Source Media, Straight from the Source

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The summer's brought a bumper crop of disasters for

Source Media

(SRCM)

. "It's been like a bad B movie," says Tim Peters, the company's chief executive.

If so, then it's been more

Roger Corman

than

Russ Meyer

. The Dallas-based interactive television outfit has:

  • Been named in a slew of class-action lawsuits claiming it artificially inflated its stock price;
  • Discovered that five salespeople ran off to start a rival company even though they had signed noncompete agreements; and
  • Gotten buried by an avalanche of hate mail on the Silicon Investor and Yahoo! finance chat boards.

The worst cut, of course, was that the stock plummeted from 39 to 6 in a few short, steamy weeks.

Although Source Media lost a total of $19 million (excluding a $26 million second-quarter write-off) over its last two quarters, the company claims it still has a leadership position in the still-embryonic digital interactive television market. If digital set-top boxes are eventually adopted by cable operators, Source Media may have a future after all. Market researchers

Paul Kagan Associates

predict there will be 9 million digital set-top boxes in the U.S. by 2000 and 35 million by 2009.

Source Media is expected to move its thousands of interactive advertising partners to the digital set-top box. Eventually, the company hopes that cable customers will access the Internet through cable wires and sign on to the company's Interactive Channel service, which will link users to their ad partners. But Source Media is faced with larger and better-financed rivals who may soon elbow it out of the way. So far, investors have taken a dim view on the company's prospects: Its stock was up 1/16 at 7 3/4 today.

At an extensive interview with the

TheStreet.com

, Source Media's Peters, along with President John Reed, tried to clear up some lingering questions.

The Buyout Rumors

Back in July, Source Media's stock first

blipped on the media's radar screen when it shot from 16 to 39 in a fortnight. According to market rumors, the company was on the cusp of being acquired by one of a handful of big-name software or Internet companies, such as

Microsoft

(MSFT) - Get Report

,

America Online

(AOL)

or

Excite

(XCIT)

. These reports were talked up by two of Source Media's biggest supporters. One was

Southeast Research Partners

analyst Anthony Stoss, who has a buy rating on the company, and Mike Rapp, a managing director at

Oscar Gruss & Son

, whose clients have held as much as 2 million shares of the company. (Southeast's a subsidiary of

GKN Securities

and Reed confirmed that GKN's clients still own a chunk of Source Media's 12.6 million shares outstanding.)

Peters denies playing any part in the rumors. "Some of your largest supporters can be your worst enemies," he says. "People think they are helping, and you love them to death, but sometimes things just have to take their natural course."

The other

thread to these rumors was that the company propped up its stock to raise some $25 million from warrant holders and set off a compensation package based on the company's share price for its top executives. For example, Peters could have earned $2.6 million if Source's stock stayed above $20 for 20 consecutive trading days. The stock could not sustain that level for long and Peters missed the target.

"We are not hypesters out of central casting," says Peters. "We have been running a nice little business in interactive advertising for the last 10 years." Source Media, formerly known as

IT Network

, went public in 1995 in an offering underwritten by

Prudential

and

Legg Mason

.

The Brite Voice Acquisition

Source Media's purchase of the electronic publishing assets of

Brite Voice Systems

(BVSI)

for $35.6 million in October 1997 has proven to be a constant source of headaches. "Five employees of Brite Voice have taken some of our contracts and started

IMS

," a privately held company in Wichita, Kan., Source's Reed says. "We already have sued them for violating their noncompete agreement, but now we are in the process of suing them for copyright infringement."

TSC

was

told last month by Reed that the case was being wrapped up. Now, says Reed, it could get uglier. "It's turned out to be much more than just a violation of our noncompete agreements," adds Peters.

This acquisition has also brought a number of opportunistic law firms into the mix. Firms such as

Weiss & Yourman

and

Milberg Weiss

are suing the company for not telling investors the true nature of problems associated with this acquisition. The company claims that many of these cases are without merit, but the relatively high price paid for Brite Voice and the significant writedown ($26 million) Source Media took in its most recent quarter for this buyout have troubled investors.

"We paid more than the contract value for Brite Voice to remove the last competitor in the audio text business," says Peters, who surprisingly adds that Brite Voice "was the best acquisition of the four we made in this industry."

All That Internet Chatter

"It killed us."

That's Peters' take on the impact Internet chatter had on his company's stock price. "We have had a very staid business plan and not tried to get a stock price ahead of our business plan because

our time is coming," he says.

Peters says now that he is still trying to figure out what to make of the Internet, a market he will need to work with if his digital technology is expected to succeed. "Internet chatters want reasons to buy our stock on a daily basis and we can't provide them with that," he says. "We're greedy, but over the long term, not now."

The Future

How much longer can Source Media wait for cable operators to sign its products up? Peters points out that the company has been waiting since 1991 for the digital set-top box market to explode. "While some believe this technology has been delayed, to us it's moving at a pretty good light speed for us."

So far, only one cable operator, privately held

Insight Communications

, has bought the Source Media service, which includes the server software called VirtualModem technology and its interactive channel, which provides Internet access and advertising to digital set-top boxes.

Even though Insight is a relatively small operator, other cable entities will be watching. So will

TSC

.