Microsoft, TCI Talks Seek Mix of TV, Computer
Software billionaire Bill Gates and cable mogul John C. Malone are negotiating a wide-ranging deal that would bring about the broadest convergence yet of Silicon Valley and the television industry, potentially enabling consumers to surf the Internet and check their e-mail on a television set equipped with 200 or more digital cable channels.
Under the deal, Gates’ Microsoft Corp. would provide Malone’s Tele-Communications Inc. with the software for advanced television set-top boxes and make a substantial investment of between $500 million and $1 billion in the Englewood, Colo.-based cable operator, according to sources close to the negotiations.
The deal between the largest software company and the largest cable operator is part of an aggressive campaign by Microsoft to retain its dominance while the computer and the television converge in living rooms across America. Microsoft already controls the desktop, with 90% of today’s computers running on its software. In a bid to increase its influence in television, Microsoft earlier this year paid $450 million to buy WebTV Networks, a novel but cumbersome system for surfing the Internet over TV. In June, Microsoft invested $1 billion in Comcast Corp., the fourth-largest cable company, causing cable stocks to rally.
Neither TCI nor Microsoft would comment on the negotiations, and sources said both sides have signed a nondisclosure agreement. Those sources said the deal could be announced before the end of the month, though various points, including the amount to be invested in TCI by the Redmond, Wash.-based software giant, are still in flux.
At a Goldman, Sachs & Co. media investment conference in New York last week, TCI President Leo Hindery hinted at an alliance that would provide “further affirmation of the convergence of Silicon Valley and the cable industry.” Hindery, who suggested an announcement “before the first snow flies,” has aggressively reorganized the financially strained TCI since joining it in February, helping to more than double the value of the stock, which closed Tuesday at $23 a share on NASDAQ, near a record high.
Sources said Microsoft also is trying to persuade Time Warner Inc., the country’s second-largest cable operator, to endorse its software, but those talks are in preliminary stages.
Microsoft has been angling since early summer to strike a deal with the cable industry, but the overtures were initially rejected because the company wanted a big cut of the revenues generated by new digital services. Microsoft’s proposal was a hot topic at the Allen & Co. media conference in Sun Valley, Idaho, in July, where sources say Gates pushed Malone to negotiate a deal.
The cable industry in general has been leery of allowing Microsoft, known for its cutthroat practices in the computer business, to set the standard for software in the digital cable business. Many in the cable industry fear that Gates will use Microsoft’s proprietary approach to become a gatekeeper into the living room, just as he has done in the computer market.
As recently as late August, at TCI’s annual meeting, Malone himself warned against Microsoft or any other single source securing a lock on supplying digital boxes. “We would be very foolish to allow that to happen,” Malone told shareholders. “That doesn’t mean it’s a go or a no-go with Microsoft. What it really means is that Bill has to accept the fact that he cannot have quite the dominance in supplying our industry as he has developed in supplying the PC industry.”
But some cable executives viewed Malone’s warnings as a classic negotiating ploy to force Gates to sweeten his terms or risk being cut out of an industry-wide initiative to establish standards for digital boxes. TCI is one of a consortium of cable companies leading an effort at Cable Television Laboratories Inc., the industry’s independent research body based near Denver, to standardize boxes so they can hook up to any cable system in the country. Such boxes could be available by early next year in some markets.
CableLabs says 23 bidders submitted proposals by the deadline last Friday, including Microsoft and rivals Sun Microsystems Inc., Oracle Corp. and Netscape Communications Corp. In an unusual split that some analysts saw as a signal of Microsoft’s weakening position with the cable industry, Intel Corp. aligned in the bidding with Oracle.
It is unclear what effect a Microsoft-TCI deal would have on the bidding process, although some industry sources say Microsoft is trying to make a preemptive strike to establish its software as the de facto standard for a new box.
“Microsoft doesn’t want to take a chance that CableLabs will pick Oracle,” said one source. “The question is whether Malone is bolting from the pack or has extracted a good deal from Gates that will benefit the entire industry.”
Sources say Malone is now trying to get other large cable operators to back the Microsoft approach, promising that it will mesh with any protocol selected by CableLabs. But some in the cable industry fear that an early deal between Malone and Gates could lead to multiple standards.
A deal between Microsoft and TCI could propel cable stocks more briskly than Microsoft’s investment in Comcast, which is less than a fourth the size of TCI. While Wall Street saw that transaction as endorsing cable as the preferred pipeline for entertainment and information into the home, cable sources say Gates’ deal with TCI could substantially reduce the industry’s costs of delivering those services, vastly strengthening cable’s franchise.
The cable industry has been slow to introduce digital boxes, estimated to be in fewer than a million of the 70 million cable homes, in part because of their high cost--more than $400 each. Sources say Microsoft has agreed to subsidize the advanced models, cutting TCI’s costs by more than half.
It currently costs TCI about $400 for digital boxes that double its channel lineup and improve picture and sound quality. The company, which reaches 14 million subscribers, spends another $400 for modems that its cable customers can use to hook their computers to the Internet at speeds 1,000 times faster than via telephone lines.
The new boxes under development would combine both functions. Microsoft’s box would use WebTV and Windows CE software to provide Internet capabilities. Sources say the deal could also involve the Microsoft Network, an online service that provides access to the Internet and a range of proprietary programs, and At Home, a competing service owned by TCI and several cable partners.
Sources say part of Microsoft’s equity investment will be channeled into TCI Ventures, a stock TCI recently set up that tracks services outside its core, including At Home, interactive television and wireless telephone arms.
The cable industry has had a rocky time delivering long-promised digital services. Most of the industry--with Time Warner a notable exception--went along with TCI in picking General Instruments to supply the first set-top boxes. “Four years later, there were no set-tops, and General Instruments had defaulted on the contract several times,” said one cable executive explaining CableLabs’ insistence on open standards and multiple suppliers.
