In this amazing interview, John Malone, the head of TCI and widely considered the Darth Vader of the infobahn, explains the real reason why the Bell Atlantic deal fell through, his eye-opening battlefield perspective on the telecoms wars, and why he'd like to shoot the chief of the FCC (just kidding – we think).
In this amazing interview, John Malone, the head of TCI and widely considered the Darth Vader of the infobahn, explains the real reason why the Bell Atlantic deal fell through, his eye-opening battlefield perspective on the telecoms wars, and why he'd like to shoot the chief of the FCC (just kidding – we think).
By David Kline
"Converging alliances" is supposed to be the catch phrase of the information age, but in many ways the emerging digital landscape looks like a vast battlefield of colliding empires. Huge cable TV companies war against mammoth regional and national telephone companies for control of information highways. Sometimes the cable and telephone companies war among themselves, and occasionally they form truce-building cross-alliances. Behind the front lines of these business skirmishes, corporate generals plot strategy, forge Machiavellian allegiances, and maneuver over a corpse-strewn marketplace. One of the most controversial of these generals is John Malone, head of the cable TV giant Tele-Communications Inc. (TCI). In October 1993, Malone engineered a merger with telephone leader Bell Atlantic, but four months later the proposed merger collapsed. David Kline met with John Malone in his field tent in Englewood, Colorado, two weeks after the demise of the deal.
Malone:
Excuse me, I don't know if you've met Ray. [Points to a life-sized stuffed gorilla, dressed in a vest and tie, sitting in a chair across from his desk.]
Kline: Is that his name, Ray?
That's Ray Smith [chair and CEO of Bell Atlantic], yeah.
Well, then, as long as we're on the subject, would you explain what really happened with the Bell Atlantic deal?
[Smiles, leans back in his chair.] Most people don't really understand why the deal blew. There were two things: First, their stock was down, and they would have had to give us more than half their company. But Number Two, they were trying to make a transition from a [conservative company whose] stock was supported by dividend payments to an [aggressive firm whose] stock is supported by earnings growth. Not growth, but earnings growth – quarterly earnings growth – which is different. Now if you're gonna try to price your company based on earnings, you'll never get credit [on Wall Street] for taking over our US$10 billion worth of assets – including our 20 percent of Turner Broadcasting – that don't contribute to short-term earnings. They're going up in value rapidly, but they don't show up on-statement. So they had a real problem paying the price.
But they had to know this when they struck the deal with you last October.
[Shrugs.] They were schizophrenic about it. Half the organization couldn't see past quarterly earnings growth, OK? They couldn't see the value of owning 20 percent of Turner Broadcasting. The other half could. There was a struggle within their company from day one.
And Ray Smith, where was he in all this?
Ray was willing to take that leap of faith all the way. Ray . . . shit, I got a lot of respect for him. He was absolutely a visionary. It's just that his organization wasn't willing to go along. So in the end it was a fundamental problem between two philosophies. My strategy – and Ray was totally in support of it – is we're gonna own a lot of 20-percents-of-things, and we're going to put a fair amount of money into it. Those things are going to be leveraged and grow like hell, and we're going to create a lot of shareholder wealth doing that. As for Wall Street, we're just going to have to keep training them to understand the value of that approach. I mean, I've been doing it my whole career.
Some analysts say that the RBOCs are in the best position to really get this information highway built.
[Malone just laughs and shakes his head.]
I take it you don't agree.
It's all posturing . . . more smoke than fire. And I'll tell you why. First, I don't think their culture makes them very competitive, and that's their big vulnerability. Sure, any one RBOC has got as much revenue as the whole cable industry put together. And sure, they're very powerful politically. But they've lived as protected monopolies in a regulated environment all these years and never had to face competition of any kind. Every time the RBOCs have tried to diversify out of their core business, it's been a disaster. So, yeah, the RBOCs have a lot of money, but in order to use it they have to change their whole way of doing business. They have to be able to financially walk away from their dividend.
All the tests show that the one interactive service that the public has a lot of interest in right now is movies-on-demand. Replacing the video store business with electronics is something that would generate maybe, from our tests, four or five bucks a month of cash flow per cable subscriber. Now, how much capital can you deploy for that little? If you're already basically there – if you've already got a network in place capable of delivering video, and it's just incremental – you can do it. But if you've only got copper in the home, and you have to build out a video network from dollar one, then it's going to be real tough. So how do these guys get the money to do it? They've either got to cross-subsidize it very heavily out of their existing telephone customers and raise rates – which is going to give their regulators problems – or they've got to raise their debt. But if they do that, their debt rating goes down and that's, like, completely verboten for these people. The only other way is to take it out of the shareholders – in other words, cut the dividend – but these guys would rather die than cut the dividend. So when you take a look at all the constraints that an RBOC's balance sheet is really under, you see they've actually got only a limited amount of discretionary capital to work with. They're just not going to be able to do much in the interactive TV business.
