No Triumph for Liberty

What went wrong and how Bennett and Malone expect to make it right

When John Malone agreed to sell Tele-Communications Inc. to AT&T Corp., media and Wall Street executives were riveted by the prospects of his next performance at Liberty Media. In selling TCI's cable systems to-some say dumping them on-AT&T, Malone was moving over full time to Liberty Media Corp., the TCI spin-off whose portfolio of programming assets had made Malone a multibillionaire.

Considered a brilliant financial engineer, Malone's investment moves over the years had Wall Street's "media Mafia" following him as closely as others track the moves of Warren Buffett. An assets shuffle with TCI and AT&T would leave Liberty with enormous financial power: $6 billion in cash, $12 billion in liquid securities, $1 billion or so in payments coming from AT&T every year and practically no debt. What would John Malone do?

Almost two years later, those same media mavens are looking at the portfolio Liberty has amassed and twisting the question: What has John Malone done?

After spending around $6 billion, Liberty has a new collection of wireless, datacom, interactive TV and Internet investments. The earlier investments are still successful: Discovery Channel, News Corp., QVC and such. But the new investments are awash in losses, the kind that are drawing criticism from places where Malone has typically found only accolades.

"Clearly, Malone has come and gone out of favor," says Larry Petrella of Omega Advisors. "I think there may be a concern that he wasn't engaged, may have lost touch a little bit. But his track record is too phenomenal for me to consider that a long-range issue."

Malone's successful campaign to become fully spun off from AT&T has drawn barely a glimmer of excitement on Wall Street in the face of the poor performance of Liberty's investments. After peaking at $30.69 last March, Liberty shares have dropped 50% to around $15 each. Liberty saw its market capitalization drop from $80.5 billion to just under $40 billion.

Lately, it's the losers that stand out. Competitive local-exchange carrier ICG is a terrible flameout, filing for Chapter 11 two weeks ago, just nine months after Liberty pumped in $500 million. That stake is now worthless. Just three months after Liberty upped its investment in by $85 million at $23.75 per share, the name-your-price auction operation has sunk to $3 per share. Mega-franchiser Cendant got $400 million last December based on plans to wire its hotel chains for high-priced Internet service. That stock has dropped 55%. Other problem investments include radio-station owner Emmis Communications, and "fixed-wireless" telcom start-up Teligent.

"I'm looking for winning investments they've made, but can't see it," says one investment banker. "Maybe some of the international stuff."

One win for Malone is the spin-off. As a tracking-stock subsidiary, Liberty is technically owned by AT&T, though Chairman Michael Armstrong wants little to do with Liberty and the regulatory headaches Malone's holdings often provoke in his deals. AT&T finally agreed two weeks ago to spin Liberty off completely next spring.

The separation will make chasing certain investments easier, such as backing a News Corp-led bid for DBS service DirecTV, buying TV stations or investing in Internet infrastructure. Those are all areas that pose regulatory conflicts with AT&T's other operations.

A full spin-off also won't change the company's investment approach, says Liberty President-CEO Dob Bennett. Liberty is targeting three areas: TV and Internet content, ventures controlling the "last mile" of broadband networks and general technology.

The high-tech market slump caught Malone and other Liberty executives by surprise. "There was a huge amount of money chasing these things, a general confidence in the market," Bennett says. "That's now gone completely, and so it's increasingly difficult for businesses that are capital-intensive, that still have a lot of investment to go."

But Liberty takes a long-term view, expressing confidence even in battered dot-coms like "It's safe to say we'll write off anything that's in Chapter 11." The good news is that in a market starved for capital, he's the man with cash. "We're sitting on a couple billion dollars-relatively more valuable than it was six months ago," he adds. "Not that we weren't conservative with the cash, but I think we will be increasingly conservative as we try to get a sense of the direction of the market."

"For the first time, Liberty has somewhat of a blemished investment record," says Jessica Reif Cohen, of Merrill Lynch. "But having said that, all of these are small investments and in developing areas. I think they're incredibly smart, but it's harder to make bets that really make a difference. When you have one or two that aren't understood or are in the early life cycle, it can be problematic."

Malone declined requests for an interview.

A glance at the past three years bears out fans' hope for Liberty's long-run opportunities. Liberty shares rose 90% in 1997 and 1998 and 150% in 1999. Investors remember the days Liberty, in its various iterations, jumped five- and tenfold as holdings in Turner Broadcasting System, then Time Warner Inc., QVC and Black Entertainment Television soared. And Bennett says he has never seen Malone so engaged in running Liberty. If shares in Liberty, a tracking stock of AT&T, have been hard hit by market disaffection, then AT&T's taking a standing eight-count. In the wake of AT&T's decision to split four ways, the stock fell as low as $21.25, more than 65% off its 52-week high of $61.

