Life beyond the royalties

While new to his job, the CEO of one of the many splinters of the interactive-TV business sought an audience with Henry Yuen. As chairman of Gemstar-TV Guide, Yuen is the dominant player in on-screen program guides. Since part of the CEO's new job would be making sure his software gets along with Gemstar's inside cable set-top boxes, the CEO figured he should get along with Yuen as well.

The CEO set up an introductory videoconference. Just a friendly chat. After introductions and a few minutes of casual conversation, Yuen got tense. He looked in the camera and shouted, "If you do anything to infringe on our patents, I'll sue you!" He got up and exited the room, leaving it to Gemstar staff to say goodbye.

That CEO, who prefers not to be identified, got a taste of how important intellectual property is to Gemstar and how aggressively Yuen will protect it. (A Gemstar spokeswoman denies any such encounter.)

For years, investors, competitors and—so important—potential customers of those competitors have seen Gemstar as a nearly impenetrable portfolio of patents covering various aspects of interactive guides. And they have been aware that, if they go anywhere near those patents, they are likely to end up on the receiving end of a Gemstar suit.

"The power of Gemstar has always been in their claims on patents," said a senior executive at one top-five cable operator. "There's a fear factor, an intimidation factor that always accrued to Henry personally."

But lately Yuen hasn't seemed so scary.

The first big dent in Gemstar's armor appeared two weeks ago when an administrative judge at the International Trade Commission (ITC) ruled that competing guides had not violated two Gemstar patents. Worse, the judge ruled that Yuen had misused another one of his key guide patents, one that lets a viewer "click" on the guide and record, say, all the baseball or game shows on a given afternoon.

News of the patent ruling sliced Gemstar's stock 40% in a day, just the latest blow to a company whose stock traded at $50 a year ago and $100 two years ago, but just $5 these days. Yuen, whose stock and option portfolio was once worth more than $2 billion, has watched it sink to around $50 million (though he moved to dump $63 million worth of stock in April).

Yuen believes the market overreacted to the ruling. As he tensely pointed out, his wider fight with rival guide providers involves seven patents not in the ITC case.

But the ruling is not his only problem. Two big operators, AOL Time Warner and Cox, have balked at signing broad guide deals, especially at the demands Yuen has made on their digital "real estate." (They use guides developed by set-top manufacturers Pioneer and Scientific-Atlanta.) And TV Guide Interactive's hugely favorable contract with AT&T Broadband will fade when Comcast takes over and folds AT&T systems under its own, less favorable and non-exclusive Gemstar deal.

At the same time, Yuen's aggressive accounting move has scared investors. And Gemstar's largest shareholder, Rupert Murdoch, is angry over the $2 billion write-off News Corp. had to take on its 43% stake in Gemstar. Murdoch has just installed a cable lieutenant, Jeff Shell, as Gemstar's COO to exercise more control over operations.

Yuen's real challenge is proving that he can operate a coherent media business rather than a sort of mutual fund of TV-related patents. Gemstar owns not just the 9 million-circulation TV Guide
print magazine, but the 50 million-subscriber TV Guide Channel, a passive, on-screen guide that has a lock on the cable industry. He also has the fledgling TV Games interactive betting operation. Critics says that, even though TV Guide
and the passive, scrolling on-screen cable guide account for 80% of Gemstar's revenues and 50% of operating cash flow, Yuen has been riveted largely on the 8 million-subscriber interactive and nascent e-book businesses with which he is more comfortable.

The biggest surprise is that Shell says his top priority is the base business. Blaylock & Co. analyst John Tinker sees Gemstar's sales dropping 10%, to $1.2 billion, and operating cash flow falling 12%, to $400.9 million, this year. Shell wants to stop that, reversing the decline of TV Guide
magazine and improving core relationships with cable operators.

