Double Your Pleasure

Viacom Chairman Redstone explains his plan to split up an empire

In a King Solomon-like answer to critics that Viacom has become too big to grow, Chairman Sumner Redstone has proposed cleaving it in half.

On the surface, the move would appear to reverse the last decade of deal-making—including the CBS and Infinity acquisitions—that built up his entertainment portfolio. But Redstone hardly sees the split-up as a reversal in strategy. To him, it's just another deal.

Freston Inc.
Division 2005E Sales (million) Change vs. '04 2005E Cash Flow (million) Change vs. '04
SOURCE: Morgan Stanley's Richard Bilotti, Bank of America's Doug Shapiro, B&C research
Paramount Films$2,547+6%$340+25%
Simon & Schuster$796+5%$64+5%
Theaters/New Media$512+5%$26+5%
Paramount Theme Parks$429+5%$48+5%
Total Freston Inc.$11,456+7%$3,507+14%
Moonves Corp.
Division 2005E Sales (million) Change vs. '04 2005E Cash Flow (million) Change vs. '04
N/A = UPN lost an estimated $80 mmillion in 2004 and is expected to lose $60 million in 2005
SOURCE: Morgan Stanley's Richard Bilotti, Bank of America's Doug Shapiro, B&C research
CBS Network$4,375+3%$433+27%
Paramount TV/King World$2,146-2%$674-8%
Infinity Radio$2,130+2%$940-1%
Infinity Outdoor$1,989+6%$497+9%
CBS Stations$1,288-2%$532-2%
Paramount Stations$543+2%$178+4%
Total Moonves Corp.$12,724+1%$3,194+3%

“The world changes,” he says. “I think what we're doing is making an intelligent adjustment to a changed world.”

Viacom will split into two companies, one largely composed of the businesses that came along with CBS—the top-ranked broadcast network, TV stations, syndication, and ailing Infinity radio—and the outdoor advertising division. These businesses would be run by CBS Chairman and Viacom Co-President Les Moonves.

The other company will be composed primarily of Viacom's pre-2000 assets—its cable networks and Paramount movie studio—run by Viacom's other Co-President and ex-MTVN chairman Tom Freston.

The goal: set fast-growing MTV Networks free from its slower siblings. Such a deal, analysts say, would allow MTV to get a bump in share price and perhaps grow bigger by acquisition. A stand-alone CBS Infinity, whose radio business has been slammed by a weak ad market, would no longer be a drag on Viacom's stock.

Redstone says that, today, MTV is locked up in a company that trades at around eight times annual cash flow, a relatively low valuation. “Separated, I believe, it will have multiple of 16. That alone is enormous change.”

Even in an era of mega-mergers, there is a suspicion that media conglomerates have grown too gargantuan for their own good. The strength of rapidly growing businesses like cable networks and DVDs is overwhelmed by slower divisions like radio and TV stations.

Bank of America media analyst Doug Shapiro has armed deal critics with harsh analyses of past acquisitions. He notes that growth in media giants like Viacom, Disney and Time Warner has slowed for several reasons but the underlying truth is that “many have simply become too big and have consequently diversified away their growth.”

Other media executives seem to agree. Just last week, John Malone's Liberty Media Corp. declared it will spin off to shareholders its 50%, $6 billion stake in Discovery Communications (see page 8). Barry Diller's Interactive Corp. is separating Home Shopping Network from its core Internet travel businesses.

Merrill Lynch media analyst Jessica Reif Cohen says Big Media executives are jealously eyeing the strong recent performance of pure-play entities like Pixar and DreamWorks Animation. That “has contrasted sharply with the general malaise that has hung over the large media conglomerates for the last several years.”

Tired of watching big media takeovers fizzle, big investors have been lobbying media giants to abandon their strategy of growing through acquisitions. They contend that media stocks will be higher if conglomerates instead spent their money paying dividends or buying back shares. After spending $3 billion supporting his stock price by buying back shares, the Viacom chairman is taking a bold step.

Still, Redstone is a little annoyed by the outcry against the conglomerates, since the same crowd cheered the big companies on when the deals were cut. He recalls that investors pushed America Online shares stock up toward $100 per share after it agreed to buy Time Warner. Viacom cracked $70 on news of the CBS deal. “The same people who drove you way up criticize you and say you shouldn't have done it,” he says.