Liberty is hardly alone in paying the price for unprecedented market volatility. Others that have been plugging money into the new-media sector point out that the downturn in techs and dotcoms is largely the result of a marked shift in capital markets, not poor investing practices.

"The money available for start-ups and early-stage ventures has dried up," says Trygve Myhren, a veteran cable executive who now heads Myhren Media, a private investment firm focusing on media, telecommunications and the Internet. "It's as bad as it was in late 1989-90..There are numbers of companies with very good prospects that have made good progress but just can't get funding."

The Malone 'halo'

Malone and Liberty, critics contend, have lost their edge, running after the sexy sector
du jour

instead of applying a cohesive approach to investing. Such potshots are hardly new. During his reign at cable operator Tele-Communications Inc., Malone frequently was the target of detractors, who questioned his financial engineering, called his predictions unrealistic and overblown, and termed the debt in his companies excessive.

In good times, Malone's overarching intelligence, wit and style imbue nearly anything he says or touches with a golden aura. Indeed, he has been so successful that the "Malone glow" or "Malone halo" has become a widely recognized phenomenon.

"There's no question that John is the leading force in this company, and there are many occasions when we benefit from that," Bennett says. "Certainly, it's deserved because of John's unique attributes. But I think the market is fickle: When things are good, there is more of a Malone halo; when they're not, then we're all idiots."

Malone's personality and influence are so powerful that they are a market force of their own. But that can be a double-edged sword in that he often overshadows his own executives.

"John, as we all know, is a couple cuts above the good business people we all know," says a source in the investment community. "The question is, how much is John involved and how much is he delegating?"

Under the typical bullish market conditions of the past decade, the Malone glow translates into a 10% to 20% premium for the stock, financial experts say. But let things head south, even slightly, and the glow fades quickly, transforming Malone from guru to goat in a New York minute.

"That's financial markets for you," says Mark Riely, of Media Group Research. "[Malone] tends to take a longer-term view, and financial markets don't. Because he is who he is, people like to kick him if they perceive that he's falling down. Some people love to say he's not so smart.

Liberty's Changing Complexion

But love Malone or hate him-and it's not unusual for the same person to do both-there's no question that he has transformed his crown jewel, Liberty Media, into a far more diverse company than it was two years ago.

At the beginning of 1999, the core of Liberty's portfolio-as it has been since the company's birth in 1991-was domestic cable programming and international cable operations and programming. In addition, there were a few satellite-related companies, including United Video Satellite Group and Sky Latin America; a chunk of technology and manufacturing assets, including 13% of General Instrument; and a dash of Internet services.

Now, almost two years later, Liberty encompasses a more eclectic collection of assets. Core holdings in video-programming services, cable and telephony, satellite services and technology and manufacturing have been substantially expanded. The Internet/interactive-television-services portfolio has seen the greatest growth, adding dozens of holdings under the banner of Liberty Digital, headed by Lee Masters. In addition, Liberty Media birthed Liberty Livewire, headed by former TCI executive David Beddow, earlier this year to provide audio and video post-production services and audio/video distribution services.

Still, Bennett says, "we're not very different in terms of what we're trying to do in life. Our mission has always been pretty straightforward: find ways to create more value for our shareholders in and around the space of media and telecommunications. Nothing in that has changed."

What has changed, he acknowledges, is that Liberty has invested billions, more than $7 billion at last count-much of it in the high-risk, potentially high-reward Internet, interactive-television and telcom-start-up sectors. A relatively small part of that went into Liberty Digital, though Digital has garnered a lot of attention.

"At our high, we were trading at $75.25," says Masters, president and CEO of Liberty Digital. "That's a huge number, and, while we all had a great time and loved and enjoyed it, did we really believe the company was worth $16 billion at one point? No."

A year ago, for instance, a snapshot of Liberty Digital showed it had invested about $166 million in the interactive-TV and dotcom sectors, with about $53 million of that in public companies and $113 million in the private sector. The stock hit its high on Dec. 31, 1999, then seesawed between the $60s and $40s until beginning a steady decline in April. In mid-October, shares hit a low of $9.75 before edging back up into low double digits.

Masters and Bennett attributed the decline partly to disaffection with the new-media and tech sectors, partly to the slower-than-expected rollout of General Instrument's high-end DCT-5000 interactive set-top box.

