The High Stakes of a Possible Vivendi-Seagram Merger

LONDON -- Vivendi (VVDIY Quote) CEO Jean-Marie Messier's glitzy ambitions to turn the onetime French utilities company into a media powerhouse by buying Seagram (VO Quote) will carry Hollywood stakes that go far beyond the price of the deal.

The possible merger raises questions about Messier's ability to manage a continually sprawling empire as well as Vivendi's complex corporate structure and its substantial debt load. For more on the possible deal see an earlier story.

A Wednesday posting on Vivendi's Web site confirmed that it is once again in talks to buy Seagram, the Canadian media and drinks conglomerate run by Edgar Bronfman Jr. Talks between the two companies, which were first reported in January, had supposedly broken down over price. Back at the bargaining table, the pair apparently has overcome that stumbling block. Analysts say Vivendi would be willing to pay around $30 billion, or $70 a share for Seagram, an 16% premium over Wednesday afternoon's price.

In New York, Seagram shares finished up 7 1/8, or 13.44%, to 60 1/8 on the news.

Should Vivendi finance the transaction through a combination of cash and stock, as most analysts expect, it would have little trouble raising funds. Charles-Henri Neme, an analyst with Exane in Paris, argued in a research note that Vivendi could sell its stake in British Sky Broadcasting (BSY Quote) or BSkyB, which is worth about 7 billion euros ($6.71 billion) at current market value. A planned initial public offering for Vivendi Environment, which includes the company's utilities businesses, is expected to raise 5 billion euros. Vivendi could also dispose of its 60% stake in Sithe Energies for an additional 2.5 billion euros.

Vivendi didn't return a phone call seeking comment.

The balance sheet of the merged entity, however, would be far from picture perfect. Vivendi is already a highly leveraged company with net debt of around 18.5 billion euros. The majority of that debt will rest with Vivendi Environment once the IPO is complete, leaving the mobile and media parts of the company virtually debt-free.

But they won't stay debt-free for long. Last week, Vivendi issued a convertible bond backed by part of its BSkyB stake to fund the purchase of a third-generation mobile-phone license in France, which along with the cost of infrastructure, could total up to 10 billion euros, according to some analyst estimates. Then there's the 7 billion euros in debt that Vivendi would inherit from Seagram.

Meanwhile, an increasing part of Vivendi's business would be loss-making, such as its Internet ventures, at a time when it's spinning off the cash-cow utilities divisions. That problem would be compounded with a purchase of Seagram, because Vivendi is expected to sell off that company's profitable drinks and theme park businesses. It would be left with the music and film divisions, which tend to have gyrating operating profits. Last year, for instance, Seagram's film business lost $200 million on an operating level.

"It's unquestionable that the leverage issue will come out in force in this acquisition," says Edward Tetreau, an analyst with Credit Lyonnais in Paris, who rates Vivendi outperform. (His firm hasn't provided underwriting services for the company.) "You will have a strained profit and loss account and balance sheet" for the combined companies.

That could force Messier to undertake some much needed housecleaning, say analysts and investors. One of the few criticisms of the executive is that even as he has had the foresight to focus Vivendi on emerging areas of growth, he is reticent to let go of older businesses that are less relevant.

"Messier has tried to be all things to all people," says Leonard Geiger, manager of (UMPNX Quote)U.S. Trust's Excelsior Pan-European fund, which owns Vivendi shares.

Some of those changes are already in the works, such as the impending Vivendi Environment IPO. Yet, even that move, which would leave Vivendi with a minority stake of the water, energy, transport and waste management concern, fails to go far enough. Geiger says a full disposal of Vivendi's BSkyB stake is a certainty. Another possibility could include a reduction in or an outright sale of Vivendi's 44% stake in Cegetel, the French fixed-line phone company. That would leave Vivendi free to focus on mobile communications, the Internet and content -- three areas that are expected to converge in coming years.

Slimming down his empire would certainly be a plus should Messier take on the management of Seagram, which has struggled to gain a footing in the entertainment world after purchases of MCA, renamed Universal Studios, and Polygram. Bronfman was given two years to turn Seagram around or sell it, and given the latter outcome it's unclear why Messier, who has an even more limited background in entertainment, will have better luck.

To be sure, Messier has made sure-footed strides away from stodgy utilities into the more glamorous world of media and mobile communications by buying Havas, the French publishing company, and launching VivendiNet, a joint venture with Canal Plus. That entity has, in turn, formed another 50/50 venture with Vodafone AirTouch (VOD Quote) and spawned Vizzavi, an Internet portal. To date, however, these deals have been on a smaller scale than the purchase of Seagram, which would place Vivendi on a more even playing field with new media giants like the merging Time Warner (TWX Quote) and America Online (AOL Quote).

The theory behind such hookups is linking content with distribution and in this area Vivendi would appear to have scored well. Seagram's U.S. content would make a perfect compliment to Canal Plus, the pay-television company in which Vivendi has a 49% stake.

In fact, Canal Plus stands to be the clear winner should this marriage take place, since it will bear few of the risks and reap most of the benefits.

That is one reason why Geiger, the money manager, says he's been considering swapping his Vivendi stake for shares of Canal. For this deal to work, Messier will have to convince other shares holders not to change channels.