Bank of America Securities analyst Doug Shapiro agrees that investors have unfairly judged Gemstar. At Gemstar's recent stock prices, investors are putting a fairly low valuation on the print TV Guide
and the passive on-screen guide that's in around 70 million homes and essentially a zero value on the interactive program guide. Though he sees problems, Shapiro has faith, citing electronic program guides as the one clear interactive-TV product that subscribers covet. "The critical, critical assumption is that people really want their guide."

Deutsche Bank's Karim Zia agrees. "Unlike the cable business, there's no capital intensity here. Unless you really assume catastrophic loss of their licensing, it's hard to see any scenario where they're not net cash generating."

Yuen shows no signs of doubt. "I am committed to running this company," He declared in a conference call with investors. "I think this company needs me to govern it to a vision that I have."

Yuen and Shell declined interview requests.

Program listings are a small part of Yuen's grand vision. He sees TV Guide Interactive "at the center of television viewing." More than just a sophisticated program listing, to Yuen, the guide is a central platform for all sorts of interaction between subscribers and their TV sets.

In Motorola set-tops, at the least, TV Guide Interactive is essentially an additional operating system that developers of other applications are forced not to merely co-exist with inside the set-top but interact with. For example, one cable executive complains that any application seeking to use the "channel up" command from a remote control must first turn to TV Guide Interactive's software: "That's one reason everything's slow."

Gemstar didn't start out with great leverage. A Shanghai-born engineer and lawyer, Yuen teamed up with an old California Institute of Technology classmate to develop a system to ease the process of setting a VCR timer to record, called VCR Plus. Get manufacturers to include the software in their machines. Get newspapers and other print guides to include codes in their listings. Collect money from both sides.

The electronic-guide business wasn't a dramatic stretch. In the early 1990s, the cable-guide business was divided between United Video's Prevue Network and Newhouse Broadcasting's Teleguide. Those were simple text scrolls using data fed into a PC at each cable headend. The prospect of interactive TV, however, raised the idea of interactive guides. Display only the sports channels or only the movies on any channel or delete the shopping channels. One click of the remote control to set your VCR to record today's soap operas.

Yuen started out with the model he already knew: develop some technology and get manufacturers to incorporate his software in VCRs. But he started acquiring other guide startups, notably StarSight, which had a couple of particularly powerful patents. That gave Yuen two avenues: license his processes to others to "make-and-sell" and, separately, sell a service to cable or DBS operators for a monthly fee.

It also cowed rivals, including the likes of Murdoch and sidekick Liberty Media Chairman John Malone. They were partners in TV Guide
-owner United Video when they realized in 1998 that they were probably going to lose a patent dispute with Gemstar. In a maneuver to extinguish the claim, United Video made a hostile takeover bid for Gemstar, securing support of a major shareholder. Yuen repelled the bid and, in 1999, ultimately persuaded Malone and Murdoch to sell rather than try to acquire.

The patent cases will hang over the company for months. Four other companies are involved: S-A, Pioneer, EchoStar and a company that makes DBS receivers for EchoStar, Sanmina-SCI Systems. Even though they are involved in a separate patent fight in federal court in Atlanta, Gemstar jumped last year to get the ITC to block import of set-top equipment that Yuen contended violated its patents.

The move backfired. Though the full decision is not yet public, the judge apparently agrees with S-A and Pioneer that Gemstar used the patent to "tie-out" rivals, keeping their guides off cable systems owned by operators wanting to divide their business between two suppliers. That patent covers methods of using the guide to display, say, all Clint Eastwood movies and record them. The judge also ruled that the guides don't infringe on two other Gemstar patents covering the user interface.

Yuen has a fistful of ways of minimizing the ruling. He'll appeal to the full ITC; he'll appeal in court; the patents will be upheld in the Atlanta litigation. The broadest one is that the patents aren't as critical as outsiders contend. He licenses technology smoothly to 180 different companies.

However, he still sounds defensive. "If left unchallenged and unchanged, the ruling could deliver a blow to intellectual-property rights holders everywhere," Yuen warned. That presumably includes Gemstar's headquarters in Pasadena, Calif.