"Relative to interactive television, we think it's really going to rebound in 2001, when the market really realizes that it is a real business and it is here now," says Masters.

Acquisitions are only part of Liberty's focus. "We've done some moving around of the parts and put some companies together, such as the TV Guide-Gemstar deal and then the Gemstar-News Corp. deal," says Bennett. "[We're] trying, as we've done in the past, to take assets, grow them to a certain level, then through transactions drive them to bigger scale, and increase the value by making them part of something bigger."

Nonetheless, it's the acquisitions that the volatile market has targeted. Most occurred in a relatively short period, the 18 months after the AT&T-TCI merger closed on Feb. 28, 1999. Before the buying binge began, Malone cautioned that "you've got to kiss a lot of frogs" to find a prince in technology. "Eight out of 10 probably won't work out."

Losers and Winners

Although Liberty has hit a number of home runs, the memory in financial markets is short; the operating philosophy, "what have you done for me lately." Thus, it's the spectacular strikeouts-ICG chief among them-that are on investors' minds. ICG is a Denver-based competitive local-exchange carrier (CLEC).

"We've never seen anything go so bad so fast," says Bennett of ICG. "To some extent, I think we were misled. Either way, we're not supposed to get misled, so we'll take the responsibility, take the criticism, and say out of the hundreds of investments we've made over the last several years, this was a big one that went bad.I don't think it's necessarily something that you can extrapolate to the rest of our businesses and say, 'Ah-ha, this is a sign of a sudden deterioration in business judgment by the management team.'"

Liberty wasn't alone on the ride down, during which its roughly $500 million investment fell to next to nothing as ICG shares slumped from $39.25 at their height to less than 50 cents recently. Hicks, Muse, Tate & Furst, which has joined Liberty in several other investments, lost essentially all of its $230 million investment, as did Gleacher Capital Partners with its $20 million investment.

What happened at ICG remains unclear, though it appears the company grossly overestimated its ability to grow its network and actually acquire customers. Liberty is now considering a lawsuit against ICG.

Such a meltdown may be an anomaly for Malone and his companies, but the ICG debacle disappointed some who may have been trying to hitch their wagons to Liberty's more recent investments. Indeed, Liberty's investment in ICG came when equity markets, and ICG's stock, were at or near highs. Historically, Malone has bought into his riskier plays at a deep discount. But one large investor says that to truly gauge Malone and Liberty's performance, look at the long-term record.

"Some of these money managers who are down 40% have invested a lot in the same companies Liberty invested in and that's why they're bitching," says the investor, who requested anonymity. It's better to bet on Malone than to try to cover his bets, the source says. "The way I look at it, he's running a business, not managing a pension-fund portfolio. I'm more interested in where he's going to be three years from now than where he's going to be next week."

Liberty investments in Cendant, the franchising giant, and in Teligent, a wireless communications provider, have also been sore spots with critics. On Feb. 2, Liberty acquired a $300 million, or roughly 7% stake, in Cendant (NYSE: CD), plus $100 million worth of stock warrants. The 18 million shares Liberty acquired cost $16.67 a share. By March 31, shares were trading at $18.50, up nearly 11%, in two months. Cendant has steadily declined since then, falling to $8.50 on Oct. 18 before starting to climb back up into the double digits.

Teligent has also declined, but the circumstances are more complex. Liberty acquired the Teligent stake, along with positions in several other firms, when it and AT&T bought Associated Group early this year in a deal that underscores the often complex nature of Liberty transactions.

The biggest asset in Associated Group was equity in TCI and Liberty. The primary thrust of the deal was to repatriate those shares and, in the case of the TCI shares, for AT&T to retire them. Liberty's acquisition of 36% of Teligent and 90% of TruePosition (wireless location services) that Associated Group owned wasn't an afterthought, but it wasn't the primary goal. Because the deal was tax-free to Associated Group shareholders, Liberty was able to buy a $1.2 billion stake in Teligent for roughly $700 million, according to Vivian Carr, senior vice president Investor Relations at Liberty. In effect, she says, Liberty acquired 21.4 million Teligent shares for about $35.50 apiece when the shares were trading around $49.In the next 10 months, Teligent soared as high as $97, then saw the bottom begin to fall out. By Oct. 17, it was trading at $7.50, though it has since begun to edge up toward double digits.

Liberty's long-standing approach is to ride out the ups and downs, extract liquidity from assets when it can and reinvest lower in the financial food chain.

