Wiring Europe

By Daniel Eisenberg

Monopolist. Bully. Cowboy. John Malone has heard it all before. As he dominated the U.S. cable-TV industry for much of the past three decades, the CEO of Denver-based TeleCommunications Inc. (TCI) was called plenty of names, including some that can't be printed here.

Skeptics said he was naive to think that Americans would shell out $10 to $20 a month for extra channels when they were happy with the ones they pulled in with rabbit ears. And when Malone ended up controlling more than 10 million cable subscribers and a stake in nearly every major cable network, from CNN and Discovery to QVC, he was called a ruthless gatekeeper to America's eyeballs. The resentment was not just over what Malone did, but how he did it: by being one of the corporate world's most feared negotiators. Square-shouldered at 61, Malone, who has lifted weights since high school, is physically and intellectually intimidating, with a flypaper memory and an ability to perform complex calculations in his head. One person who has sat across the bargaining table from him says he has a "frictionless mind." Other negotiators complain that Malone has an annoying penchant for tweaking the deal to his advantage just as closure seems at hand. When he finally decided to sell his crown jewel to AT&T for $37 billion in stock in 1998, many competitors and partners alike wanted to wish him good riddance.

Now Malone is back in the game, this time in Europe. And judging by the heavy odds he faces and the already nasty reception, he must feel right at home. The Connecticut native is busy trying to build a new cable empire--one that eventually wires all of Europe and offers not just interactive cable TV but high-speed Net access and telephone service as well. With a $2 billion war chest and a long-term investment philosophy that doesn't worship at Wall Street's altar of quarterly earnings, Malone is one of the few big players willing and able to make such a bold bet.

By consolidating a debt-ridden, fragmented European cable industry worth $70 billion, he thinks he can achieve the economies of scale in programming, equipment and marketing that helped turn TCI into such a titan. But he faces a much tougher task on a continent that, despite its efforts at economic union, confronts any newcomer with a thicket of regulatory and cultural barriers. "Malone has been getting an education in Europe," notes Tom Crema, a partner in Compere Associates, the London investment firm that is bidding for some of the same German cable assets that Malone failed to win earlier this year.

One need only glance at the recent business headlines to see the hurdles Malone, now chairman of Liberty Media, faces. In Britain the premium over-the-air service ITV Digital recently shut down, and each of the country's two big remaining cable companies, Telewest (in which Liberty holds a 25% stake) and NTL, is saddled with billions of dollars in debt. NTL bondholders rebuffed Malone earlier this year, and if he continues to be shut out of Britain, "there will be a serious piece missing" from his master plan, notes Gary Klesch, a London-based media investor and former Malone partner.

In Germany, the world's second largest TV market after the U.S., Leo Kirch's premium TV service, Premiere World, boasts an impressive lineup of soccer matches, Formula One races and Hollywood movies, yet it has managed to lure only 2.4 million paying subscribers. After losing $1.4 million a day, it ended up dragging its parent company into bankruptcy, and buzzards from four continents have converged--among them Bertelsmann, Liberty Media, News Corp. and Sony--to pick at the carcass. In Italy, where stealing satellite service is pursued with the same ingenuity and gusto as is tax avoidance, two competing pay-TV services, Vivendi's Telepiu and News Corp.'s Stream, have fared so poorly that they have had little choice but to combine their 2.3 million subscribers. Two struggling Spanish providers of pay TV by satellite, SogeCable and Via Digital, are headed down the same path.

To put it mildly, Malone's European strategy is a contrarian play. But that's what he has always sought. Now that many cable companies have exhausted themselves and the patience of their bankers by trying to string copper wire and coaxial cable from the North Sea to the Baltic to the Mediterranean, he can come in and scoop up the fruits of their labors for pennies on the euro. "What seems to be cheap seems to get cheaper as one waits," he quipped, with his typically dry sense of humor, at the recent shareholder meeting of Liberty Media, the onetime TCI programming arm that Malone has turned into a mini-media conglomerate. "We're trolling. We've got our bait in the water, but so far we haven't landed any big fish."

That doesn't mean they haven't caught anything. Malone has already taken advantage of the depressed market, pouring in much-needed funds to gain effective control over United GlobalCom, the leading international broadband provider, which has nearly 10 million cable subscribers scattered across the Netherlands, Germany, Austria, France, Scandinavia and Eastern Europe. And although he has been stiff-armed so far, Malone watchers believe he may end up combining Telewest (whose bonds he is trying to buy up) with NTL to form one British cable provider, with 4.7 million subscribers, that could compete with Rupert Murdoch's popular British Sky Broadcasting (BSkyB) satellite-TV service. Lately Malone has been making a play for NTL's Swiss cable subsidiary, Cablecom, as well as Dutch cable concern Casema, owned by France Telecom. A cable provider in France, NC Numericable, may also be up for grabs.