Pacific Bell says they're going to spend $16 billion to build the highway in California.
Yeah, we can do California for a small fraction of that and provide the same services, so who's gonna have the low-cost service?
But if what you say is true about their financial constraints, how are they going to come up with US$16 billion?
The answer is they won't.
Just to be safe, I think I'll keep an eye on my phone bill. I can't afford that kind of money.
Don't worry. I mean, there's nothing the phone companies would like better than for all this info highway stuff to go away. All they want is to retain their local phone monopoly and be able to go after the long distance marketplace.
You're saying the phone companies have absolutely no interest in interactive TV?
Let me ask you this: Who started the information superhighway? Who really talked about new technology allowing interactive two-way information and entertainment services? We did. It wasn't the telephone companies. I went out on a road show a year or so back, meeting all the RBOC CEOs, and they were all sitting there saying, "Isn't there some way we can avoid conflict?"
What were they afraid of?
Pressure on local telephony rates.
Meaning, if you can one day ship a movie down your wire for a couple of bucks, why couldn't you ship a phone call basically for free?
Right. Once we have the right terminal devices, we certainly would be in a position to provide telephony at substantially lower prices than you're currently being charged. I mean, all of our models say that. So, sure, we can knock the shit out of the cost structure of the telephone business.
So they were afraid of you getting into telephony.
Why do you think they started buying up cable companies?
Well, they said it was to get into interactive TV. To build the info highway.
No. It was so that they can go on the offense rather than on the defense in telephony. Look, if you could really get the RBOCs to tell the truth, they'd tell you that the plain old telephony business is huge – I mean, look at their revenues – and that's what they're primarily going after. And the interactive video business is a lucky strike extra, OK? US West's attitude, when we started seeing the penetrations we were getting in the UK against British Telecom with our [cable-based] telephone service, I mean they just said, "Geez, if you project these numbers to the US – wow! This is a terrific business."
So, when last October everyone said, "See, there won't be a war between cable and the RBOCs after all. They're going to get married and happily ever after build the information superhighway," that was ....
That was wrong.
But why would the RBOCs buy you out just to prevent you from competing one day? I mean, even you said that you guys are mere pipsqueaks compared to the RBOCs.
Right.
[A long pause.] You're suggesting that the RBOCs real goal here was raiding other RBOCs!
Ri-i-ight.
And the information highway was just a great flag to wave around while doing it?
Absolutely. I mean, there was an element of legitimacy in their [talk about multimedia]. But their dominant thinking was, "We're gonna take a hit in our local market from [cable-telephony and cellular] competition, so let's go over and make that up in the other guy's market." And it's driven by, you know, by regulatory concerns. In other words, they're freer in the other guy's market than in their own. So they wanted to go out of their market, to take the offense against other telephone companies. For them, the idea of using cable to get out of their territory and into the other guy's territory was like opening a second front.
Machiavelli would be proud.
Oh, they fall apart on a few things, but basically they're a club. By and large, they coordinate. They talk to each other all the time. I mean, the RBOCs, what they do is they have a big meeting out on the golf course somewhere, and they decide who's gonna do what and to whom.
You're quite serious about that.
Yes, absolutely. There's no question in my mind. These guys are very friendly with each other. I'm not saying anything sinister. I'm not alleging that these guys are engaged in any practice that's even close to being illegal. I'm just saying that there's an alignment of interests.
Did Ray Smith stop getting invited to play golf?
I believe he did. I believe that when he did the deal with us, he became persona non grata. But I think Ray is probably back in the club again, doing a mea culpa. Now it's interesting, there's an increasing divergence [in their ranks]. They've poached a little bit on each other in cellular. And a little bit in Yellow Pages, but that created a lot of animosity, and it didn't work anyway. Clearly US West is out of the club since its deal with Time Warner. Clearly Southwestern Bell [has broken ranks] with its move into cable in Bell Atlantic's Washington, DC, market area.
So when Bell Atlantic was gonna do a TCI deal, that strategic alignment got disrupted. And now that it's dead, they're realigned again. And if Southwestern Bell's deal with Cox collapses [as it did on April 5 – Eds.], they'll be realigned, too. So even though the club may not be as cozy this year as it was a year ago – the strains of strategic variance, you might say – I suspect that with TCI-Bell Atlantic dead the RBOCs are a lot closer in philosophy and strategy than they were at least a few months ago.
