Malone

Dr. John Malone’s Liberty Global has picked up an extra billion dollars it can use towards any plan to combine Time Warner Cable and/or Cablevision under Charter Communications.

Liberty has sold off some of its assets to build an enormous financial war chest it could use to launch a new wave of cable consolidation in the United States, potentially leaving Charter Cable as the country’s second biggest cable operator, just behind Comcast.

AMC Networks announced it will pay $1 billion to buy Liberty-owned ChelloMedia, a major international programmer and content distributor that operates 68 channels and networks available to more than 390 million households in 138 countries. Chellomedia is not well-known in North America but its networks are household names overseas. The deal includes Chello Multicanal, Chello Central Europe, Chello Zone, Chello Latin America and Chello DMC. In addition, Chellomedia’s stakes in its joint ventures with CBS International, A+E Networks, Zon Optimus and certain other partners are also part of the sale.

That $1 billion could be a key part of any blockbuster buyout deal because Malone can leverage that and other money with an even larger infusion from today’s easy access capital market. He has done it before, leveraging countless buyouts of other cable operators that built Malone’s Tele-Communications, Inc. (TCI) into the country’s largest cable operator by the early 1990s.

According to Shahid Khan, a media and cable industry consultant with Mediamorph, by this time next year Charter Communications could be just two million subscribers away from beating Comcast as the nation’s biggest cable operator.

Khan believes Malone laid his consolidation foundation with Liberty’s significant ownership interest in Charter Communications, from which he can build a new cable empire.

The most likely targets for consolidation are Time Warner Cable and Cablevision. According to Leichtman Research, as of this summer Comcast is the nation’s largest operator with 21.7 million subscribers. Regulators are unlikely to approve any deals growing Comcast even larger. But combining Charter, Time Warner Cable, and Cablevision would deliver 19.1 million subscribers under the Charter brand. A handful of smaller deals with minor operators like SuddenLink, Cable ONE, Mediacom, or Bright House Networks would quickly put Charter over the top of Comcast.

Malone’s public argument is that larger cable operators have more leverage to secure better deals and rates for cable programming, equipment vendors, and suppliers. It also delivers “cost savings” mostly through layoffs and cutting back on redundant operations like customer care call centers.

But Malone could also use the combined market power of the supersized cable company to keep competitors non-viable, especially for cable television programming. Frontier Communications learned what it is like to be a small player when its inherited FiOS networks in Washington, Oregon and Indiana lost Verizon’s volume discounts for cable programming. Frontier quickly found the programming rates it could negotiate on its own were so dramatically higher, it tried to convince FiOS TV subscribers to switch to satellite television instead.

Charter could also raise prices for broadband services in areas where its potential partners have not increased them quickly enough.

Ironically, AMC Networks’ one billion dollar buyout of Chellomedia could ultimately become the catalyst for a Malone-driven buyout of AMC’s former owner — Cablevision.

As Dr. John Malone positions his pieces on the cable industry’s chess board to win back the title of King of Big Cable, it is important to consider history.

Malone’s growing interest in a combined Charter-Time Warner Cable, under his effective control, is the first step towards re-envisioning Tele-Communications, Inc. (TCI) — America’s largest cable operator in the 1980s and early 1990s. Although most of the original TCI Cable systems are now owned by Comcast, Malone’s notorious way of doing business may soon affect millions of Charter and Time Warner Cable subscribers in the not-too-distant future.

