Stop Them Before They Shop Again

A major Viacom shareholder recently sent Sumner Redstone a letter essentially imploring him not to make any big acquisitions. While applauding "the size and diversity" of Viacom's operations, the investor didn't want Redstone to expand them as he has for 17 years. Instead, he offered a more mundane strategy to lift the share price: buy Viacom's stock on the open market.

So how does the stubborn, deal-hungry chairman and CEO of Viacom react to such pleas? After reading the note to a group of investors, he said, "All I can say is 'Amen, brother.'"

Come fall, Redstone plans to follow the advice. Based on the simple belief that there's nothing else better to do with Viacom's money at the moment, Redstone plans a major stock buyback estimated to be between $5 billion to $6 billion.

He's not the only titan under such pressure. Many onetime fans of big media takeovers have turned into critics. They're not the usual suspects—foes who think media consolidation is bad for America. Instead, they are investors who now worry that acquisitions are bad for business.

Big media investors typically fixate on mergers and acquisitions. Instead, they are clamoring now for media giants to spend their billions—even borrow billions more—to buy back their own stock or to pay out dividends.

The hue and cry reflects a fundamental shift in media investors' attitudes that could directly impact the direction of an entire market sector. For more than a decade, investors rewarded these companies for growth. Today, as many businesses mature, investors are seeking more stability and less risk, and media companies are getting the message.

In addition to Viacom's expected buyback after it completes the spinoff of video-rental chain Blockbuster, Comcast declared last week that it is spending $1.7 billion buying back its own stock. Clear Channel has bought up $934 million of its stock and wants $1 billion more. In June, MGM paid out a one-time $1.3 billion dividend and has put itself up for sale.

In an extreme case, after years of hearing investor complaints that it was sitting on too much cash, the unfathomably rich Microsoft agreed to pay out $32 billion in dividends. And it still has $30 billion in the bank, which it plans to use to buy back stock.

"We have been very vocal with management that they should return the capital to shareholders," says Glenn Greenberg, managing director of Chieftain Capital, which is heavily invested in cable operator Comcast Corp. "With the stock down where it is, the highest and best use of their cash is to buy back stock. When the stock price goes up, they should start paying dividends."

The plea has become a chant among some investors. "They are like a herd," says the CEO of one major media company. "And they keep saying, 'Return the capital, return the capital.'"

One big reason investors are hot on buybacks is that many media companies are starting to generate huge amounts of "free" cash. For years, cable operators, for example, have borrowed billions of dollars to upgrade their systems to deliver advanced products. But that spending is largely over, and those products are starting to kick out profits. So at Comcast, free cash flow—profits after capital spending and interest payments—should surge from $600 million last year to $2 billion.

Comcast CEO Brian Roberts believes that allows Comcast to strike a balance between "new initiatives" and stock buybacks. "After 10 years of substantial capital investments," he says, "our shareholders will soon begin to enjoy the benefits of increasing amounts of free cash flow."

Media companies have always used takeovers to try to boost financial growth and power. Money is typically reinvested in operations, such as upgrading cable systems, or in buying assets on which management can pump up returns. Dividends, in the view of certain media chiefs, are for wimps. Stodgy telephone companies or electric utilities pay big dividends.

Above the din of the debate over dividends, though, an even larger concern looms for many media companies: If we stop doing deals, how will we grow?

Time Warner CEO Dick Parsons, currently eyeing takeovers of $20 billion Adelphia Communications and the $5 billion MGM studio, is frustrated by the current mood. He told investors last week that the same people calling for stock buybacks were recently demanding that Time Warner pare its debt so it can pounce on the next takeover opportunity: "Those same folks not that long ago were sort of beating on us, 'You're overleveraging. You've got to get some flexibility in this changing world.'"

Part of the clamor comes from the drop in media stocks, which are off 15% so far this year (radio station stocks have dropped 25%).

Now a sobering new study by a respected Wall Street analyst concludes that top media firms, such as Viacom and Comcast, would have been far better off if they had never engaged in some of the biggest deals of the past decade—a Wall Street twist on It's a Wonderful Life.

In the study, Bank of America analyst Doug Shapiro unwinds Viacom's original operations from its string of multibillion-dollar acquisitions, from Paramount and Blockbuster in the 1990s to the purchase of CBS. The primary asset of a smaller Viacom would be MTV Networks, which has been a huge growth engine. Sure, Viacom would have less revenue and operating cash flow. But it also wouldn't have issued 1.8 billion shares in deals that diluted existing shareholders. Shapiro believes that old Viacom would be $77 per share, 123% more than last week's price of $34.47.

As for Time Warner, Shapiro notes that books have been written on how much value was destroyed by its 2001 merger with AOL. He figures old Time Warner would be trading for $43 per share, 157% more than last week's $16.73 for the combined companies.

If Comcast hadn't bought AT&T Broadband, the cable operator might be trading 27% higher, at $35 rather than today's $27.

"They basically haven't worked," Shapiro says of the recent media mergers. "These deals, in many cases, have not created value and, in many cases, have destroyed it."

The major exception is Disney. Shapiro figures, with assets acquired along with Capital Cities/ ABC, Disney actually trades 4% more than it would have. That's because ESPN has proved a financial powerhouse, offsetting the problems at ABC and Disney theme parks.

Wall Street is even questioning the value of smaller acquisitions. Morgan Stanley media analyst Richard Bilotti recently examined several of Viacom's deals, such as the $2.9 billion takeover of cable network BET and the $13 billion buyout of public shareholders in CBS's Infinity Radio. His conclusion: The return on capital of those deals will fall short of the average return generated by companies in the S&P 500 index.

"All of these smaller acquisitions were supposed to be accretive," Bilotti says. "They really aren't."

Viacom disagrees with the broad conclusions of Shapiro's and Bilotti's analyses, dismissing them as speculation. For example, Viacom executives say Bilotti analyzes the May 2003 takeover of Comedy Central, which was done too recently to properly judge.

Viacom CFO Richard Bressler says his company can maintain healthy growth without spending on another mega-merger. "You don't have to do a big acquisition, but you continue to grow and invest in your business smartly," he says. "You do a lot of small and medium acquisitions."

Time Warner's Parsons agrees. It would be unwise, he says, "to say, 'We're not interested in anything that is going on out there. Let's go back and use all of our firepower to buy in our stock.'"

But unless Parsons and his peers can get their stock price up, Wall Street's demands that they stop buying won't end.