October 16, 2002 -- New York.
A Conversation with John Malone
with John Malone and Ken Auletta.
On October 16th, the New Yorker staff writer Ken Auletta interviewed John C. Malone, the chairman of Liberty Media, at a breakfast hosted by Syracuse University's S. I. Newhouse School for Communications. He spoke to Malone, whose company owns parts of five of the six largest media companies in the world, about the future of his industry and the economy. Auletta has reported on many of the leading players in the media and communications business for The New Yorker, including Ted Turner, Howell Raines, Barry Diller, Rupert Murdoch, and, in February, 1994, Malone himself. Here are some excerpts from their conversation.
KEN AULETTA: When I first went to profile John Malone, about eight years ago, in his office in Denver, one of the first things I noticed was that he, one of the most powerful men in television, didn't have a television set in his office. I also noticed that a man who had early on championed interactivity didn't have a PC on his desk. As I spent time with Malone, I also realized that he had no investment bankers around him. He tended to do the math in his head. And one of the things you discover about John Malone is that, in fact, he's a guy who plays chess while most of his peers and competitors play checkers. Today, John Malone's Liberty Media owns a piece of five of the six largest media companies in the world. And he's also, by the way, the holder of the largest number of cable systems in all of Europe. We thought today was a good moment to talk to Malone about Liberty, and about the world around us, which is changing so rapidly. Now, let me begin by asking, as you play chess at Liberty Media, what are your next moves?
JOHN MALONE: Well, I wish I knew. You just have to be opportunistic, and try to figure out what creates value—where the bottom is, what creates incremental value, and in what combinations.
Are we near the bottom of the economy?
Ah, that's the sixty-four-thousand-dollar question. We could be in a very dangerous economic situation right now, with the consumer losing enthusiasm. I think the federal government has got pretty much all the adrenaline in the system that they can pump in with interest rates and cash availability for the consumer. And the consumer may be running out of steam, if you look at consumer sentiment. So if, in fact, the consumer loses enthusiasm and the business community is very negative right now, you could see a serious double whammy here that puts the country in very bad shape. The other issue is that it looks to me as if the rest of the world is not in particularly good shape. Japan's eighteen-year recession doesn't seem to be getting better; Germany's in recession; Latin America's in free fall; Canada, Australia, and England seem to be O.K.; France is black—so it's not exactly a pretty picture on a global basis, either.
In the investments you have, you've taken a hit in the past year or so. How would you grade your performance?
Well, recently somebody said, "Hey, you lost weight," and I said, "Yeah, thirty-five pounds and three and a half billion dollars." So I'm quite a bit lighter and more flexible than I was. In March, 2000, we had a management retreat for our small Liberty management group, and we came away with the conclusion that every single asset we had, every investment we had, was at an all-time high. And this couldn't possibly be due to our intelligence; it had to be an overheated market, and it couldn't possibly continue. We made the decision that the technology exposures that we had were the ones that were the most inflated and the most vulnerable. So we began a process of hedging our exposures in things like personal computers, wireless, Motorola—things of that nature. What we missed entirely was the broader economic impact on the media industry, so that with our portfolio in media—which was AOL and News Corp and, ultimately, Vivendi and Viacom—we really didn't take any meaningful measures to hedge, because we didn't see the exposure there. That was perhaps our biggest error, retrospectively. Also, keep in mind that Liberty is kind of a hybrid: we have operating businesses, but we also have a pretty substantial investment portfolio, and just selling a position would expose us to substantial tax liabilities, so we've tended to want to avoid that, and instead we tend to do either collars, hedges, derivatives, or tax re-exchanges. Trying to manage the economic value of the enterprise in that way leads to a different outcome than if you were just in a tax-free environment and you'd just say, "This is high, I'll sell it," which is the way mutual funds operate.
But why are you so driven to avoid taxes?
