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May 20, 1999

"They Won. We Lost. Next."
The Defeats & Victories of Barry Diller
Part 2

by Louis Corrigan (TMF Seymor)

The Return of the Jedi -- To Build an Empire

Denied a chance to manage a media gem, Diller has been pretty much left with the challenge of turning zirconium into gold. With the support of super-astute dealmaker John Malone, the omnipresent cable mogul who heads TCI Communications and Liberty Media -- both now part of AT&T (NYSE: T) -- Diller has gone on a buying spree in recent years. He's managed to cobble together an ever-growing assortment of media assets, many of which seemed very nearly junk before he applied his Midas touch.

He started in August 1995 by taking control of Silver King Communications, which owned 12 UHF home-shopping stations that were broadcasting QVC rival Home Shopping Network, controlled by Malone. Later that year, Silver King acquired the Home Shopping Network and lowly film studio Savoy Pictures, which also owned four other UHF stations. The new entity was called HSN. If he couldn't buy a network, Diller would build one -- again. (The company now operates 13 UHF stations, including stations in seven of the nation's top 10 markets, and reaches 31% of U.S. households.)

His initial goal was to create a hybrid network that combines cable with local broadcast stations running inexpensive local programming. Ratings still matter as far as advertising goes, but the plan calls for the network to generate direct sales as well as ad revenues. Indeed, think of the home shopping gestalt and infrastructure melded onto television programming.

Even as Diller has been developing programming for the local stations, he's continued shopping. In February 1998, Seagram's (NYSE: VO) Chairman and CEO Edgar Bronfman Jr. sold Diller that firm's cable assets (USA Networks and the Sci-Fi Channel) and Universal television production studios. Seagram walked away with 46% of Diller's company and $1.6 billion in cash.

Four months later, the renamed USA Networks acquired concert and sports ticketing monopolist Ticketmaster for $468 million in stock. Then last September, the company acquired CitySearch, which runs a network of city websites providing local content. A couple of months later, Diller took Ticketmaster Online-CitySearch public.

And the deals just keep on coming. In April, Diller acquired Seagram's art-house movie distributor October Films and parts of its Polygram Filmed Entertainment, including Gramercy Pictures. These properties provide a pipeline of movies for USA's cable channels. Diller has even invested $10 million in the novel Free PC initiative that gives people computers if they agree to be bombarded with ads, a move that suggests he's serious about exploring radically new business models.

What are the potential synergies of this collection of assets? Well, the same prime-time broadcast might appear both on cable's USA Network and on a local station, boosting ad revenues by increasing the audience reach. But even better, let's say you're a fan of the USA Network's Xena: Warrior Princess. An infomercial seen during the show might hawk merchandise while telling you when actress Lucy Lawless will be in your area for a Xenafest. You're sent to your local CitySearch website for more details.

There, you get all the info you need plus another chance to buy official Xena gear or actual tickets to the event through the firm's Ticketmaster Online. When you receive your order, you might find materials promoting Home Shopping Network, which would have already added you to its database of 20 million customers. Or something like that. In the process, Diller maximizes the financial asset that is you, the viewer, while promoting his network of sites where content opens seamlessly into commerce.

Adding Lycos to this mix would have made sense partly because Diller's television assets could drive traffic to the Lycos properties. USA's current broadcasting and cable assets reportedly reach 100 million households, or more than 90% of U.S. television viewers.

More important, though, Home Shopping and Ticketmaster also possess the order processing infrastructure to do e-commerce, something the other portals and most other media companies lack. With the capacity to process a million transactions and ship 200,000 orders per day, the Diller empire could have maximized the financial potential of Lycos's current audience, which includes some 31.9 million Web surfers, or 51.8% of all Internet users.

Indeed, what the Lycos daytraders seemed content to ignore is that Diller's ragtag empire is remarkably profitable because of e-commerce. The Home Shopping Network was on the skids when Diller took it over, but it delivered $1.1 billion in revenue (nearly 40% of USA's total revenues) last year and twice as much cash flow as Disney's ABC network. Including the 13.9% of revenues derived from ticketing, some 53.5% of the company's revenues last year came from commerce. Meanwhile, its cable networks and television production studios accounted for 44.8% of revenue, with the rest coming mostly from its Internet assets, including CitySearch. USA Networks is very much a content/commerce hybrid.

Altogether, Diller's properties, on a pro forma basis, generated nearly $2.8 billion in revenue in FY98, up nearly 10%. Meanwhile, operating profits jumped 36% to $187 million and EBITDA (earnings before interest, taxes, depreciation, and amortization), a common metric used to value media companies, increased 15% to $478 million. Moreover, you see the benefit of Diller's hard-nosed, take-it-or-leave-it approach to acquisitions in the fact that USA's balance sheet includes just $776 million in debt, largely balanced out by $445 million in cash. Excessive debt can lead to a loss of control, and Diller is a notorious control freak.

Yes, Seagram now holds a 45% stake in USA Networks and Liberty Media another 21%, but Diller has clearly chosen business partners that recognize he's The Man. Although Bronfman's business acumen has been questioned since he began remaking Seagram's into an entertainment company, his decision to let Diller manage most of Seagram's non-music entertainment assets was clearly a smart move. Moreover, no one's ever made money betting against Liberty's Malone, who's long been considered cable's shrewdest executive. His support for Diller, dating back to the QVC days, has been unfailing -- and quite telling given that Malone insists on bankable talent.

Now What?

Although the merger agreement with Lycos is kaput, at least for now, the three companies have agreed to a joint marketing pact. Lycos will promote CitySearch's network of local entertainment content and add links to Ticketmaster. In turn, Ticketmaster's envelopes will carry Lycos ads and USA's television and cable properties will promote the portal. Lycos must also pay USA Networks $35 million if it accepts a rival bid before July 15, and USA is prevented from buying Lycos shares between now and then.

Even so, there's still speculation that USA Networks could end up making another bid for Lycos. The Wall Street Journal has reported that Diller may have backed away from the offer now so that he could step in again should the price of Internet stocks fall sharply in coming months. Though some analysts have mentioned Microsoft (Nasdaq: MSFT) or Amazon (Nasdaq: AMZN) as potential bidders, Lycos's Davis thoroughly shopped the company around before originally pushing for the pact with Diller. So it's unclear if the daytraders will get the premium bid they want.

CMG's Wetherell has developed a rabid following among Internet investors. Still, TheStreet.com columnist Christopher Byron has asserted that "Diller has most likely already forgotten more about the ways of Wall Street than David Wetherell will probably ever learn." Given Diller's decades of dealmaking, I believe it. Time will tell if Wetherell has enhanced or torpedoed value for Lycos shareowners.

That's because Diller has nearly unrivaled experience in building, programming, and managing highly profitable media businesses and interactive commerce properties. Although the convergence of the Internet and television, commerce and content, remains unchartered territory where many may strike gold, Diller would seem to have a greater chance than most to turn audience reach into substantial profits. After all, that's what he's been doing for three decades.

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Other Related Links:
Lycos Message Board
Lycos Held Captive by Speculators -- 05/19
USA Networks Message Board

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