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How bad was life with TCI as your local cable company? Listen to Alan Garner, then-City Attorney for Jefferson City, Mo., who testified before Congress in March, 1990 about the uniquely abusive, allegedly criminal behavior of out of control TCI executives. (5:04)

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Sen. Daniel Inouye (D-Hawaii) was so stunned by the events in Jefferson City, he first asked if TCI’s threats were documented and on learning they were the basis of $35 million in court-ordered damages, the chairman of the Senate Commerce Committee remarked, “you got thugs around there.” Under detailed questioning by Sen. John Danforth (R-Mo.) Garner talks about the “B-Movie” threats from TCI executives who warned city officials “we know where you live,” constant rate hikes, take-what-we-give-you service, and the fact TCI was willing to rip down cable lines and leave the city without cable service if they were denied a franchise renewal. (14:12)

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A befuddled Sen. Conrad Burns (R-Mont.) asked Garner why the city would still want to stay involved in the cable franchise process after the city’s horror story. Garner explained cable operators use public property to wire service to customers. Without local oversight, Garner believed TCI would still be scattering cable lines across neighbors’ backyards, across sidewalks, and draped over fences. TCI had a unique way of managing local service complaints, according to Garner. It threw service orders into a random cardboard box and let cable repair crews fish them out one by one. The ones furthest back in the box were the oldest, and the least likely to ever be chosen. TCI only listened to city officials when they had some oversight and enforcement powers. (3:13)

The next name of Time Warner Cable?

Charter Communications is laying the foundation for a leveraged buyout of Time Warner Cable before the end of the year in a deal that could leave Time Warner Cable’s broadband customers with Charter’s usage caps.

Reuters reported discussions between the two companies grew more serious after last week’s revelation a poor third quarter left TWC with 308,000 fewer subscribers.

Charter is relying on guidance from Goldman Sachs to structure a financing deal likely to leave Charter in considerable debt. Charter Communications emerged from bankruptcy in 2009 and is the country’s tenth largest cable operator, estimated to be worth about $13 billion. Time Warner Cable is the second largest cable operator and is worth more than $34 billion.

The disparity between the two companies has kept Time Warner Cable resistant to a deal with Charter, stating it would not be beneficial to shareholders. Charter executives hope to eventually win shareholder support for a buyout stressing the significant cost savings possible from a combined operation, particularly for cable programming.

The deal would likely end Time Warner Cable as a brand and leave Charter Communications CEO Thomas Rutledge in charge of a much larger cable company. Pricing and packaging decisions are usually made by the buyer, which could bring faster broadband speeds to Time Warner customers, but also usage caps already in place at Charter.

John Malone’s War on Customers

Malone

Cable billionaire John Malone, former CEO of Tele-Communications, Inc. (TCI) — America’s largest cable operator in the 1980s — believes consolidation is critical to the future of a cable business facing competition from phone companies and cord cutting. Malone’s Liberty Media, which now holds a 25% stake in Charter, is currently buying and consolidating cable operators in Europe. Malone’s post-consolidation vision calls for only two or three cable operators in the United States.

Malone’s quest for consolidation is nothing new.

Under his leadership, TCI eventually became the country’s biggest cable operator, but one often accused of poor service and high prices. More than a decade of complaints from customers eventually attracted the attention of the U.S. Congress, which sought to rein in the industry with the 1992 Cable Act — legislation that lightly regulated rental fees for equipment and the price of the company’s most-basic television tier.

Despite the fact consumer advocates didn’t win stronger consumer protection regulations, TCI was still incensed it faced a new regulatory environment that left its hands tied. One executive at a TCI subsidiary advocated retaliation with broad rate increases for unregulated services to make up any losses from mandated rate cuts.

A 1993 internal TCI memo obtained by the Washington Post instructed TCI system managers and division vice presidents to increase prices charged for customer service calls and add new fees for common installation services the company used to offer for free. TCI’s Barry Marshall recommended charging for as many “transaction” services as possible — like hooking up VCR’s, running cable wire, and programming remote controls for confused customers.

“We have to have discipline,” Marshall wrote. “We cannot be dissuaded from the [new] charges simply because customers object. It will take awhile, but they’ll get used to it. The best news of all is we can blame it on re-regulation and the government now. Let’s take advantage of it!”

Tele-Communications, Inc. (TCI) was the nation’s largest cable operator. Later known as AT&T Cable, the company was eventually sold to Comcast.