It's a leakage of economic value. And, to the degree it can be deferred, you get to continue to invest that component on behalf of the government. You know, there's an old saying that the government is your partner from birth, but they don't get to come to all the meetings.
This, in fact, is very much a part of your libertarian philosophy, too, isn't it?
Oh, I guess, yes.
You mentioned some of the companies for which you didn't see what was coming down the road. To start with, let's talk about AOL Time Warner. If you were in the driver's seat, or if you had the voice you might one day have, what would you be doing?
I would put it at two levels. There's a need for leadership in the intersection between content and distribution. And then internally, within that company, they need to fulfill the vision. In other words, the vision was taking unique content and marrying that with the Internet, and, particularly as the Internet transitions to high speed, you convince the world—that is, your dial-up subscribers—that high speed creates a value in content that wasn't there at slow speed. And so you shift AOL from being essentially a transport mechanism to being a way to receive unique content services and pay for it—a subscription-content model, as opposed to a connectivity-payment model, where little value goes to the content. The bigger view I have is that the thesis "If you get it off the Internet, it ought to be free, even if it's somebody's copyrighted product" is a real cancer to the content industry. It will ultimately undermine economic values and content, because the public has it in their heads. We've even had politicians who have tried to build their reputations as the founders of this technology basically saying that even connectivity should be free. The philosophy that everything you get ought to be free is, I think, a terrible imploder of economic values for people who create and own content.
But if you're AOL Time Warner or Comcast A.T. & T. or Newhouse, and you own the cable-system wire and you also have content, in addition to charging a premium, or a subscription premium, should you also favor your own content? As cable did?
Let's not call it favoring your own content. I think that you should have a broader view about content as a category. And you really have a huge vested stake in the public understanding that content isn't free—that it's something you legitimately should be willing to pay for and underwrite. Right now, I would say, there are three camps. You have the people who sell equipment: every place you see them, they're trying to undermine the ownership of content value, commoditize it, make it free. Think about the VCR and the big fight about whether it's legal to record information. The distributors, the cable companies, the satellite companies, they're sort of in the middle of this. On the one hand, people like the A.T. & T. guys that we sold our company to had a mentality that threw them in with equipment guys. They said, "Hey, the more stuff that people can steal, the more they're going to want to be connected to our services, right?" And "Let's take the economic value out of the content side and make our service more valuable." Then, you have the people who look at it the other way: that there are some valuable services we can provide that include content and the availability of that content, and the public should be willing to pay for that. That's HBO. This is an old struggle that goes way back, to when there used to be cable guys who didn't scramble their HBO signal very well because if people could steal HBO they would be more likely to sign up for cable. The cable guy got a hundred per cent of the cable money and had to split the HBO money with HBO. So if they can steal HBO you can raise your cable rate, give the consumer a better economic value. The people who used to make de-scrambling equipment for satellites made a lot more money selling de-scramblers to the black market—so people could steal the satellite signals—than they did selling it to legitimate distributors who would then require the consumer to write a check to receive the content. So, to me, this is a big struggle between various well-heeled forces that have lobbying power in Washington as to what content is worth.
Now, this has become really crucial, as every PC that is being shipped today can burn DVDs and CDs. So technology with the ability to record, to give access to and essentially to steal intellectual property, is proliferating enormously. High-speed connectivity, whether it's cable high-speed or DSL from the telephone company, is rapidly penetrating the market. Not only can you steal and keep it, but you can do it quickly and efficiently. This is a big cannon, as far as I see it, aimed at the content industry.
Look at what's happened in music with Napster. The public really likes this stuff, the public is going to find a way to use it, and if it's not provided to the public in a way that's convenient and that they can pay for, and promoted to them as something that they need to do legitimately, this whole value proposition would shift around content and turn us into a nation of thieves. Most studies show that people are using high-speed Internet connectivity for two big things right now: computer software—downloading, that is, stealing—and videos. Go to any college campus where high-speed connectivity is readily available and you'll find that people are sharing movie files like mad. Straight out of China. You can watch the latest Viacom, the latest Paramount hit in your college dorm room, thanks to some server somewhere in Asia. And international law can't deal with it. Privacy considerations in this country will prevent the F.B.I. from monitoring these bit streams, and the public will feel it's their legitimate right. The more they do it, the more they feel legitimate doing it.
