Creating an Entertainment Giant : PROFILE: A BIG WINNER : Artful Design of Acquisition Is Sweet Deal for TCI’s John Malone

Using tough negotiating tactics, an encyclopedic knowledge of government regulations and some key leverage, John Malone has emerged as perhaps the biggest winner in Time Warner’s planned acquisition of Turner Broadcast.

First there is the 50% premium Malone would get on his Turner holdings. Malone’s Tele-Communications Inc. affiliate Liberty Media would receive an estimated $2.2 billion worth of Time Warner shares in exchange for Turner shares that were worth just $1.4 billion before the deal was announced. That would be a 450% return on the $500 million he paid to buy those Turner shares over the past eight years.

Then there are the little goodies. Liberty would receive the option to buy Turner’s share of SportsSouth, a sports channel covering southern states, for $60 million, and Sunshine Network, a Florida-based sports channel, for $14 million. The deal would give Liberty virtual total ownership of channels that are key to its effort to build a national sports network.

Finally, there is the masterstroke--a complex set of side deals that would not only give Malone access to a new cable station at a cut rate over 20 years, but also new sources of advertising revenue. Analysts say the deal could be worth hundreds of millions of dollars to Malone.

Not bad for a few weeks of playing hard to get.

From the beginning, Malone has controlled the negotiations, making it clear that he would not go along with a deal that didn’t respond substantially to his demands. Gerald M. Levin was forced to travel to TCI’s headquarters in Englewood, Colo., several times to carry out the tough negotiations.

But Malone also succeeded by artfully designing a deal that also would give Time Warner something extra.

“It’s a great deal for Malone,” says Jessica Reif, an analyst at Merrill Lynch. “But it’s also not a bad deal for Time Warner.”

The idea of the side deal is to turn Turner’s broadcast offering, WTBS, from what regulators call a “superstation” into a network. Since networks are regulated more loosely, local cable operators would be able to add advertising. As a network, Time Warner also would be able to change its offerings so its best show appears during prime time in New York and again three hours later in Los Angeles, making it more attractive in each market.

Time Warner could charge more in subscriber fees for the network channel. Cable operators like Malone get new sources of revenue by selling local advertising.

Here is how the deal works:

Malone agreed to sell Southern Satellite Inc., which distributes WTBS to cable operators, to Time Warner for $360 million. Analysts estimated the value of the property at just $110 million.

Owning Southern Satellite would enable Time Warner to renegotiate deals with cable operators that use WTBS.

Time Warner agreed to grant Malone rights to carry WTBS for 20 years. Not only is the time span of the agreement unusually long, giving Malone a lock on good programming far beyond the typical three-year period of most such agreements, Malone reportedly negotiated a favorable rate for the service.

It is unclear how much additional revenue Malone would be able to earn by selling advertising .

Other cable operators are grumbling TCI would be getting an unfair deal. They also worry that Malone’s 9% share in Time Warner would give him an advantage in negotiating other deals with Time Warner.

US West, which has a programming partnership with Time Warner, is also concerned about the impact Malone’s deals might have on the value of its holdings.

“To the extent there are vendor-vending relationships [between TCI and Time Warner],” said Doug Holmes, US West chief financial officer, “clearly there are economic consequences and we would be concerned.”

Some analysts suggest there could be other questions raised about the deal Malone reached. Details of the deal haven’t been released.

Although Liberty Media is 100% owned by TCI, a “tracking stock” trades separately based on expected earnings from Liberty. Since it was Liberty Media, not TCI, that owned the shares in Turner, says one analyst, it might be considered inappropriate for Malone to use that leverage on TCI’s behalf instead.

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Malone Gets What He Wants

John Malone, president and CEO of Tele-Communications Inc., the nation’s largest cable operator, knows mega-deals. His prominence in the cable industry and TCI’s large stake in Turner Broadcasting System Inc. delayed Turner’s acquisition by Time Warner Inc. What Malone would get from the merger:

* TCI’s Liberty Media exchanges 65 million shares of Turner Broadcasting, worth $1.4 billion before the deal, for 55.6 million shares of Time Warner worth $2.2 billion.

* Liberty Media acquires Turner’s interests in SportSouth, a regional sports network, for $60 million.

* Liberty Media acquires Turner’s Sunshine Network for $14 million

* TCI gets an agreement to carry Turner programming at favorable rates for 20 years until 2015.

* WTBS programming will be structured as a network so that TCI can sell advertising on Turner programs.