Trouble at Home

Liberty is saddled with Starz financial woes

Spinning off its international operations may simplify Liberty Media, but it doesn't solve its problems at home. Announcement of the company's action was clouded by new revelations about the crisis at its pay-movie service.

Starz Encore is in huge trouble, with cash flow on a steep, 65% slide over two years. Liberty took a $1.3 billion write-off on value of the network.

A less severe concern is how domestic sales at the newly acquired QVC have stalled, though profits and international sales are stronger. CEO John Malone's mission to simplify his company for investors is hamstrung by Liberty's huge positions in stocks that are tangled up inside complex derivative securities.

Another plus: The strength of Liberty's 50%-owned Discovery Communications, which increased sales 16% to $2 billion last year while boosting operating cash flow 34% to $314 million. Discovery's U.S. networks—notably Discovery Channel, TLC, and Animal Planet—continue to drive the company. But there is a downside: A chain of retail stores burning cash at the rate of $50 million a year cuts Discovery's profits by 11% a year.

Yet that amount is paltry next to what Malone faces with Starz. In a conference call with investors, he openly expressed his disappointment in the network. He acknowledged he would consider selling it but said no buyer would be interested until it stabilizes. "Starz Encore has got to prove itself," he said, adding, "It has to deliver on the investment that it's had in all of these [film] rights."

Big drawback: Starz Encore is being eaten up by movie costs and slow growth. As the third entrant in the pay-movie business behind HBO and Showtime, Starz made big commitments to Hollywood studios to feed theatrical films to its core network, Starz!, sibling Encore, and a cluster of themed movie channels (Westerns, for example). And the tab is higher than expected. Securities filings show that, a year ago, Starz estimated it would pay $200 million for film rights in 2004. Now its networks expect to pay $558 million. Next year's bill is expected to run $231 million, 70% more than the company had been predicting.

Why the surge? Blame Disney. Since movie license fees are tied to box-office performance, Disney's surprisingly strong slate last year—including Finding Nemo
and Pirates of the Caribbean—will slam Starz Encore this year.

Starz Encore had been expecting to pass that cost to AT&T, whose cable systems were burdened by an old, terribly expensive contract inherited when the telco bought Liberty sibling Tele-Communications Inc. When Comcast bought AT&T Broadband, it broke that sweetheart deal and cut a new one. That means Starz has to absorb all the rising film costs itself.

The Comcast dispute also cost Starz 900,000 subscribers, though that doesn't cause financial pain. There is even a bonus: While fighting to shed the onerous AT&T contract, Comcast stopped pushing Starz and its sibling networks to its customers. Which may be the only good news in the Starz constellation: The move saved Starz Encore some $57 million in sales and marketing expenses.