But isn't that an argument for you to get out of this business?
No. It's an argument for leadership in the industry. It's an argument for them to sit down and bring their respective organizations together and say, "How do we offer the public a well-organized, well-promoted way to receive this stuff legitimately and pay for it, as opposed to allowing this thing to just evolve to where it's theft?" That's what's really needed, and that's the big question, because otherwise the same thing will happen to the video industry that's happened to the music industry. You can say, "Well, then, if there's no money, who's going to produce this stuff?," and that's right. But what you have then is an imploding value proposition, and you start looking like the telephone industry, where it's not like there are winners and losers; everybody loses in the end. Because, if the stuff isn't produced that people really want to buy, then the people who distributed it aren't going to have a very good business, and then the whole thing implodes. An awful lot of the economic infrastructure of media and communications relates to this question of the sanctity of content.
You're a partner with Barry Diller, and have been for a long time. Vivendi is selling some assets, or talks about selling some assets. What might you be interested in?
We own twenty-five per cent of Barry's company, USA Interactive. And we're also a direct shareholder of Vivendi; we own four or five per cent of Vivendi. It's not entirely clear where Vivendi's going. They have a lot of debt, and they have a choice: they can either shift their weight toward Europe—cellular in Europe—or they can divest of those assets, lighten their debt burden, and become essentially a U.S. entertainment company. And I don't think they've decided yet which way to go; they're going to be opportunistic and see where the values are the greatest in terms of lightening ship. They have a list, I think they've said publicly, of seventy miscellaneous assets, including their publishing assets, that they have put on the block for potential liquidation. If they're successful and get the prices they're looking for, they will be able to retain both Vivendi Universal Entertainment, the music business, and Cegetel, which is their French telecom provider, and pay off most of their debt.
Are you interested in acquiring their studio and music business?
Well, we think, Wouldn't it be dandy if we could combine certain cable assets that we have with certain cable assets they have with Diller's management skills into a bigger programming entity in the U.S.? So that would be attractive to us, as a direct investor or participant. For instance, our Starz Encore unit, which is quite successful, would make a very nice fit with their library and the USA networks that used to belong to Diller and to us. That kind of combination could produce some very real synergies if it makes economic sense to do so.
So "synergy" is not a dirty word for you.
Oh, no, synergy is the driver. There are two levels of synergy: there are operating synergies, which, you know, you'd have to be stupid not to try to take advantage of, and then there are strategic synergies. In other words, in what positions you would be more sustainable, more long term, and so on.
But when you look at some of the big mergers that have taken place over the past several years—AOL Time Warner being the prime example—that were driven by this notion of synergy, one plus one equals four . . .
And it didn't happen.
Well, everything from personalities to different points of view to absence. A good example of this would be when the Turner organization was merged into Time Warner in the first place. And Time Warner—which had always been regarded as a collection of fiefdoms, run by a rather impotent king—shifted. And I think that when Gerald Levin stepped into the power position after the merger, and he had kind of broad shareholder support from us and from Ted, it worked quite well, and the company did quite well, and they did generate some synergies. When the AOL merger took place, I think what was lacking was a power base that the C.E.O. had which allowed him to be somewhat dictatorial. I'm sure that as the Newhouses regard corporations they're benevolent dictatorships. They are not democracies, they are not co-ops. And if you try to run a big complex organization as a co-op you always run into trouble. I think that after the AOL merger there was an effort to run the company as a co-op. The different points of view were just too disparate to not have somebody there with sufficient organizational power to bang heads and say, "We're going to do this," and do it. Absent that, organizations tend not to be able to find synergies. Synergies are something that the C.E.O. basically has to force to happen, because organizations are, generally, like bodies in motion that tend to stay in motion. It's very hard to get big organizations to change. And it takes really a very powerful mandate to force things to happen. It's one thing to cut a few overhead people out of the finance department. Most C.E.O.s have enough power to do that. What's very hard is to force behavioral change, where you say, "We just bought AOL. We were into twenty-six million households. The music division needs to create a product that we can bundle with AOL exclusively—not exclusively, who cares, but we need a product that we can sell." And it didn't happen. To me, that's really where the vision has to become reality, and it takes a really strong mandate to force that to happen.
