TCI Music Benefits From a Little Internet Alchemy

John Malone utters the magic word 'Internet' to change a loser into gold.
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Can I get rich by taking money out of my left pocket and putting it in my right pocket? I can on Wall Street in the spring of 1999, if I'm Dr. John Malone, that is.

In case you missed it, the conjurer's trick of the year took place April 5, when Malone, who is nothing if not inventive when it comes to moving around his assets, took $708 million of certain properties out of one company he controls as chairman of the board,

Liberty Media Group

(LMGA)

, and moved them to another company where he calls the shots,

TCI Music

(TUNE)

. In doing so, he thereby magically caused the latter company's market value of $447 million to spurt to more than $13 billion within 48 hours.

I'm impressed, really. It's frankly quite amazing when someone can take $708 million and $447 million, add them together and have Wall Street come up with $13 billion for a total. How'd he do that? Our assignment for this week: Figure it out.

The explanation is not only simple, but familiar to readers of this column. To add value to a stock on Wall Street these days, it is no longer necessary to put some impressive numbers on the board, or even talk about putting some impressive numbers on the board. All management needs to do is utter the magic word "Internet" and start pocketing the loot. Malone's stunt shows just how much loot is out there to be pocketed -- and how easy the pickings are when investors lose their heads in a stampeding bull market.

Malone is not dumb, and he's been able to read the wall writings as well as anyone. The company he ran until just the other day,

Tele-Communications Inc.

, is the biggest cable operator in the country, with tentacles that reach into everything. In the past couple of years, the business has done well by its shareholders, rising from barely 21 per share in autumn 1997 to 38 per share by last June. That's when Doc Malone (he's not a real doctor; the title is for some kind of Ph.D.) sold the whole shebang to

AT&T

(T) - Get Report

for just a bit more than $50 per share. The deal finally closed early last month.

Now anyone who presides over a stock run-up of more than 80% in barely nine months' time, then cashes out for yet another 31% gain, ought rightly to feel pretty good about things, wouldn't you think? After all, the economy isn't growing by 111% every nine months. Nor are the earnings or cash flow of the cable television industry, or even Tele-Communications Inc. itself. Nor is inflation. I know my standard of living isn't going up by 111% every nine months. So, no matter how you cut it, we'd have to say that Malone came out ahead.

But how can you feel good about presiding over a stock that takes an entire nine months to double when Internet stocks have been doing the same thing in mere weeks or days or, often, even hours? That's the problem with Wall Street: No matter how much you make, somebody else is always making more.

Here's my current favorite example:

Audiohighway.com

(AHWY)

, which sends audio to your computer over the Internet. The company launched its Web site in November 1997, yet has so far taken in gross revenue of exactly $139,000. (No, there are no zeros missing. That's the entire number.) Nonetheless, the stock went public at 6 1/2 a share Dec. 18, and as of April 8 it was selling for 35, creating a market value of roughly $140 million, which is 1,007 times trailing revenues.

I love numbers like that. They're so, well, big. But imagine how they must make a guy like Malone feel. There he was, slogging away in that corner-office salt mine of his, trying to stick a few more billion on the market cap of kindly old Tele-Communications Inc. while a parade of Internet companies no bigger than his expense account passed him by. Where's the justice in that? On a 1,007 trailing-revenues multiple, Malone could have sold out to AT&T not for a measly $32 billion, but for a much more respectable $7.5 trillion -- that is, four times the gross national product of France.

All of which helps explain why Malone has now unfurled his little prank to become an Internet player and to start making some real money for a change. To get the full flavor of what he did, which turns out to be quite brilliant when you think about it, we're going to have to rerun the hustle in slow motion.

Observed thusly, we'll be able to see that the Malone really didn't transfer Liberty Media's Internet properties from Liberty Media Group to TCI Music at all. That's because, for starters, Liberty Media Group doesn't actually have any assets; it only seems to. In fact, Liberty Media isn't even a real company; it only seems to be one.

In reality, Liberty is a so-called "tracking stock," issued a few years back by Tele-Communications Inc. as a stock dividend to its shareholders. The whole tracking-stock rigmarole had been set up at a time when Tele-Communications Inc.'s stock price was in the Dumpster and Malone was frantic to get it out. So with the help of some clever investment bankers, they cooked up a tracking stock in hopes that Liberty would be valued by investors as if it were an actual, free-standing media company instead of something buried within a cable company. In reality, Liberty's assets all continued to be owned by Tele-Communications Inc. itself -- Malone being a hands-on (and never-let-go) kind of guy.