Malone isn't in Europe just for the bargains. He's also looking for outlets for the programming assets in which he owns stakes through Liberty Media. Though Liberty is publicly traded on the New York Stock Exchange, Malone owns 44.6% of the voting shares and controls the company as its chairman. Liberty owns the Starz and Encore premium movie channels, plus 50% of Discovery Communications (which includes Discovery, Animal Planet, Learning and Travel channels) and 43% of the home-shopping channel QVC. In addition, it holds valuable stakes in Vivendi (3%), News Corp. (18%), USA Interactive (20%) and AOL Time Warner (4%), the parent company of this magazine. Liberty also invests in cable and programming companies in Latin America and Japan, where its Jupiter Communications is the largest cable provider (though still a money loser).

With the media and cable industries rapidly consolidating, there's not much room left for a maverick like Malone. Stripped of the enormous leverage his cable empire once gave him, Malone can no longer dictate the terms at the bargaining table. AOL and Comcast are now the gatekeepers, and content players like Disney, Viacom and News Corp. carry much more weight. Malone has effectively acknowledged the corner he's in, indicating that lucrative Liberty stakes in certain closely held assets like CourtTV, E! and QVC will, within a couple of years, probably be sold to whichever media behemoth will pay top dollar. As he puts it, "We're in the business of moving goods." Nearly every major media power, from NBC to Viacom, would love to acquire Discovery, a worldwide, multibillion-dollar franchise. Says a longtime business acquaintance: "John is at a crossroads. Liberty is ineffective if it stays purely an investment company. Either John has to become a substantial operator of select media assets or he should begin to distribute his various equity ownerships."

But those who would become successful cable operators in Europe must step over the bodies of brave people, including Microsoft's own Bill Gates, and pick their way through cultural minefields. Premium cable TV has been a bust across most of the Continent, where people spend more time in cafes and pubs, and less in front of the tube, than Americans do. When Europeans watch TV, they're used to getting high-quality programming on state-subsidized channels. Only a few years ago, German media giant Bertelsmann gave up entirely on the floundering pay-TV market. Dutch TV production company Endemol, which created the reality series Big Brother, doesn't work with a single pay-TV provider in the Netherlands. "TV in Europe is viewed as a utility," says UBS Warburg analyst Chris Dixon. Even Malone concedes that "these are not investments for wimps," as he told the Wall Street Journal earlier this year in a rare interview. (No one at Liberty Media, including Malone, would comment for this article.)

About 30% of Western European homes have cable, compared with 68% in the U.S., and powerful satellite players like News Corp.'s BSkyB and Vivendi's Canal Plus feed signals to 20% of the Continent's TV sets. Gross margins in the cable business hover at about 12%--about a quarter of those in the U.S.--and subscribers outside the U.K. bring in only $13 a month in revenue.

Much of cable's woe stems from the high cost of programming in Europe, driven up a decade ago by newcomers KirchPayTV and BSkyB, which wanted to kick start their fledgling services. Soccer--which is quite literally "the only game in town," as Carmel Group analyst Jim Stroud puts it--has seen the cost of its coveted broadcast rights soar in recent years. Kirch alone paid $350 million a year to distribute the German national championship league, a cost that contributed to the German company's eventual downfall. Even BSkyB hasn't turned a profit on its most recent investment in soccer.

The Continent's cultural diversity makes it hard to turn a profit on other homegrown programming; the lack of an export market to recoup costs doesn't help. Pornography, the quiet cash cow of the U.S. cable industry, is not as much of a draw in countries where full-frontal nudity is routinely shown on free TV.

As if that were not enough, there are entrenched telecom monopolies, local media companies and wary regulators to contend with. Malone learned that lesson the hard way earlier this year in Germany, when powerful private broadcasters like RTL and public providers such as ARD and ZDF did their best to block him. "A scheme in which one player controls the heart of TV's infrastructure is against open competition," says Didier Bellens, CEO of RTL Group, which is controlled by Bertelsmann. Given that kind of opposition, it wasn't surprising that after spending months negotiating a deal to purchase six of Deutsche Telekom's regional cable systems for $4.9 billion--which would have given him 12 million subscribers and 60% of the German cable market--Malone found himself at loggerheads with German regulators.

It's not an uncommon position for Malone, who has a deep distrust of government and counts Ronald Reagan and Dwight Eisenhower among his heroes. But Malone also has a stubborn and patient sense of the value of a deal. So when the German Cartel Office demanded that he spend an extra $1 billion to $2 billion to upgrade the country's aging cable lines and offer cable telephony immediately--instead of gradually, as he had planned--he decided to walk away, as he often has at the last minute. "A very wise man," Liberty Media CEO Robert (Dobb) Bennett said at the recent stockholders' meeting, gesturing toward his mentor, "once told me the best investments are the ones you decide not to make."

Or at least to delay. Many observers think Malone is playing his classic waiting game in Germany, using his patience to drive down the price of Deutsche Telekom's cable assets before he swoops in again. "I don't believe he's done in Germany. This is how he negotiates," says a longtime Liberty observer. But price is only one part of the parley. Germany may be Europe's largest television market, with 33 million households, but it's also one of the most antiquated. Already, two foreign players in the German cable market, NTL's Iesy and Callahan Associates' Ish, have had to scale back the pace of their digital TV and telephony roll-out as well as earnings expectations.