But take a company that has promoted synergy and has a leader, a chief executive who doesn't run it like a co-op and is authoritarian: Disney's Michael Eisner. Why doesn't it work there?
Well, I think it worked great for a long time, and it did create an enormous shareholder value over a long period of time. But where he's being attacked is primarily on his inability to drive ABC against NBC—this is the most visible contest out there, and I've got to believe that's a pretty tough thing. It's pretty tough to pick the right shows, and I think people are analyzing Disney pretty narrowly when the criterion is whether or not ABC is doing well. If you look at ESPN, they've done very well at extracting money from the rest of the distribution world.
But your friend Gordon Crawford, who you're close to as a major investor in media stocks, dumped his Disney shares recently. Was he right?
I don't know. There's this bigger question. If you look at our society broadly, find me an organic-growth business that looks good. O.K.? Other than health care, and that has different problems. The real problem in our society right now, as we go into this century, is growth. What is a growth business? Where do you find a growth business that has organic growth? Disney is basically getting sold down because it lacks organic growth; that is really the issue. Cable TV, over the years that we were in it directly, was a growth machine. The internal organic growth rate of the business exceeded the cost of money. And if you do any kind of present-value-of-cash calculation, that means that the equity values are nominally infinite. Which means it has high returns to equity, because you can borrow money against a growing cash-flow stream, and as long as your growth rate's faster than your cost of money it's a wonderful business. Now, go find me a business that has organic growth at eight, ten, or twelve per cent. The fact that equities are being sold down, despite the lowest interest rates in recent history, simply means that the market doesn't see growth ahead for very many businesses. G.E. says that the next couple of years are going to be really challenging, and Microsoft is turning into a slow-growth or no-growth machine—Gates is out there beating his head against the wall trying to find something that will give him growth. Dell is cannibalizing the PC industry trying to find growth, and can't find growth. Nobody can find growth right now. And if you can't find internal organic growth it's pretty hard to justify high multiples. Because multiples are, basically, what the future is worth: when the multiples come down, you're just saying that the visibility of future growth, of future value, just isn't there. It's a big club out there, and the guys who make the headlines—and maybe this is an indictment of media—you know, they're just the guys who happen to stick their heads up at a particular point in time, but everybody is sick with the same flu. It's just that some guys are going to die sooner than other guys.
But there's an argument that you can make that the disease is cancer, not the flu. If you look at some of the headlines—like Enron, WorldCom, Global Crossing, Adelphi, Grubman, Wall Street analysts—well, you were quoted last summer, and you didn't seem terribly agitated about this kind of rogue's gallery of characters. You said, "It looks to me like spring. When the snow melts and you see the dog shit that's been there all winter."
Right. That's right.
Are we seeing something more than dog shit?
