Cap Cities Builds Media Highway From Its Own Back Lot

Now that an outsized merger has collapsed at an on-ramp to the information highway, it pays to look at how smart people, such as those at Capital Cities/ABC, are conducting their business and making their plans.

The stock of Cap Cities, which owns the ABC network, most of ESPN and other cable interests, the Kansas City Star and other newspapers and magazines, hit an all-time high of $698 a share last week just as the $33-billion Tele-Communications-Bell Atlantic merger fell apart.

And though Cap Cities fell back in the general stock market retreat late in the week, its price is still up almost 40% in the last year and analysts expect it to go higher. They offer many reasons but cite prominently the company’s quiet and deliberate approach to the dawning of the information age.

Cap Cities people, its Chairman Thomas Murphy and its principal owner Warren Buffett, don’t think you can buy a future in multimedia by making mega-billion offers for movie studios.

Instead Cap Cities, which is a big company with $5.6 billion in revenues last year and about $470 million in net profit, has invested $300 million in recent years in TV program production companies and networks in Germany, France, Spain and the Scandinavian countries.

The investments still lose money, but will turn the corner shortly. Their significance is that Cap Cities has ownership at a reasonable price in a revolution about to happen.

The European TV scene today is like the United States in the ‘60s, just before the proliferation of cable channels began. “It’s like being in a time warp,” says analyst Alan Gottesman of PaineWebber. An American, such as Harry Sloan, a filmmaker and broadcaster who put together a Scandinavian firm with a Cap Cities investment, “can see what’s going to happen, and get in position to make money.”

Also, owning European programming is practice for the big change here. The federal financial and syndication rules that have barred TV networks from owning or sharing in the lucrative syndication of programming are all but repealed now. ABC is dramatically increasing its program production, to $200 million worth last year from $100 million the year before.

Earlier this month, Cap Cities pledged more than $100 million to a joint venture with Brillstein-Grey Entertainment to produce programming for ABC and its cable channels. And it’s reported to be in discussions on similar joint ventures with top entertainment personalities.

What’s so good about programming? A hit product can go on earning money forever. ABC owns great series, such as “Roots,” “Winds of War,” and the stylish “Moonlighting”--programs with long-term value just like movies.

Also, fundamental calculations of supply and demand have changed in the media business. Years ago, distribution outlets for advertising were scarce--only three networks, a shrinking number of dominant newspapers. But then channels for advertising increased dramatically, with cable in electronic media and all sorts of specialized publications and mailbox fliers in print.

Distribution will be even more plentiful with the advent of 150 cable channels, or 500. “That reduces the intrinsic value of our media investments, although all remain fine businesses,” Buffett wrote in 1990.

And it was then that Cap Cities began to make programming investments in earnest. The reason was simple: The new oversupply of distribution channels creates a yawning demand for programming; “content,” as the pros call it, became the new scarce resource. That’s why Walt Disney Co. has geared up to produce 60 films a year and other studios are likewise expanding.

Programming can be risky, more like the oil business or venture capital than communications. “The rule is you invest $1 billion, waste $800 million but get rich because the $200 million brings you $3 billion,” says a Hollywood financier.

So Cap Cities, which owns substantial distribution assets--ABC, several cable channels and the lead stations in the five largest U.S. markets, including KABC Los Angeles--is increasing its investments in programming.

Cap Cities stations are the heart of its business, and not only because they record 48% operating profit ratios, the highest in the television industry by far.

The company was founded in 1954 by the late Frank Smith who hired Murphy, then a 24-year-old Harvard MBA to run a near bankrupt UHF station in Albany, N.Y. Murphy tells the story of Smith driving him to the station’s ramshackle house, dropping him off and telling him make it work.

And he did. The company grew from that one station to the point in 1986 when it paid $3.5 billion, with investor Buffett’s help, and acquired ABC.

But there’s tension in the picture. Murphy at 68 years old stepped back this month into the chief executive’s post he retired from in 1990. Buffett, 63, took some money off the table in December by selling 1 million of his shares back to the company--at $630 a share, a tidy gain from the $172 a share he paid in ’86. He retains 2 million shares or 14% ownership.

Clearly, Cap Cities leadership is preparing for something--either the elevation of 42-year old Executive Vice President Robert Iger to the top job, or an alliance with another firm.

Analyst Jessica Reif of Oppenheimer & Co. believes an alliance, possibly with Disney or Ted Turner, is likely. A Cap Cities acquisition of King World, distributor of “Jeopardy” and “Wheel of Fortune,” also is mentioned. With all those hypothetical link-ups, Cap Cities would acquire programming; with one, it could acquire management. Michael Eisner, 51, chairman of Disney, worked 10 years at ABC early in his career.

Nothing is likely to happen in a hurry. The network business is good again, Cap Cities stock is strong--analyst Reif suggests it could rise to $900 or even $1,000 a share on strengthening cash flow--and Murphy will be in charge for a good while yet.

“There’s a two-year window,” in which big questions will be answered, suggests investment banker John Tinker of Furman, Selz. But whatever happens you can bet it will be better planned and executed than the mega-merger that fell apart last week.

Cap Cities people are quiet, but smart. For an idea of where the information highway is really heading, this is a company to watch.