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Liberty Challenged

A month after Liberty Media unveiled a grand plan to juice its stock by dividing the company, investors have sent a message to Chairman John Malone: Is that all there is?

In March, Liberty finally detailed its much anticipated plan to spin off the company's international holdings—which include investments in cable systems from Tokyo to Buenos Aires to Prague—into a new company called Liberty Media International. The company's domestic operations and investments will remain inside Liberty.

Wall Street pegs the value of Liberty Media's international business at about $6 billion once it is spun off this summer. Morgan Stanley estimates Liberty's total asset value before the spinoff at about $55 billion.

One critical goal for Liberty is to simplify its operations. As Liberty has pushed to expand foreign cable systems and networks, the company's asset mix has proved intimidating to U.S. media investors, who aren't particularly savvy about the economies, consumer tastes, and media regulation of international markets.

A second, equally crucial objective is to create a currency for big international acquisitions that won't spook investors interested primarily in the U.S. assets. Liberty currently has the world's third-largest collection of cable systems, and Malone is aggressively expanding in foreign markets.

He had hoped for a big rally on the news of the spinoff, but it never appeared. After Liberty disclosed the plan March 15, the company's stock actually traded down, then perked up; it has been flat for the year. "The reaction has definitely been disappointing," said Liberty Senior Vice President of Finance Mike Erickson.

The plan calls for Liberty to issue investors one share in the new international company for each 20 Liberty shares they own. The international unit's holdings would include a 55% stake in European cable-system operator UnitedGlobalCom, its 44% stake in Japanese operator Jupiter Telecom, and a 50% stake in Argentine operator Cablevisión S.A. After the spinoff, Liberty International expects to raise around $1 billion by selling more stock to its existing shareholders.

Liberty executives see two major reasons for the market's lackluster response. First, prior to the announcement, many Wall Street analysts and traders were expecting a more elaborate split into three pieces: international, domestic, and a third piece, which might have included bite-size acquisition candidates for other media giants.

Second, Liberty also disclosed horrible financial problems at one of the only businesses it actually owns and operates, pay-movie network Starz Encore. The HBO rival bet heavily on digital cable, paying up to secure theatrical movies from Disney and Universal. Liberty was counting on covering those costs through a sweet deal cut with cable operator Tele-Communications Inc. when they were siblings and then with AT&T Broadband, which bought TCI.

When Comcast bought AT&T Broadband last year, though, it scrapped that deal and left Starz Encore all alone on a very expensive hook. Liberty took a $1.3 billion write-off and disclosed that Starz Encore's cash flow is expected to plunge 65% over the next two years.

Money managers said the spinoff makes Liberty simpler to understand but doesn't actually make it simple. "If that's all there ever is," says Larry Petrella, a portfolio manager at New York money manager Eminence Capital, "with maybe just a little cleanup in the rest of the portfolio, it's hard to see a big change."

Indeed, the domestic company will remain a tangle of small and large investments in other media companies. Some of those are relatively easy for TV and entertainment investors to follow, like Discovery Communications or Court TV. But seriously tracking Liberty's prospects requires understanding businesses as varied as online travel and mortgage banking (Barry Diller's InterActive Corp.), British and Australian newspapers (a big part of News Corp.), and cell phones, both service (Sprint Corp.) and manufacturing (Motorola). And that's counting only Liberty's holdings worth more than $1 billion each.

"It's still tough to get your arms around this company," says a manager at one $500 million hedge fund. However, he's interested in the international company and is considering a sizable purchase after the spinoff is complete because he expects many U.S. investors to unload their shares.

The market's response to the spinoff is the latest disappointment for Malone, long lauded for his financial savvy. His trademark financial engineering doesn't wow the market as much as it did in the 1990s, when he used the leverage of cable giant TCI to persuade both competitors and partners to see deals his way.

Under the current plan, Malone will be chairman and CEO of Liberty International and no longer an executive of the domestic company. Most of his wealth, however, will remain tied up in it.

Investors want Liberty to strike a deal, and now Malone may be ready to comply. He acknowledged last week in the Financial Times
that he's negotiating to buy some international assets from News Corp. And, domestically, he has hinted that he might sell some Liberty assets to News Corp.

Erickson wouldn't comment on any possibilities, saying, only, "We do think we have a lot of value that can be created."