotti said.
Of course, the argument could be made that growth rates have not been higher because media properties have sold at such high premiums. In fact, companies have achieved that modest growth only after resorting to immediate post-merger cost cuts and consolidation-the only two actions that yield any appreciable balance sheet gains.
The well-entrenched fundamentals of the business-such as advertising dependence, spiraling program costs and the gatekeeper fees associated with the content distribution-continue to be obstacles to establishing more rapid growth tracks. These are not easily changed.
So one of the few ways to accelerate return on investment from media deals is for the combined companies to more immediately and aggressively sell their noncore assets and stakes so they can maximize use of a more tightly focused stable of assets and balance sheets. Media companies generally are better at understanding that theory than they are at putting it into practice.
`corporate weight loss’
That plan for “corporate weight loss,” as Mr. Bilotti calls it, too often is missing from most buyers’ post-deal strategies. In the past year players such as AOL Time Warner and Comcast have sold non-core assets to reduce what was nearly $30 billion of debt at each of the companies.
There are more de-leveraging sales in the pipeline: Walt Disney could sell its radio stations, retail stores and partial cable networks stakes; AOL Time Warner could sell its 50 percent stake in Court TV, its publishing business and its recorded music business; and Viacom could sell Blockbuster.
The fact that media mergers and acquisitions-even under the best of circumstances-have only marginally contributed to exceptional growth should be top-of-mind for VUE bidders. That is because a closer look reveals how, theoretically, the acquisition of VUE assets could actually cost each of the bidders much more than the sale price before they begin to realize post-merger cost efficiencies or synergies.
For instance, under one leading scenario, John Malone’s Liberty Media Corp. would create a new entity within its corporate structure in which VUE would be integrated with existing Liberty assets, such as Discovery Communications and Starz Encore. A potential second wave of deals could involve Jeffrey Katzenberg’s DreamWorks SKG or Joe Roth’s Revolution Studios (to which Liberty has ties) to manage and expand the studio business, through merger, acquisition or alliance. Another equity alliance could be struck with General Electric’s NBC to extend both companies’ cable broadcast reach.
Even with the addition of $1 billion in annual free cash flow generated by its recently acquired QVC, Liberty faces the huge cost of not simply acquiring but expanding upon and repositioning VUE in its own sphere. That is why, sources tell me, Liberty has been in discussions with a handful of powerful financial players-including some linked with the competing VUE bids of Edgar Bronfman Jr. and Marvin Davis-to gain more fiscal firepower.
Clearly, it will be a while before the VUE assets are generating appreciably more money than it will cost Liberty or any other acquirer. However, return on investment may come more quickly, since Vivendi Universal is selling the assets at a multiple that could be about 40 percent less than what it paid several years ago. In that case, the VUE sale may be indicative of the more prudently priced and financed media deals to come.
On a pro forma basis, with VUE and QVC under its belt, Liberty would morph into a bigger operating company with $2.6 billion in annual earnings and nearly $500 million in annual free cash flow on $13 billion in annual revenues, nearly $500 million in annual free cash flow and at least $15 billion in debt, according to Jessica Reif Cohen of Merrill Lynch. The projected revenue and cash flow growth for Universal Television Group, Universal Pictures Group and the VUE cable networks would continue where they are now, at or slightly above average industry growth rates.
To Mr. Bilotti’s point, media companies merging and acquiring don’t often break out of their initial financial funk, despite their best intentions. Hopefully the past has taught all powerful deal-making constituents that scale and vertical integration at any price is not an option. Instead of blue-sky synergies, buyers and their lenders and investors are aiming for above-average growth rates and improved return on investment. Certainly paying more reasonable multiples increases the chance for quicker, better returns.
If the bidding process overall remains rational, then a VUE sale could mark the start of smarter, more valuable media deals. But as one powerful investment banker reminded me, such rational deal-making could quickly be foiled by greedy sellers who simply want more. And wouldn’t you know, sources close to Vivendi confirm that when all is said and done in the auction process, the French conglomerate could still opt to take VUE public in a buoyant stock market.
So much for Mr. Bilotti’s best business practices theory.