Malone’s Shrink Rap

Discovery spinoff is all about Liberty CEO’s contraction

Look at everything John Malone does these days through this prism: He’s a seller of U.S. assets, not a buyer.

If you keep that idea in mind, it’s a lot easier to understand last week’s complicated deal to spin Liberty’s $6 billion stake in Discovery Communications Inc. off to Liberty’s shareholders. Malone is not just making Discovery a little easier for someone else to buy. He’s making Liberty Media itself more digestible, more alluring to a buyer.

The move is related to Malone’s recent moves to acquire control of a larger stake in Rupert Murdoch’s closely held News Corp.; Malone is already the biggest outside shareholder. The knee-jerk reaction of many Wall Streeters was that he wanted to mount a takeover. In fact, Malone wants Murdoch’s full attention, prodding him into making an offer for some or all of Liberty Media’s assets.

Complex Deals

Malone is openly fond of complicated deals, but even by Malone’s standards, his Discovery plan is convoluted. Malone proposes spinning Liberty’s 50% stake in Discovery off to Liberty shareholders. A new company, Discovery Holdings, would trade like any other stock even though Discovery itself would remain a private company.

Because the new company needs to have some sort of actual operating company inside to keep the deal from triggering any taxes, Malone is tossing his $300 million Ascent Media hotel pay-per-view and TV-production unit into the deal.

Discovery’s other two major shareholders—Cox Enterprises and Advance Newhouse—are being invited to contribute their shares. There’s a few good reasons it’s highly unlikely they will do so (more on that later), but Malone says he’ll move forward without Cox and Newhouse.

Since SEC filings show that they have right of first refusal on “any proposed transfer” of Liberty’s Discovery shares, it will be interesting to see if Cox or Newhouse not only passes on Malone’s invitation but actually tries to thwart his plan.

Discovery founder John Hendricks told executives last week that going public would put the company more in control of its own destiny. As a public company, Discovery wouldn’t be quite as beholden to the financial needs of its three large owners. Also, the public stock becomes a currency that Discovery can use to buy other networks.

But the odd structure of Malone’s proposal doesn’t call for Discovery itself to really go public. His new company would be sort of a mutual fund, with Liberty’s 50% in Discovery as its primary holding. Under terms of the deal, each shareholder would receive 0.5 Discovery Holdings share for every Liberty share. The stock of the new Discovery Holdings could zoom.

That would change if Cox and New­house threw in their shares, but it’s hard to see why they would rush to join in. First, if they wanted Discovery to go public, it would already be public. Investment bankers have been pounding down the Discovery partners’ doors for years, begging for an IPO assignment. Hendricks has lobbied as well. Cox and Newhouse don’t need a Malone shell company to do that.

Why stay private? Cox Communications President Jim Robbins and Advance Newhouse President Robert Miron have always said they didn’t want to give away the upside. Discovery doesn’t need to raise capital. So if they think Discovery is going to continue growing, they wouldn’t want to share that growth with clients of Charles Schwab.

Surrender Control

And it certainly seems that Robbins and Miron would be surrendering control. Right now, any Discovery partner has veto power over major decisions. But as controlling shareholder of Liberty, Malone would also be controlling shareholder of Discovery Holdings. Would Robbins and Miron give up that control to get some liquidity?

Last year, Robbins looked like a possible seller, but that’s not likely. When Cox Enterprises took cable operator Cox Communications private in November, the larger company took on $8 billion in new debt. And executives at the conservative, family-owned newspaper company are notoriously debt-averse. Cox disclosed just last week that it plans to sell almost $3 billion worth of cable systems, all in its Mid-America division. Rolling a publicly traded Discovery into a derivative security would also let Cox pare $3 billion in debt.

Look for Liberty to shrink even further. Right now, Liberty Media is valued about $37 billion. That’s too big for most potential buyers. Shedding Discovery is a start. Liberty’s QVC unit is another candidate for a spinoff, with a value of about $15 billion. Another step could be reorganizing its $3 billion stake in Barry Diller’s Interactive Corp. At that point, half the remaining value in Liberty would be the News Corp. stake.

If executed, the deals could shrink Liberty down to a manageable bite—just the right size and flavor for Rupert Murdoch.

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