Tracking rainbows

Cablevision network unit spins off, looks to expand

After years of pondering, planning, false starts and an aborted auction of its core networks, Rainbow Media is finally getting some legs of its own-and walking right into the teeth of a recession.

Cablevision Systems' creation of a tracking stock around its Rainbow networks also, unfortunately, comes at a time when the network group has begun betting more heavily on advertising revenues, after years of relying primarily on less volatile streams of license fees from cable and DBS operators. Artsy network Bravo started selling conventional advertising just three years ago and is substantially boosting programming spending to drive Nielsen ratings. American Movie Classics is heading down that same road.

Rainbow President Josh Sapan reveals no anxiety, though. "We're in a fairly strong relative position," he explained. "A greater portion of our revenues come from license fees. Secondarily, the newness of our channels to advertisers and the smallness of our budgets means we can still see growth."

Cablevision Chairman Charles Dolan and his lieutenants have been talking about some sort of Rainbow spin-off for five years. Vice Chairman Bill Bell contends that investors had treated the networks as an afterthought, valuing Cablevision's stock almost entirely on the cash flow from its cable systems. "We were not getting the value in the public markets," he said.

Of course, Cablevision hurt its cause for years, hiding detailed financial results on Rainbow's individual networks and thus clouding their performance and value.

The good news is that however Rainbow trades in the coming days, the move has already proven to be a success.

To Bell, Dolan's financial architect, the tracking stock was a success long before trading commenced. "If you look at our stock since we announced the tracking stock, it's been higher than our peers'." Cablevision shares have ticked up 25% since the tracking-stock plans were announced last August. That's better than other MSOs and certainly the major stock indices, which have dropped 10% to 50%.

That's one reasons UBS Warburg media analyst Tom Eagan downgraded Cablevision shares recently. "It's all already in the stock," he said.

Investors got half a share of Rainbow for each Cablevision share. The tracking stock is tied to the performance of Rainbow's American Movie Classics, Bravo, Independent Film Channel, MTV wannabe MuchMusic USA, and regional sports networks. Cablevision's systems, sports teams and networks tied to New York, such as MSG, are not included.

It's the simplest and most conservative route that Cablevision could have taken. In addition to highlighting the value, among other things, it gives Sapan a handy currency for use in acquisitions.

Trading didn't officially begin until Friday morning. But shares had been informally trading on a "when issued" basis a week earlier in the $22 to $24 range. That valued Rainbow's assets about $3.7 billion, less than a recent deal with MGM valued the entertainment networks.

After the aborted auction, MGM, which lacks the financial firepower to acquire Rainbow Entertainment outright, locked down a deal to buy 20% of the entertainment operation for $820 million.

Media and Wall Street executives laughed at the deal. Rainbow gets to pay off all its debt but doesn't give up any management control. Dolan gets the $4.1 billion valuation he sought on the entertainment assets. Sapan doesn't give MGM a board seat and needs MGM's approval only for such actions as going into Chapter 11 bankruptcy protection.

Sapan had big plans even before he got such financial flexibility. Bravo is the big project. Having begun selling ads in 1998, Bravo is investing far more heavily in programming than ever. Sapan just agreed to pay a record $1.2 million per episode for the off-NBC series The West Wing, having just agreed to $250,000 per episode for the off-HBO Larry Sanders Show.

Bravo garnered its highest ratings ever in the first quarter, averaging a 0.4 in prime time. That's low for cable but double the network's average in recent months.