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Could News-DirectTV Deal Tip Integration Scales?

AT&T Corp.'s spin off of Liberty Media Group, effective Aug. 10, would mean much more than just another milestone in the company's historic effort to separate into four independent units.

It would also represent a major structural change within the cable industry, by accelerating a trend in which operators exercise less control over their programming suppliers.

And even as AT&T loosens its grip on cable networks, the industry's chief competitor — the direct-broadcast satellite providers, which historically haven't owned any content —could be on the verge of moving in the opposite direction. News Corp., with the help of newly independent Liberty, is trying to acquire DirecTV Inc.

In fact, if News Corp. and Liberty manage to snatch DirecTV from General Motors Corp. unit Hughes Electronics Corp., the DBS provider would become the largest vertically integrated video provider in the country. It would also be able to operate with a significant regulatory advantage over cable.

But while industry executives concede that DirecTV would become a much more formidable force after a deal, neither programmers nor operators were overly concerned that such a move would adversely affect their day-to-day business relationships.

Under federal rules, cable operators are required to sell their satellite-delivered networks to DBS providers. But the rules — fashioned by the Federal Communications Commission in 1993, when DBS was still in its infancy — exempt satellite providers from the same must-sell obligations.

In just a few weeks, AT&T and Liberty will head in opposite directions. AT&T will be transformed from the industry's largest controller of content to one of its smallest.

Although Liberty always remained firmly in the grasp of chairman John Malone, the company FCC program-access rules considered it to be vertically integrated with AT&T. After acquiring Liberty in 1999 and MediaOne Group Inc. last year, AT&T gained control over 64 national cable networks, or 23 percent of the 281 cable networks that the FCC said were existence in 2000.

The Liberty spin-off would leave AT&T with a financial interest in just the 12 networks it acquired with MediaOne, reducing AT&T's programming ownership from 23 percent to 4 percent of all cable programmers.

But AT&T's ownership could drop even further, because the MSO has indicated to the FCC that it's interested in selling some of the networks that came with MediaOne's 5 million cable subscribers.

In January, AT&T informed the FCC that it intended to dispose of its stakes in E! Entertainment Television, pay-per-view purveyor In Demand, New England Cable News, Fox Sports New England and Food Network.

AT&T would still own about 25 percent of Time Warner Entertainment, a limited partnership that includes Home Box Office. But AT&T chairman C. Michael Armstrong said last week that AT&T is continuing its effort to divest the TWE stake.

Lastly, the FCC considers AT&T to be vertically integrated with Rainbow Media Holdings Inc., the programming arm of Cablevision Systems Corp. Rainbow owns six networks, including Bravo, WE (formerly Romance Classics), and Independent Film Channel.

AT&T is trying to sell its stake in Cablevision, a move that would sever the regulatory link to Rainbow. For nearly a decade, the FCC has kept a close watch on vertical integration in the cable industry, releasing its finding in an annual report to Congress.

Year after year, the FCC's data has shown a steady decline. In 1994, MSOs were affiliated with 53 percent of the networks; last year, the agency found that just 35 percent of networks had one or more MSO owners.

If both Liberty and the former MediaOne-owned cable networks become free agents, cable operators would remain in control of 35 networks, compared with 99 the prior year,. That represents a 67 percent decline in the industry's vertical integration in just a matter of months.

Based on FCC data from last year, AT&T's departure from the programming business would put AOL Time Warner Inc. at the head of the pack of cable operators, with ownership in 34 networks; followed by Cox Communications Inc. with 28; Comcast Corp. with 19; and Cablevision with 10.

The figures do not add up to 35 — the number of vertically integrated programmers remaining after AT&T's divestments — because they reflect both total and partial ownership stakes by multiple cable operators.

While the cable industry, led by AT&T would shift in one direction, the DBS industry would radically move the other way.

A merger with News Corp. and Liberty would quickly propel DirecTV — which has never owned cable networks in its seven-year existence — to the top of the list.

Controlled by Rupert Murdoch, News Corp. is a broadcasting, cable and satellite giant with global reach. In addition to being a large News Corp. investor, Liberty owns dozens of cable networks, big stakes in AOL Time Warner Inc. and Viacom Inc., and last week announced a $4.7 billion deal to buy 3 million subscribers in Germany.

Control of DirecTV would make News Corp. and Liberty an incredibly powerful force.

"You've easily got the largest [pay] TV entity in the world," said Jimmy Schaeffler, a DBS analyst and CEO of The Carmel Group. "The potential for it to be not only an 800-pound gorilla, but the Godzilla of the whole wide world, is very great."

If News Corp. controls DirecTV, industry watchers said it will certainly have an interest in preserving any competitive advantages it holds over cable. But one MSO executive, who wished to remain anonymous believes that News Corp. wouldn't rob Peter to pay Paul.

"I don't think they would run the risk of losing subscribers for its cable networks to boost DirecTV's value to consumers," said the operator. Programmers also voiced few concerns about any adverse effects from a News Corp. takeover of DirecTV.

"One of the reasons DBS has made the inroads it has is that it provided a broad array of programming to its consumers," said one programming executive. "They would imperil its appeal if it plays hardball with competitive programmers and risk losing popular networks that cable would then offer exclusively."

DirecTV declined to comment for this story.

Although Murdoch is said to be nearing a deal for DirecTV, there is no guarantee that transaction will transpire. EchoStar Communications Corp. chairman Charlie Ergen is amassing a war chest to bid for DirecTV.

An EchoStar-DirecTV union, however, would not raise the same programming issues as DirecTV deal with News Corp. and Liberty, because neither DBS firm currently owns content.

SG Cowen cable analyst Gary Farber said he expects a DirecTV in the hands of Murdoch and Malone would be willing to sell programming to cable.

"It is certainly an issue, but I think at the end of the day cable is four times the size of the satellite business," Farber said. "At the end of the day, the audience for cable is too large to be ignored."

One area that News Corp. can capitalize on its DirecTV's sports holdings, and particularly its out-of-market sports packages. While cable PPV distributor In Demand has secured distribution rights to three of the four popular professional sports out-of-market packages, it has yet to obtain carriage rights to the industry's most lucrative package, NFL Sunday Ticket.

DirecTV Inc. exclusively distributes the package, which is expected to generate $232 million this season, according to industry publication DBS Investor.

The National Football League broadcast and cable rights holders, including News' Fox Broadcasting Co., must decide whether operators can gain access to the package. Industry observers said News Corp. would most likely vote against offering the package to cable in an effort to retain DirecTV's sports advantage over the operators.

On the regulatory front, the DBS industry has been urging the FCC to ensure that cable continues to sell its satellite-delivered programming to DBS after next October, when the must-sell rules are slated to sunset. DBS also wants the rules expanded to include cable networks delivered terrestrially.

None of those rules apply to DBS, even if DirecTV unites with Murdoch and Malone (except for Liberty programming that is co-owned by other MSOs, such as Discovery Channel and The Golf Channel).

James Ashurst, spokesman for the Satellite Broadcasting & Communications Association, said the DBS industry is not ready to retreat from its program-access position.

"If the position of our member companies were to change, then we undoubtedly would change our position as well. At this point, we are doing what our member companies want us to do on program access," Ashurst said.

DBS analyst Schaeffler said if DirecTV ends up with the largest block of programming among cable and satellite providers, the DBS industry would likely have to re-evaluate its position on the extension of program access rules.

"The bigger they get, the less defensible it gets," Schaeffler said.