Apart from trying to use cable companies as a dagger against each other, which is basically how you described it, where else do the RBOCs have a community of interests?
I imagine last year [after the AT&T buyout of McCaw cellular was announced], they got together and said, "OK, who can afford to take on AT&T right now? Let's see if we can stir up a little trouble, slow that down a little." And they draw straws, and BellSouth says, "OK, I'll do it. I'll go sue 'em on this McCaw takeover." There's no question the RBOCs hate the idea of AT&T buying McCaw. They hate it.
Wasn't it shortly after the AT&T-McCaw deal was announced that two communications bills in Congress really got moving? Personally, I think telecommunications law needs drastic rewiring to open the business up to competition. But those two bills seem to be rather heavily weighted in favor of the RBOCs, as opposed to long distance, for example.
Oh, it's very pro-RBOC. It's weighted very heavily. The RBOCs can get immediately into intrastate long distance, which is big, and through resell options, they can basically knock all the [restrictions] down over time. So the AT&T guys, who if you talked to 'em before, would have said it's gonna be four or five years before there's any meaningful [RBOC movement into the long distance business], are now saying we'll see 'em in the business in one or two years. Meanwhile, the RBOCs are, behind the scenes, trying to talk the government and the Justice Department into stopping or slowing down the AT&T-McCaw deal. And they're powerful guys. Any one of the RBOCs has 150 full-time lobbyists in Washington. We have one. I mean these are great big giant companies, and they've had 120 years to hone their political skills. They have enormous political clout, and when they focus it on the cable industry, they can get the government to tank us. Now they're using it very aggressively to go after AT&T and the long distance market. [On April 5, the court delayed AT&T's acquisition of McCaw – Eds.] On the other hand, AT&T's no slouch either.
The RBOCs are far and away the most powerful monopolies in the country. And they've been able to kind of hide their monopoly while attacking ours – which is quite an interesting act of political strength, wouldn't you say? To get away with calling us a monopoly?!
But be that as it may, the reality is that many people see TCI as some sort of Atilla-the-Hun company.
The reality is we're really very naive politically. We have never spent any money on it. We've never had any focus on it. We've got one guy in Washington and one guy here worrying about government and public relations for the whole company – all states, all divisions, everything. That's probably quite inadequate, looking at the realities. We recognize that we've got to do a better job of telling our story to the public and to the politicians.
But for me personally that's not the way I want to spend my life. I don't want to spend my life in front of regulators and at cocktail parties with politicians and so on.
I'd love to have a venture capital organization for the "information superhighway," where inventors and entrepreneurs with good ideas can come to us and we can invest in them and help them. I've already got a couple dozen things going. What I want to do is formalize the process, 'cause that's what I enjoy personally. Like, we have this compression-uplink facility, which we spent 100 million bucks putting in. We call it an artists' workshop. And we're inviting programmers to come in and test their concepts, and we'll distribute them, see if the public is interested. And if we really like an idea, we'll invest in it, help you distribute it, and we'll provide the whole infrastructure. Studio, compression facilities, marketing, the whole thing. We've got a lot of magazine publishers coming in to test video versions. That's the sort of thing I'm interested in spending my time on.
You have to remember, though, that we grew up as pretty much this frontier, cowboy company. We were growing very rapidly, and at the top, we were spending a lot more time on capital formation than we were even on operations, let alone public relations.
But now you've also got the FCC on your back. What effect has the rollback of cable rates had?
I think the cable industry is only temporarily injured by the FCC. But for the last three or four years we've been shifting a lot of our assets into the international arena. I mean if you really look at TCI today, two-thirds of our market value is based on nondomestic cable businesses. And we'll also continue moving into programming, which the government has a very hard time regulating because of First Amendment issues. These noxious FCC rules are not going to be able to constrain the economics in entertainment for very long. What's gonna happen is there'll be a shift from basic to a la carte services. If our programming is strong, then we'll see a quick recovery of the cable industry growth rate in entertainment and in interactive video and so on.
We'll continue to diversify away from the regulated government-attacked core. And meanwhile, we'll continue to slug it out in the trenches in the domestic cable business, recognizing that the government's got to kill a lot of smaller cable operators before they can really hurt us much. I think what you'll see is that most of the announced new cable-RBOC deals will blow up, as the RBOCs say, "Oh well, after the FCC rollback, you guys are the walking dead." [Southwestern Bell said basically just that when they called off their deal with Cox on April 5 – Eds.] Hopefully, when the blood and the body count starts to pile up, we think government will finally realize that they've gone too far. And despite what [Federal Communications Commissioner Reid] Hundt says, he's wrong. I think they have gone too far this time.