When Tele-Communications Inc. merged with AT&T, all of its assets passed into the control of AT&T, and naturally, the Liberty Media "tracking stock assets" went along with the deal. AT&T has since combined them with another, separate Tele-Communications tracking stock,

TCI Ventures

, and the two have now become a new free-floating tracking stock known as Liberty Media Group.

Are you with me so far? Well, here's where it starts to get interesting. One of the assets that AT&T consequently now owns, and which Liberty is supposed to track (in other words, an asset that Liberty appears to own but really doesn't) turns out to be TCI Music, the very company to which Malone appeared to transfer Liberty's Internet assets to (but actually didn't). According to Liberty's own press release describing the transfer, Liberty already owned 86% of TCI Music's shares at the time of the deal. (Not owned as in "I own this," mind you, but owned more in a kind of Clintonian, it-all-depends-on-what-you-mean-by-own sort of way.)

Thus, we may say, with neither hyperbole nor distortion, that when Liberty Media announced April 6 that it was transferring substantially all of its "Internet and interactive television assets" to TCI Music, it was actually just engaging in a kind of financial peek-a-boo with Wall Street investors. In effect, it was taking some goodies from its left pocket (Liberty Media), flashing them around like a wad of boodle for investors to gawk at, then placing them in the right pocket (TCI Music), while hoping no one noticed that both pockets belonged to the same pair of pants inside of which stood the arresting presence of who else but Malone.

And the really incredible thing is how little of this anyone seemed to notice. TCI Music, the thing into which Malone dumped his dreck, is itself really a pathetic little operation. During 1998, the company lurched along with revenue of $84 million followed by negative numbers all the way down the rest of the page: net operating loss ($17.5 million), net pretax loss ($23.5 million), net bottom line loss ($29.1 million), net operating cash flow loss ($6 million).

Investors looked at this sea of red ink, and giving the company the benefit of the doubt, bestowed upon it a $4.50-per-share price tag -- and a resulting $366 million market cap -- which prevailed without interruption from last October until the end of March. That's when Malone arose from his lawn chair and sent forth the word that he had, in effect, had a conversation with himself and decided to transfer certain Liberty Media assets to a company that was actually part of Liberty's grab bag of make-believe assets all long.

How much did Malone figure these assets were really worth? No mystery there: roughly 128.8 million shares of TCI Music, that being the amount he was willing to extract from his left pocket and place in his right, in return for the fantasy assets that he was pretending to extract from his right pocket and place in his left. Since TCI Music was trading at 5 1/2 April 1, the last trading day before the deal was announced, we may divine that Malone figured the assets in question -- consisting mainly of shares in four Internet start-up companies (

priceline.com

(PCLN)

,

iVillage

(IVIL)

,

SportsLine USA

(SPLN)

and

drugstore.com

) and a bandwidth deal between Tele-Communications Inc. and AT&T -- were worth approximately $708 million. Add that to the company's then-prevailing market cap of $447 million and you come up with a combined market value just short of $1.2 billion.

So let's recap: TCI Music, a real company that is 86% owned by a make-believe company (Liberty), gets to pretend that it has received $708 million worth of new assets. On the other hand, it has had to issue $708 million worth of actual new stock to Liberty in order to carry on the charade -- becoming, in the process, 94% owned (in this make-believe sort of way) by Liberty itself, whose assets are all really owned by AT&T.

Given all that, any reasonable person would have to conclude that if TCI Music were to benefit in any way from this arrangement, fully 94% of those benefits would flow to Liberty. But that's not what happened, as Internet-crazed daytraders, noticing only that TCI Music was acquiring Liberty's Internet properties (and not realizing that if TCI Music were to go up, then Liberty should, too), chased TCI Music from 5 1/2 April 5 to an intraday high of 61 April 7 -- a 1,009% explosion that turned a $1.2 billion company into a $13.1 billion company. Meanwhile, pity poor Malone, whose Liberty Media Group shares should have "tracked" the TCI Music shares right into orbit, but barely budged, rising a mere 11% to 62 in the same two-day period.

But who knows? By the time you read this, Wall Street's gang of marauding Internuts may have discovered their oversight and chased Liberty up to where it apparently belongs also. After all, if TCI Music can sell for 61, then simple arithmetic says Liberty ought to sell for 90.

Anyway, that's our Eye to the Keyhole lesson for this week: how to pretend to give yourself $708 million that isn't yours in the first place -- and turn a money-losing $84-million-a-year company into something worth $13 billion overnight. Maybe money really does grow on trees after all.

Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. Byron holds no positions in any of the stocks discussed in his column. While he cannot provide investment advice or recommendations, he welcomes your feedback at

commentarymail@thestreet.com.