The slowdown in U.S. consumer spending is emerging at a particularly complicated time for John Malone. The mogul behind Liberty Media is in a tussle with his longtime business partner, Barry Diller, about the future of his stake in IAC/InterActiveCorp ( IACI). With Diller planning to break up his hodge-podge of Web businesses in an attempt to unlock shareholder value, investors on Wall Street are speculating that Malone may move to swap his controlling stake in IAC for HSN. HSN, IAC's home shopping network, competes directly with QVC, the main holding behind Liberty Media Interactive ( LINTA), the stock tracking Web businesses owned by Malone's holding company. For its part, QVC posted disappointing third-quarter results on Friday due to softness in retail spending amid the U.S. housing slump, and investors have doubts about whether this is a good time to double down on that business. "Malone does not like to pay taxes, so if he could get it done on a tax-free basis, then I could see it happening," says Steve Roge, manager of the Roge Partners Fund. "That doesn't bode well for Liberty Interactive because it would just further complicate the already opaque nature of the holding company and the fundamentals of the business could deteriorate further." Shares of Liberty Media Interactive recently were down 59 cents, or 2.9%, to $19.92 after the company reported that third-quarter revenue rose just 2% at QVC.
"We are disappointed with the soft sales results in the U.S., driven in part by a sluggish retail environment and difficult year-over-year comparisons," said Mike George, QVC's CEO. "However, we chose not to adopt a heavily promotional focus in the quarter and were able to maintain stable margin rates despite the slower sales growth." QVC's third-quarter revenue was $1.69 billion, including a 2% rise in the U.S. to $1.17 billion and a 2% rise overseas to $512 million. Apparel sales increased while sales of gold jewelry and home products slipped. The unit's operating cash flow was down 1% to $364 million. The company said sales were weak in its German and Japanese operations because of heightened competition and regulatory issues. "The company continues to see pressure from a sluggish economy," says Jeffrey Shelton, analyst with Natixis Bleichroeder. "The results were less than my expectations and most people's expectations." On the other side of Liberty Media's business, which is tracked by Liberty Media Capital ( LCAPA) shares, results were better thanks to the Starz Entertainment division. Revenue at Starz, a network of paid movie cable channels, rose 11% to $253 million. Its operating cash flow nearly doubled to $88 million, and Liberty said Starz had experienced continued subscriber growth and reduced programming costs. Liberty Media doesn't report net income figures for QVC or Starz Entertainment.
Despite the performance, Liberty Capital shares were also selling off, recently down $1.62, or 1.3%, to $121.29. Roge says the trading action was more connected to a broader selloff in the stock market than to a disappointment in the company's third-quarter results. "Starz Entertainment, their main operating company on the capital side, had a blowout quarter," says Roge. "Revenue was up dramatically and operating income was up dramatically. All around, it's an impressive performance and a great business." Meanwhile, Roge is optimistic about Liberty's recently announced plan to split its capital business in half, with one side retaining the title of Liberty Media Capital and the other side becoming Liberty Media Entertainment. The split will take place after Liberty's pending deal with Rupert Murdoch's News Corp. ( NWS-A) closes. Malone last year agreed to swap his stake in News Corp. for News Corp.'s controlling stake in DirecTV ( DTV), the satellite TV giant. Liberty's DirecTV holding will become the main component of the capital side of its business, along with its cable holdings, while Starz and other assets will comprise the entertainment side. "I'd love to own both of them," says Roge. "Both have very good growth prospects, and the break-up will only add to their stock prices over time. We'll be a buyer of both companies going forward at the right price."
All the slicing up of media assets in the industry heralds the eclipse of giant media conglomerates, like News Corp., Time Warner ( TWX) and Disney ( DIS). Even smaller companies like Belo Corp. ( BLO) and E.W. Scripps ( SSP) have recently announced break-ups to separate their slower-growth businesses, like newspapers, from the rest of their portfolio. Liberty CEO Gregory Maffei said on a conference call with analysts following the company's earnings release that he was pleased with plans to break up IAC. "I think it highlights the value of the components there, which we don't think have been fully recognized in the marketplace, and I think it allows us to begin a dialogue with IAC about how we're going to work together in the next phase of our relationship," Maffei said. Malone has disagreed with Diller over the make-up of IAC's balance sheet, where he sees more opportunity to take on debt and return value to shareholders. "In the past, Malone has preferred to have a leveraged business model to the extent that cash flows can support leverage, and Barry Diller has always been more conservative and has been running a net cash balance," says Shelton. "There has been back-and-forth over the years in which Malone has encouraged him to increase the leverage either through share repurchases or perhaps through acquisitions."
Investors have applauded Diller's decision to break up IAC, which owns disparate businesses like HSN, Lending Tree, Ask.com, Citysearch and Match.com. That said, IAC's recent stock gains have been nearly erased by the overall retreat in the stock market this week. It remains unclear how Diller and Malone will resolve their interests in the company. "It's ultimately going to depend on how IAC structures the spin, but it's an opportunity for the company to put their heads together and come up with a solution," says Shelton. "Liberty has this big IAC equity stake and they'd like to tax efficiently monetize that. The way to do that would be some sort of asset swap with IAC and something like that probably happens before the assets get spun off." For his part, Roge doesn't see upside in Liberty's interactive holdings as a result of the restructuring. He says the home shopping business is a bad investment in the long run because the Internet will provide better ways for consumers to shop from home. "It's profitable now, and if Malone thinks it'll be profitable in the future and there's global expansion opportunities, then so be it," says Roge. "I just tend to think it will be one of the mistakes in his legacy."