The FCC’s interim chairman at the time — James Quello, charged with monitoring the cable industry, was not amused.

“It typifies the attitude of cable companies engaging in creative pricing and rate increases to evade the intent of Congress and the FCC,” Quello said. “There is little doubt that the cable industry has an economic stake in discrediting the congressional act they vehemently and unsuccessfully opposed.”

Marshall defended his internal memo, although admitted it was inartfully written and was not intended for the public. Revelation of a damaging memo like this would normally lead to a quiet resignation by the offending author, but not at John Malone’s TCI, a company with a reputation for being difficult.

Mark Robichaux’s 2005 book, Cable Cowboy: John Malone and the Rise of the Modern Cable Business, was even less charitable.

Robichaux describes Malone as a “complicated hero,” at least for investors for whom he was willing to ignore banking rules and creatively interpret tax law. Robichaux wrote Malone’s idea of customer service was to ‘charge as much as you can, but spend as little as you can get away with.’

TCI’s top priority was to keep up the cable business as an “insular cartel.” The predictable result included accusations of “shoddy service” customers were forced to take or leave. In the handful of markets where TCI faced another cable competitor, TCI ruthlessly slashed prices to levels some would describe as “predatory,” only to rescind them the moment the competitor was gone. TCI’s intolerance for competition usually meant mounting pressure on competitors to sell their system to TCI (sometimes at an astronomical price) or face a certain slow death from unsustainable price cuts.

Among Malone’s most-trusted friends: junk bond financier Michael Milken and Leo Hindery, former CEO of Global Crossing.

Congressman Albert Gore, Jr., later vice-president during the Clinton Administration, was probably Malone’s fiercest critic in Washington. Gore’s office was swamped with complaints from his Tennessee constituents upset over TCI’s constant rate increases and anti-competitive behavior.

The cable industry’s biggest competitor in the 1980s-1990s was a TVRO 6-12 foot diameter home satellite system.

Gore was especially unhappy that TCI’s grip extended even to its biggest competitor — satellite television.

In the 1980s and early 1990s, cable operators made life increasingly difficult for home satellite dish owners, many in rural areas unserved by cable television. But things were worse for home dish owners that walked away from TCI and began watching satellite television instead. To protect against cord-cutting, the cable industry demanded encryption of all basic and premium cable channels delivered via satellite. It was not hard to convince programmers to scramble — most cable networks in the 1980s were part-owned by the cable industry itself.

To make matters worse, unlike cable systems that only leased set-top boxes to customers, home dish owners had to buy combination receiver-descrambler equipment outright, starting at $500. Just a few years later, the industry pressured programmers to switch to a slightly different encryption system — one that required home dish owners replace their expensive set-top box with a different decoder module available only for sale.

Gore was further incensed to learn TCI often insisted home dish owners living within a TCI service area buy their satellite-delivered programming direct from the cable company. Customers hoping to leave cable for good found themselves still being billed by TCI.

Sometimes the rhetoric against TCI and Malone got personal.

”He called me Darth Vader and the leader of the cable Cosa Nostra,” Malone said of Gore. “You can’t win a pissing contest with a skunk, so there’s no point in getting involved in that kind of rhetoric.”

“There’s a joke going around Washington,” John Tinker, a New York-based Morgan Stanley & Company investment banker who specializes in cable television said of Malone back in 1990. “If you have a gun with two bullets, and you have Abu Nidal, Saddam Hussein and John Malone in a room, who would you shoot? The answer is John Malone — twice, to make sure he’s dead.”

TCI itself was a four letter word in the many small communities that endured the cable company’s insufferable service, outdated equipment, and constant rate “adjustments.”

