Rupert's Vertical Reality

Tough sledding ahead, but Murdoch finally has his DBS system
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Rupert Murdoch should have a much easier time clearing regulatory scrutiny than did the previous suitor of giant DirecTV, EchoStar's Charlie Ergen. But that doesn't mean the News Corp. chairman won't have to quiet the alarms last week's satellite-TV deal is setting off around Washington.

One shrieking alarm is Murdoch's seeming concession to cable operators, which would face News Corp.'s Fox both as their biggest competitor and as one of their most important program suppliers. Murdoch declared that he would abide by federal program-access rules that currently govern only cable networks with co-owned cable systems, not satellite TV. Those rules prohibit such networks from discriminating in their distribution deals.

But cable executives' attention has been drawn to a footnote in News Corp.'s pledge sent around Washington last week. "You can drive a Mack truck through that," said Michael Willner, CEO of Insight Communications and chairman of the National Cable & Telecommunications Association.

"There's going to be a war out there," says Rocco Commisso, CEO of Mediacom, the No. 9 MSO. "The government should be more concerned about protecting me than the satellite industry. I don't have the same power as Murdoch."

The government should use this deal to reopen the program-access law and level the playing field between cable and satellite, Commisso said. "This is no longer a fledgling industry."

The deal would also mark the first marriage of a major multichannel video provider (DirecTV) and a major broadcast network (Fox). "Clearly, it has the potential to create some seismic shifts in broadcasting," said Ken Johnson, spokesman for House Energy and Commerce Committee Chairman Billy Tauzin (R.-La).

The DirecTV deal must be approved by the FCC and one of the federal antitrust regulators, probably the Justice Department. Congress also will likely hold hearings on the merger, which could affect the regulators.

Consequently, regulators are likely to use this merger to set program-access rules for cable programmers with DBS holdings in the corporate family. In other words, they may codify Murdoch's non-discrimination pledge.

Murdoch predicts that the regulatory process will be completed by January. "We will make our content readily available to all satellite-television providers as well as cable and other competing platforms," he said. "Our creative strength as a company will increase the vitality of the American television market as a whole, enabling the sort of fair and fierce competition that our company was built on and that quite frankly which we've always thrived on."

Investors weren't thriving on the deal, whose broad strokes call for Murdoch to pay $6.6 billion in cash and stock for 34% of DirecTV's parent company Hughes Electronics.

The structure of the deal is surprisingly unfavorable to outside shareholders of Hughes and News Corp. unit Fox Entertainment (which trades publicly). Both stocks got hammered after the details became clear. Even Merrill Lynch analyst Jessica Reif Cohen—a longtime Murdoch fan – put a "sell" recommendation on shares of Fox Entertainment, although she maintained a "buy" on Fox's 80% owner, News Corp.

But that doesn't translate into Washington problems. There's little sign that the regulatory friction will be anything like the heat that torpedoed EchoStar's planned takeover of DirecTV parent Hughes Electronics last year.

For one thing, Ergen's chief opponent in that process was Murdoch, who lost out in DirecTV's first auction. News Corp. campaigned hard to scuttle the deal, hoping to step back in after antitrust regulators scuttled it. (So far, that plan is on track.)

More important, though, News Corp.'s control of DirecTV isn't as blatantly anti-competitive. A takeover by EchoStar would have reduced the number of multichannel video competitors from three in most markets—EchoStar, DirecTV and a cable system—to just two. And, in some cable-free rural markets, the number of providers would have dropped from two to just one. The hit on competition was so obvious that even the Department of Justice and the FCC of a merger-friendly Bush Administration moved to kill the deal.

In this round, the winds are blowing Murdoch's way. He's a conservative owner of news outlets that are aligned with the Republican line. The questions about competition directly affect not consumers but primarily rival cable operators and networks.

"I think it's just a question of how hard are the backslaps as he goes through the regulatory gauntlet," said Reed Hundt, former FCC chairman and currently an adviser to consulting firm McKinsey & Co. Programming-supply and pricing issues aren't substantial enough to scuttle the deal and possibly wouldn't even require a consent decree. "Rupert's opponents have as much chance as the Republican Guard," Hundt says.

"Washington had one bite at DirecTV," said Jimmy Schaeffler, CEO of media research firm The Carmel Group. "They wanted to make sure there was competition within the DBS industry, and they got it."

But even News Corp. executives recognize that program access is a hot, hot issue.

Securing control of DirecTV would make Fox the second-largest distributor of "cable" networks (behind cable operator Comcast) and an important producer of cable content, particularly news and sports channels. That would make the combative Murdoch cable operators' biggest competitor and one of their most important program suppliers. His networks include the Fox Sports regional sports networks, the top-rated Fox News Channel, and a handful of less powerful channels, including FX, Fox Movie Channel, and Speed Channel.

That kind of vertical integration is not unusual among cable operators. AOL Time Warner, for example, owns cable systems serving 10 million cable homes at the same time it controls Home Box Office and the popular Turner networks. So, in 1992, Congress mandated "program access." Vertically integrated cable operators have to license their networks to DBS rivals on the same terms the channels are sold to other cable operators. Cablevision, for example, can't withhold its AMC from DBS or charge, say, $4 per subscriber monthly when cable operators only pay 50 cents.

Murdoch acknowledges that as an issue. The legislation didn't contemplate that the then-nascent DBS companies would be big or powerful enough to use networks against either cable or rival DBS services. Nevertheless, Murdoch said DirecTV would submit to a level playing field: "We will agree to be bound by FCC program-access regulations."

However, there are a couple of exceptions. DirecTV will keep or seek exclusivity for programming in which it has no ownership. That would most notably include the NFL Sunday Ticket package that gives sports junkies every National Football League game for $200 per season and is considered DirecTV's biggest programming advantage.

What has caught cable operators' attention, however, is a footnote in a "summary of commitments" News Corp. faxed to regulators and Congressional staffers last Thursday. That footnote excludes programming owned by any "affiliate" that owns a piece of News Corp. Right now, that means Liberty Media, which is News Corp.'s largest outside shareholder, owning 18% of the company's equity.

Liberty owns parts of many cable networks, including Starz!, Encore and the Discovery Channel, and has moved to buy control of more. CEO John Malone has been a partner with Murdoch in a number of ventures and shares his taste for confrontational business stances.

Cable executives worry that News Corp. could use the exception to structure deals around Liberty or some other cooperative entities.

"It's a clear indication that they would like to exclude a substantial amount of programming and keep their options open to distribute to themselves exclusively," said Insight's Willner.

But News Corp. executives say the concerns are overblown. Lobbyist Maureen O'Connell called the clause "a narrow exception." It's intended to keep some sort of DBS-only package from going straight to EchoStar simply because it was tied to Liberty or someone else that owned more than 5% of News Corp. "If the FCC has a concern about it," she said, "we'll change it."

Bill McConnell contributed to this story.