I think what we're seeing is the snow melt. I think if you focus on the snow melting, which is the bigger, broader economic question for the country, there's always been dog shit there. If you step in it, you notice it. If you don't, you don't. I mean, there's always been a little bit of hand in the till going on. But, believe me, in none of those issues you cite did the executives actually steal enough money from the companies to cause a difference as to whether the company was going to make it or not. Never. It had nothing to do with the success or failure of those companies. So Kozlowski has a six-thousand-dollar shower curtain. Did that break Tyco? Give me a break. No, the real issue here is that companies get in trouble, and the media looks for gee whizzes. And that, sort of in a public domain, becomes the reason these companies fail. WorldCom did not fail because of a loan to Bernie Ebbers; actually, the loan to Bernie Ebbers came right back to the company, because Bernie exercised stock options, and the money went to WorldCom. You could say it deluded the shareholders, but it didn't cause the value of the equity of WorldCom to go to zero. In fact, quite the opposite: it supported the value of the equity of WorldCom. So all of this stuff is confused out there. WorldCom hit the wall because the telephone business turned shitty. Why it did turn is a broader question.
Well, why did businesses that seemed so promising in the nineties seem so crummy in this century? The answer is that you had too much money chasing too few business opportunities that were capital-intensive, and they did a lot of it with borrowed money. The Internet's a good business. The fibre business is a good business—for one or two providers—but for thirty? All funded with borrowed money? That's the implosion that's taken place in the cellular business. Great business for one or two providers. Questionable business for six, especially when it's financed with a bunch of bonds. So you had a huge excess of capital availability both in the equity markets and in the debt markets in the nineties, which basically created too many hogs at the trough. And now all the hogs are getting skinny; some of them are dying. There just isn't enough business there. For people who've been in the cable industry, this is like a massive overbuild. It's capital-intensive, like what happened in the airline industry—to talk about a really crummy business. Do you know that the pension liability of American Airlines exceeds the market cap of all the airlines? The pension, the unfunded pension liability. You talk about really crummy businesses, here are some really crummy businesses. To me, this is the reason we got into this: a government that believes that the more competition the better, so wherever they had a chance they tried to create more competition. Now, what triggered that? Well, look at different industries for triggering events. The telecom industry started its massive downward spiral like a little bird going in concentric circles, following that giant sucking sound of every government in the world deciding that a great way to put some more money into the politicians' hands was to sell third-generation cellular licenses at huge prices—even the European telcos, which were partly owned by the governments. So that giant sucking sound was something on the order of three or four hundred billion dollars of private-equity capital coming out of the telephone industry and going onto government balance sheets.
You've been a lifelong critic of government and, as I said earlier, a libertarian, and yet you supported the government's action in denying a merger of EchoStar and DirecTV, in claiming that it would be a monopoly.
I think it's pretty clear that they would be. They essentially would not only be a monopoly but they would be a monopoly that would own all of the means of providing the service. So it would be a government-licensed monopoly.
But if I were a resident of Denver, why wouldn't TCI, your former company, be a monopoly?
Because I could be overbuilt. If I was making enough money in the business so that somebody else could come in and overbuild me and make a business of it, that would act as the discipline on my behavior. You don't have to have competition; you have to have the possibility of competition. Now, in the satellite business, once one guy owns all of the spectrum that's feasible to be used for the provision of direct-satellite broadcast, the game's over. There is no possibility of competition. And the other issue is not just monopoly power over the consumer—which that combination would have, especially in rural areas, where there would be no cable, only satellite and one guy—but also the monopsony power, the purchasing power, that that entity would have over the content industry, because basically it would be so potent relative to the people who own the programming and supply the channels that it could dictate terms. There would be no other way to get to that customer. So if that deal got done it would be a political deal; it certainly wouldn't be a legitimate antitrust enforcement. The politicians would have to be rolled, and the contributions would have to be huge. That's the way I look at it.
I want to ask one other question. When you sit across from a fellow-C.E.O. negotiating, what is the thing you worry about most, be it an individual or some other point? What gives you nightmares? What do you fear most in a negotiation?
What you really are afraid of is that you're competing against somebody who is rich and irrational. I mean, it used to be a given, a saying in the industry: Don't ever bid against Rupert Murdoch for anything Rupert wants, because if you win you lose. You will have paid way too much.