"We're not a trader. We're not a mutual fund," says Bennett. "We're not trying to buy things and hold them for six months and then sell them at a profit. The assets that we buy are building blocks of a larger structure that we're trying to assemble."

That doesn't mean Liberty is a passive victim of market volatility. When the going gets tough, Liberty hedges.

Selling an asset is the simplest form of hedging, but an approach Liberty rarely uses because of the tax consequences. One approach Liberty does use is issuing exchangeable securities, as it did with Sprint PCS. In that instance, Liberty issued nearly $2 billion in debt convertible into Sprint PCS stock in 30 years. Liberty's betting it can do well enough investing that money to more than offset gains it would have had in PCS stock 30 years out.

"We traded [potential] upside in the PCS stock for, in essence, no cost to carry the money," Bennett says.

A third hedging method Liberty employs is cashless collars. Here's how it works: Liberty buys a certain numbers of puts, the right to sell a stock at a set price (a hedge against a decline in the stock price) that go into effect after a certain period. At the same time, its sells an equal value of calls, or rights to buy a stock at a set price (and a bet the stock will go up), for the same period. From Liberty's perspective, the put is a floor and the call is a ceiling. If the stock goes up, Liberty benefits from some, but not all, of the upside. If the stock goes down, Liberty is protected. The difference between traditional options trading and Liberty's approach is that with cashless collars, no money changes hands, and thus no tax liabilities kick in, until an actual sale occurs.

Spinning Into The Future

When Malone or one of his companies is in a trough, that's the time to pay closest attention because a move almost certainly is coming. Speculation-always plentiful where Malone is concerned-focuses on three areas: Liberty's relationship with AT&T; Liberty's stake in European cable operator United Global Communications; and Liberty's expanding stake in News Corp.

Economically, Liberty's separation from AT&T carries some slight downside. As long as it remains an AT&T tracker, Liberty passes tax losses to the parent and gets cash in return. As a stand-alone, Liberty could still take those losses but as net operating losses over a period of time, thus losing the time value of money benefit of its current status.

Partly through its acquisition of a 45% chunk of United Globalcom (UCOMA), Liberty now passes roughly 27 million cable homes and has about 14 million subscribers, making it the second-largest cable operator in the world-behind only parent AT&T. Some analysts contend Liberty paid too much for its UCOMA stake, a criticism Bennett rejects, saying Liberty acquired most of the UCOMA stake with similar assets, such as its Latin American cable holdings and its Telewest stake.

Criticism notwithstanding, most Liberty watchers are sanguine about the UCOMA holdings. "Liberty is far better off having its stake in UCOMA, which longer term is a control stake, than it is in having those individual private assets," says Media Research Group's Riely. "You can think of UCOMA as the TCI of the world."

Liberty and News Corp. have agreed to a deal by which Liberty will swap its Gemstar-TV Guide International stake for an 18% interest in News Corp. and a 4.76% pre-IPO interest in Sky Global Networks. As a result, Malone appears on his way to being one of the larger players in the satellite arena, a long-sought goal; Malone has publicly said he's "platform agnostic."

"When Liberty announced the Gemstar [News Corp.] transaction, it not only made a shift toward Murdoch in terms of alliance, but also made a shift from cable to satellite," contends Jimmy Schaeffler of the Carmel Group, a satellite-industry research and analysis firm. "To me, that was a shift in the tectonic plates."

So now the question is, what does Malone do next. "I would never bet against John," says Amos Hostetter, who sits on AT&T's board with Malone. "I've known him for 40 years, and that's a formula for going broke. He has been and will continue to be one of the smartest investors there is. It's a tribute to John and the rest of his group that the stock is down only 50%."

Liberty's Tough Portfolio

3/15* price 11/15 price % change

Corus Entmnt.








Crown Media




USA Networks




Time Warner








News Corp.




On Command




Gemstar-TV Guide Int'l








Emmis Comm.








Liberty Livewire




Sprint PCS








United Global Com








Liberty Digital















ICG Comm.





XM Satellite Radio




Alloy Online











iBeam Bdcst.







Liberty Satellite & Tech.;















Quokka Sports












Interactive Pictures







Long-held investments like Cablevision and Time Warner aren't so bad. But they're overwhelmed by the terrible performance of recent high-tech investments. Includes only public companies.

*Or earliest date if recently gone public.

Other large Liberty investments are privately held and not listed. They include 49% of Discovery Communications, 35% of BET Holdings and 46% of QVC Networks.

Source: Company reports, Bloomberg