He denies that Viacom or media companies in general are simply too swollen to move. “It depends on the situation. We're not Time Warner,” Redstone says, referring to the disastrous merger between AOL and Time Warner. “It depends on the company. It depends on the assets. It depends on the strategic direction of the company.”

The split-up contrasts sharply with comments Redstone made just three weeks ago. During Viacom's quarterly earnings conference call, he declared, “From top to bottom, Viacom is moving in one direction. We know where we want to go, and we know how to get there.”

Under the new plan, Freston would run Viacom's fastest-growing assets, including MTV Networks and BET. He would keep responsibility for ailing Paramount, which is on the rebound from Viacom's past management missteps. He would also get the slowly growing Showtime Networks.

A February analysis by Morgan Stanley—whose investment bankers are now representing Viacom in the deal—estimates that Freston's operations will generate more than $11 billion in revenue this year and $3.5 billion in operating cash flow, growing those profits at a fast 14%.

Moonves would get the CBS network and stations, Paramount Television, and King World production and syndication units. But he would also get Viacom's problem children: the Infinity radio and billboard divisions, whose growth has been terrible even though they are profitable. Moonves' unit should generate more revenue than Freston's this year, more than $12 billion, and around the same amount of cash flow. But the CBS Infinity properties' growth rate is just 3% this year, and network TV is a fickle business.

Freston's division is worth around $45 billion, while Moonves' could be worth about $30 billion. Neither men was talking publicly last week, but neither has much to be unhappy about. Freston gets the strongest assets and gets to run the show. Moonves gets the old CBS back and eliminates the risk of losing a fight with Freston over who will succeed the 81-year-old Redstone as Viacom CEO.

Redstone says the plan is far more than a grab for a short-term pop in Viacom's stock (which jumped 11% on the news before settling back to a 6% gain). “There's been so much emphasis on this moving the price of the stock,” he says. “As much as I care about investors, I wouldn't have done this if I didn't think it was a strategic move.”

What is that strategy? MTV Paramount will have relatively less debt, so Freston has financial flexibility to invest in its existing businesses. And he gets to acquire tightly fitting businesses, notably cable networks. Right now, Viacom's low trading value of eight to nine times cash flow makes it a weak currency for buying assets worth 15 to 18 times cash flow. But a successful MTV Paramount stock could chase companies like Discovery or Rainbow Programming as they come onto the market.

CBS plans to saddle CBS Infinity with more debt, while its free cash flow goes to pay dividends and buy back stock, meeting Wall Street's latest clamoring for “returning capital to shareholders.”

Last summer, Shapiro published a sobering study concluding that top media firms, like Viacom and Comcast Communications, would be far better off if they had never engaged in some of the biggest deals of the past decade. In it, he concluded that, if Viacom had never acquired CBS, Blockbuster or even Paramount, its shares would be trading at around $77, double its price today.

Shapiro unwinds Viacom's original operations from its string of multibillion-dollar acquisitions, from Paramount and Blockbuster in the 1990s to 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.

Redstone maintains that “we've always been careful about the deals we do, and you know that.” He notes that he passed on deals for USA Network and Telemundo because the prices were too rich.

Fulcrum Global media analyst Richard Greenfield takes a darker view of Viacom's track record with deals. In the past three years, the conglomerate has taken more than $20 billion in write-offs against fizzled acquisitions: $10.9 billion against Infinity Radio, $7.1 billion against Infinity Outdoor and $2.8 billion against Blockbuster Entertainment.

“Whether they thought they paid a fair price at the time or not, the bottom-line impact is that Viacom overpaid for these assets,” Greenfield says, adding, “The lesson learned by management is hopefully that Viacom should not be making major acquisitions in the next 12-24 months.”

Of course, no Viacom shareholder has taken a greater hit from the stock slide than Redstone, who owns $7.5 billion worth of the company's shares. Asked directly if he thinks he would be better off financially if he had never done the CBS deal, he ducks the question. But he does declare that he doesn't regret buying the broadcaster: “If I had it to do over again, I would do it.”