German basic-cable subscribers can watch as many as 30 channels that air popular game shows like Wanna Bet? or mini-series like The Count of Monte Cristo for $10 to $20 a month, which is typically included in apartment rents. To complicate matters, German cable providers don't own the "last mile"--the wire into the home. That privilege is reserved for thousands of so-called Level 4 operators, made up of everyone from real estate companies to apartment-house owners. "The oddest part of it all is that the cable operators themselves don't get the lion's share of the money. The Level 4 operators do," says Michael Lynton, head of AOL Time Warner's international ventures. "Ultimately the economics of the business have to change for cable operators to be interested in further investment."

Malone may face a similarly uphill march in Britain, but for different reasons--chief among them his friend, business partner and rival, Murdoch. Over the past decade, Murdoch's BSkyB has become Britain's pay-TV service of choice, known for offering its nearly 6 million subscribers superior customer service, compelling content and innovations like on-demand sports replays. As cable systems have tried to compete, it hasn't helped that until recently prospective customers have had to wait to have a trench dug nearby before service was available. Some 20% of cable customers still get fed up and ditch the service, roughly double BSkyB's churn rate. BSkyB not only controls the customers but also controls many of the sports and film rights that Malone will need to stay competitive. Fortunately for Malone, the two moguls already share a rich history of collaboration, including News Corp.'s Malone-backed but aborted bid last year for the U.S. satellite-TV firm DirecTV.

Cable may yet arrive. With its two-way capabilities, cable can eventually offer a wider assortment of interactive services--from online gambling and games to video on demand--than satellite can. And now that Parliament has passed a sweeping media-liberalization law, American firms will soon have a chance to grab some British broadcasting assets like itv and Channel 5. "I've always seen satellite as a transition technology," says Michael Grade, a longtime British TV executive and now chairman of Pinewood Studios.

Malone is banking on a bundle of TV, broadband and telephone service, known in the industry as the triple play, to make his business viable. By the year 2010, some 40% of British cable subscribers and 15% of European subscribers will be paying for such a trio of services, according to UBS Warburg. Still, when it comes to phones, Malone faces fierce competition--from the wireless kind. "Telephony doesn't make any sense," says Robert Routh, an analyst at Arnhold & S. Bleichroeder, "because Europe has a culture of people who don't use landline phones."

Broadband looks more promising. Almost half of Europeans are online, although fewer than 5% have true high-speed service. But in Europe, unlike the U.S., the telecom monopolies have got off to an early lead. Deutsche Telekom has garnered 2.3 million broadband users in addition to its 8 million dial-up subscribers.

The setbacks in Germany, the ad recession and Liberty's sinking media holdings have caused its stock to lose about 40% of its value over the past 12 months. But some loyal investors maintain that if anybody can thrive in Europe, it's Malone. Bill Nygren, manager of the Oakmark Fund, which holds about 7 million Liberty shares, says, "These are the smartest minds in cable, and he's the best wealth builder i've ever invested with."

Malone holds a B.S. from Yale in electrical engineering, master's degrees in industrial management and electrical engineering, and a Ph.D. in operations research from Johns Hopkins. He even worked as a scientist at Bell Labs for a few years after college. An intense listener and a keen analytical thinker, Malone is notorious for complicated transactions and financial gymnastics that keep his taxes low. And he understands the technologies underlying his various visions.

What the shy, aloof son of a General Electric engineer doesn't enjoy is managing people. "I hate having 35,000 employees who need to be patted on the back," Malone told Broadcasting and Cable magazine. "Just give me a corner somewhere where I can sit and scheme." When he's not scheming, Malone likes to sail off the coast of Maine with his wife Leslie, whom he met at the beach the summer before starting college. He also enjoys gardening at his Colorado home and delving into a political biography or a thick company report.

One firm he follows closely is AOL Time Warner. Documents filed with the sec earlier this year show that Malone is trying to renegotiate with the FTC an agreement he made in 1996 that restricts his stock ownership and voting rights in what has since become AOL Time Warner. Some analysts believe Malone would like to shake up the stumbling media giant. AOL Time Warner opposes lifting the FTC's restrictions on Malone.

Friends say, though, that Malone's main focus is on Liberty Media and Europe. He has lost millions not only on AOL but also on investments in Priceline.com Teligent and ICG, and he's determined to redeem his reputation. Malone, whom Al Gore once famously dubbed Darth Vader, can handle being called almost anything--except, of course, a loser.

--With reporting by Thomas K. Grose/London, Chris Franz Koehl/Cologne, Eric Roston/New York and Andrew Rosenbaum/Amsterdam

With reporting by Thomas K. Grose/London, Chris Franz Koehl/Cologne, Eric Roston/New York and Andrew Rosenbaum/Amsterdam