The New York Times reported John Malone’s TCI had a reputation for treating customers with “utter disdain,” and provided examples:

• In 1973, rate negotiations stalled with local regulators in Vail, Colo., the local TCI system shut off all programming for a weekend and ran nothing but the names and home phone numbers of the mayor and city manager. The harried local government gave in.
• In 1981, TCI withheld fees and vowed to go completely dark in Jefferson City, Mo., if the city failed to renew its franchise, while a TCI employee — “who turned out to have a psychological problem,” said Malone — threatened harm to the city’s media consultant. Again, a beleaguered local government renewed the franchise — although in a subsequent lawsuit, TCI was fined $10.8 million in actual damages and $25 million in punitive damages.
• In 1983, the small city of Kearney, Neb., also dissatisfied with poor service and rising rates, tried to give Malone some competition in the form of a rival system built by the regional telephone company. TCI slashed fees and added channels until the enemy was driven from the field.

“That’s the dark side, if you will, of TCI,” said Richard J. MacDonald, a media analyst with New York-based MacDonald Grippo Riely.

By mid-1989, Malone’s frenzied effort to consolidate the cable industry resulted in him presiding over 482 merger/buyout deals, on average one every two weeks. Among the legacy cable companies that no longer existed after TCI’s takeover crew arrived: Heritage Communications, United Artists Communications and Storer Communications.

To cover the debt-laden deals, Malone simply raised cable rates and shopped for easy credit. Bidding with others’ money, the per-subscriber price of cable systems shot up from $998 in 1983 to an astronomical $2,328 in 1989.

The General Accounting Office, the investigative arm of Congress, found deregulating the cable industry cost customers through rate hikes averaging 43 percent. In Denver, TCI raised rates more than 70% between 1986 and 1989.

Malone’s attempt to finance a leveraged, debt-heavy buyout of Time Warner Cable seems to show his business philosophy has not changed much.

Time Warner Cable’s summer was “horrible,” to quote one analyst, after three percent of customers left over programming disputes and increasing prices for broadband and telephone service, with more likely to follow as price promotions expire and rates increase further.

Cable analysts were shocked Time Warner Cable lost 308,000 customers in the last three months, most leaving over interruptions of CBS and Showtime over a contract dispute. But customers were also ready to leave over increasing modem rental fees, rate increases, and the company’s growing pullback on promotional pricing. Time Warner Cable’s poor results have ironically caused its stock price to increase this morning, but only because investors suspect a shareholder value-boosting merger with Charter Communications could come within months.

“Just horrible,” MoffetNathanson analyst Craig Moffett wrote in a note to investor clients this morning. “The CBS dispute apparently took a much larger toll than anyone would have imagined, and this colored all the results.”

Sources have told Reuters that cable billionaire John Malone has approached Time Warner Cable about a full takeover by Charter Communications, but has been rebuffed by Britt so far. But with Britt exiting and Time Warner Cable’s underperformance, shareholder pressure for a deal with Charter will only increase.

“This enhances Malone’s appeal to Time Warner Cable shareholders that they would be better off with another management team,” Brean Capital analyst Todd Mitchell told Reuters.

When promotional prices end, a growing percentage of TWC customers drop services or take their business elsewhere.

The subscriber losses pushed profits down 34 percent at the cable company, to $532 million. The triple play tragedy saw subscriber losses for all the company’s residential services. At a time when other cable companies cannot process High Speed Internet sign ups fast enough, at least 24,000 Time Warner Cable broadband customers left over rate hikes and equipment fees. Analysts had expected the company to pick up more than 46,000 broadband customers during the last three months, not lose them. The company’s phone service is also in decline. Only rate increases and customers upgrading to higher speed tiers delivered a slight revenue boost.

