The Price of Liberty
John Malone is frustrated that his empire sells at a discount. So are shareholders. Can new CEO Greg Maffei help boost the stock?
By Janet Guyon

(FORTUNE Magazine) – I'm driving south on Denver's I-25 to meet Liberty Media chairman John Malone and his new sidekick, Greg Maffei, when a sudden snow squall bursts out of nowhere. I can hardly see the 15-foot steel eagle proudly standing outside the company's headquarters as I pull into the parking lot. Being blinded by a blizzard turns out to be an appropriate overture for the interview. Over the next two hours, Malone and Maffei present me with a flurry of numbers relating to puts, calls, collars, and other financial exotica, not to mention the recently announced plan to create a tracking stock for Liberty's QVC televised home shopping network. It's all designed to boost Liberty's stock (L, $7.75), which has dropped by 34% over the past five years.

I'm personally keen on that prospect, because I bought 100 shares of Liberty at $11.50 each in July 2003, when analysts were saying the stock was worth 40% more than that. Since then, Malone has spun off Liberty's international cable assets into Liberty Global (LBTYA, $24.50) and its 50% holding of Discovery Communications into Discovery Holdings (DISCA, $15.75). Those stocks have risen, but that increase has been matched by a fall in Liberty, which, besides QVC, consists of a bunch of stakes in what Malone calls "old media" companies like Time Warner (FORTUNE's parent), Viacom, and News Corp. Including my shares in the spinoffs, my Liberty investment is now worth $1,183--that's a whopping gain of $33, or 2.7%, over two years.

Malone's not thrilled about that either, considering he owns 4.6% of Liberty and, through his voting shares, controls 31% of the company. "If you're not happy, imagine how I feel," he says. As part of his latest effort to fire up the stock, in November he hired Maffei, 45, as his CEO, paying him $1 million in salary, plus a bonus and 5.5 million stock options at a strike price of $7.95 a share. A financial whiz, Maffei rose to be CFO at Microsoft, where he and Bill Gates made acquisitions involving everything from software for set-top boxes to cable TV. He left Microsoft to run a telecom company, called 360networks, which went bankrupt; he then landed at Oracle as CFO, where he lasted five months. (Maffei says he joined Oracle with the goal of becoming CEO, then realized that CEO Larry Ellison "wasn't giving up the job for a long time.") Now Malone wants him to help untangle Liberty's web of stockholdings.

That Malone, who holds a Ph.D. in operations research from Johns Hopkins, should find himself in such a bind is somewhat ironic. Throughout the '80s and '90s he dazzled Wall Street with his dealmaking. Through his cable company, TCI, he made a lot of money for himself and his shareholders by buying cable systems and investing in programming assets such as Turner Broadcasting, Gemstar, and Black Entertainment Television. Over time, big conglomerates bought many of those companies, usually for stock. As a result, after Malone sold TCI to AT&T in 1999, he was left with a grab bag of stakes in media and communications companies. Today Liberty Media owns 18% of News Corp., 21% of IAC/InterActiveCorp., 100% of Starz Entertainment, 4% of Time Warner, 7% of Sprint, 3% of Motorola, 50% of Court TV, and slices of about a dozen others worth a total of $20 billion.

Yet Liberty's market cap is only $22 billion, meaning investors are sharply discounting the value of those holdings. Why? For one thing, there's the tax liability: Simply selling those stakes would generate a huge capital gains bill. In addition, to generate cash Malone has initiated a slew of complex financial transactions using his stock as collateral. Here's an example of one of his simpler monetizations: Two years ago Liberty used its Time Warner shares to back $1.8 billion worth of bonds that paid 0.75% interest and are exchangeable for Time Warner stock at $17.42 a share, starting in 2008. Liberty has a host of deals just like that--including one that ties up its Sprint stock for the next 25 years.

Malone has used the cash from those maneuvers to buy more stock in News Corp., as well as cable systems in places like Switzerland, Slovenia, and Romania. But the fancy footwork has created such a complex structure that investors can't figure out what Liberty is worth. "I have no idea what is in the Liberty portfolio," says Alan Gould, senior media analyst of Natexis Bleichroeder.

"All the undervaluation of the company, in our opinion, relates to the relative illiquidity of our big portfolio of public securities and its tax issues," says Malone. "If you could sell it all, pay the taxes, give the money to the shareholders, what would you have left? Not a heck of a lot more than what the stock is trading for. It's like the monkey with the banana in the jar," he adds, as Maffei chuckles. "We've got our hand in the jar; we've got our hand on the banana. But we can't get our hand out of the jar with the banana without squishing it."

Malone's latest attempt to extract the banana is to create a tracking stock that will represent Liberty's biggest operating unit, QVC, as well as its investments in two e-commerce companies, Expedia and IAC, which are run by another iconic media kingpin, Barry Diller. The rage during the '90s, tracking stocks were designed to help companies get higher valuations for their faster-growing assets. But they fell into disfavor after the market crash. Malone, however, has used them five times, made money on them, and remains a fan. "He's a serial tracker," says Maffei.

Even if the tracking stock is a success, Malone will have to figure out what to do with the rest of Liberty Media. The Street thinks he'd like to unload it on Rupert Murdoch, who would be happy to get that big chunk of News Corp. stock out of Malone's hands. But Murdoch isn't biting. "It's a hell of a thing to buy," Murdoch told reporters after News Corp.'s Nov. 16 annual meeting in Australia. "John is all about liquidating his company, but on two conditions: One is that it is tax-free to everybody, and two, that he gets the full retail price. I think that's a very unlikely path."

Malone insists he's not liquidating. Instead, he hopes Maffei will figure out how to free up money from that stock portfolio so that he can buy more stuff. Maffei says he'll steer Malone toward investments he knows best, in what he calls the TMT, or telecom, media, and technology sector. "Where we have businesses with synergies," says Maffei, "we think we can add incremental value."

Does that prospect mean Liberty Media stock is a buy? Probably not. The stock has traded down ever since Malone announced the tracker; he has yet to show he can realize his goal of becoming the Warren Buffett of media investing. "The everyday investor looks at this and says, 'I've got better things to do,'" says Michael Savner, an analyst at Bank of America. As for my shares, Malone, upon learning what I paid, doesn't offer much comfort. "Well, that was pretty high," he says. "Timing is everything in life." Feedback?

Running in place

With Liberty's share price sagging, Malone has done two spinoffs. Next up: a tracking stock. Liberty Media Stock price 1/30/1999-11/21/2005 SPINOFF NO. 1 Liberty Global owns cable companies overseas, mainly in Europe and Japan SPINOFF NO. 2 Discovery owns 50% of Discovery channel; Cox and Newhouse own the rest.