Outgoing CEO Glenn Britt set the stage for the current forced retreat on its revenue forecast for the year:

• Time Warner Cable executives made the decision at the end of 2012 to stop heavily discounting service and cut back on promotions. Their theory was the company would attract a larger base of stable customers willing to pay non-promotional rates and tolerate rate increases;
• Executives announced as Time Warner’s phone service was brought “in-house,” the company would stop aggressively pricing triple play bundles that included phone service. That turned out to be a bad decision for growth because customers, already prone to landline cord-cutting, downgraded their bundle or left when promotions expired and ditched the phone line;
• A year of broadband price increases and the introduction of a modem rental fee rubbed customers the wrong way. “We have raised prices recently in the form of modem rental fees, but it’s really just broadband price increase,” again admitted Britt this morning. Future rate increases on modem rentals will give broadband customers another push to shop around for a better deal. At least 24,000 did that over the summer and left, mostly for AT&T U-verse in the midwest and Verizon FiOS in the east.

The lengthy dispute between Time Warner and CBS did the most damage and not just to customers directly affected by channel losses. A major increase in call volumes from alienated customers overwhelmed national call centers, creating long hold times for everyone calling in.

Time Warner expects 40 percent of the cable company’s service area will be overlapped by major competitors AT&T U-verse (now 27%) and Verizon FiOS (now 13%). That represents one million more homes than last year.

Bye Bye: Time Warner Cable lost residential customers for all of its services during the third quarter.

Incoming CEO Robert Marcus said he was dissatisfied with subscriber results from current promotions and rates. New Time Warner Cable customers, Marcus noted, are paying higher prices for fewer or less robust services as part of current promotional packages. Although that has driven a “dramatic improvement in recurring revenue” among customers actually signing up, many choose the lower-priced competition instead.

Marcus also noted customers are taking fewer services and are resistant to upgrading to double or triple play packages, reducing the potential average revenue per customer (ARPU).

“To a great extent, these are expected outcomes of our pricing and packaging strategy and the trade-off between ARPU and volume, but I’m confident we can do better on volume without giving up the ARPU benefits we’ve been achieving,” Marcus told analysts on a morning conference call.

Instead of getting more aggressive on pricing, the company plans to trot out free gifts and pitch discounted slow speed Internet to attract price-resistant DSL customers.

“Next week, we’ll launch our holiday offer, which includes a free Samsung tablet loaded with all of our apps, including TWC TV, with the purchase of higher-end packages,” Marcus said. “I think this will generate lots of interest and really highlight TWC TV and the value it adds to our service offerings.”

Marcus called it inconceivable and unacceptable that at least 4.5 million people are still subscribed to telephone company DSL in Time Warner Cable service areas. The company plans an advertising blitz to steal customers away from companies like AT&T, Verizon, Frontier, CenturyLink, Windstream and FairPoint.

At the center of that effort is the recently announced 2/1Mbps Lite package, which will sell at the everyday price of $14.95 a month. Marcus wants at least 500,000 DSL customers switched to Time Warner over the next 18 months.

“Over time, as these customers’ speed and capacity needs increase, we’ll be well positioned to sell them higher-end product,” Marcus said.

Or they will switch back to the phone company if Time Warner increases the price.

Malone

So far Dr. John Malone isn’t getting very far with his ambitious plan to merge Charter Communications and Time Warner Cable into a single cable company, but that has not stopped him from trying.

GDP Insider reports Malone is quietly keeping the pressure on Time Warner Cable management to do a deal with Charter. Malone controls a substantial interest in Charter Communications.

Liberty Media, a holding company controlled by Malone, is spearheading the courtship under the direction of Greg Maffei, Liberty’s CEO. It’s a tall task, considering Time Warner Cable is a larger company than Charter.

Both men are betting they will get a friendlier reception after current CEO Glenn Britt retires at the end of the year.

TWC’s new chief financial officer, Artie Minson, isn’t exactly rebuffing Malone and Maffei.  Minson said that in the event of an acquisition or merger deal, the company will consider taking on more debt to help finance the transaction.

Many Charter shareholders are unconvinced such a deal is worth the amount of debt likely required to finance it, especially as cable television subscriber numbers continue to erode and the rate of new broadband sign ups has peaked.

Malone has argued a combined Charter-Time Warner Cable could realize savings in cable and broadcast retransmission fees through volume discounts.