Do you feel like the sacrificial lamb here? That government officials, in planning to deregulate the communications business, wanted to look like populists and so went after the easiest target around? Meaning you, the so-called Darth Vader and all-around bad boy of the cable industry.
I think there were forces in Congress that really wanted to see blood from the cable industry, and when, after the first rate rollback, the blood wasn't very visible – and it certainly wasn't uniform – they just decided to come back for a second bite. Ed Markey [the Democratic US representative from Massachusetts] felt like the cable industry had gotten away too easy with the first round of FCC rules. So he put a lot of pressure on Hundt and got him to take another whack. But I've been around long enough to know that this pendulum will swing back the other way again. It's just reality. I'm not a conspiracy theorist. I don't believe that there's this great big conspiracy between the RBOCs and the elected politicians and the regulators to kill the cable industry. I don't believe that's how it works. I just don't see that. What I do see is some pretty naive regulators wanting to hand Ed Markey his victory. In fact, I would not be at all surprised – maybe this is being naive - but I wouldn't be at all surprised to see Markey soon become the cable industry's best friend. Those RBOCs are going to be even more powerful now, and people are pretty soon gonna want someone to stand up to them.
After we announced the Bell Atlantic deal, [Senator Howard] Metzenbaum says, "Jesus, John, I always thought you were going to be the guy who'd take on the RBOCs." [Representative] Jack Brooks gave me the same story: "What the fuck are you doing merging with the RBOCs?" he said to me. And I says, "Jack, they're just so big and they're so powerful, and I'm getting old, and I just can't fight 'em any more."
Gee, maybe you should go lie down! [Laughter.] But before you do, let's sketch out a map of the competitive battlefield here. It seems to me that even though the RBOCs are quite strong tactically, strategically they're going to eventually be reduced to circling the wagons, right? Against both long distance and cable.
Yeah, the first thing you're going to see is the RBOCs, or at least a lot of the RBOCs, getting together and combining their cellular activities, so that they have a strategy to take on AT&T-McCaw in cellular. That's the first manifestation of circling the wagons.
Which presents the long distance providers like AT&T with a rather difficult strategic problem, wouldn't you say?
The only immediate thing they can do is move into local telephony through cellular. So, yeah, the long distance guys have a serious long-term strategic issue here. Several years ago they figured that they could maintain some kind of uneasy peace with the RBOCs and maybe just haggle over the access fees and poach a little bit in terms of cellular. But now the game has changed. I think their perception is that it's going to be a full-scale war.
Between long distance and the RBOCs?
That's correct. And so now the long distance guys are very anxious to find allies against the RBOCs. And we in the cable industry represent a kind of strategic leverage, a strategic advantage in this war. So everything, all the alignments, are going to shift.
You're talking an alliance with AT&T.
AT&T or an MCI or a Sprint, yeah. And now that the long distance guys know that the RBOCs are coming at 'em, I think they'll find it very much in their interests to try and stimulate competition in local telephony. And the cable people are the only people on a cost basis who can provide local telephony besides the RBOCs.
What are your chances of pulling off an arrangement with one of the long distance companies?
[Smiles.] Excellent.
Are we talking relatively near or long term?
Relatively near. Yeah, I mean, as long as we were screwing around with Bell Atlantic it was hard to pursue those discussions. But I've been very busy [lately]. I've been to New York and Washington three times in the last two weeks. And there's a lot of interest from the long distance guys in this area, so we'll see what evolves. But I do think something very interesting and very powerful is going to evolve.
And what is the chief advantage for you of an alliance with a long-distance network – say AT&T?
Well, skill in telephony, financial strength, and especially branded services. If it's AT&T cellular or MCI long distance or Sprint video telephony, then it's a branded name that we can promote on our network; people will feel like there's real value in the bundle because they recognize the value of each one of the branded components. If I can do a deal with an MCI or an AT&T or a Sprint, then I have stronger brands to play with than the RBOCs do. And I got all the brands in entertainment, too. So that's my strategy. If I can go in with a package bundled with MCI or AT&T or Sprint, and then match that up with, say, an HBO in movies, and a PG&E in home energy management – I can save the homeowner probably enough money on his electric bill to pay for his cable service – if I can do that, then I've got a very powerful package.
That's the race, for bundled services to the home – branded bundled services. And if I can buy it wholesale and sell it retail – bundle it, package it, discount it – then I think I've got an enormous edge.
OK, now we come to the biggest question of all. You've got your RBOCs over in one corner of the ring, your long distance over in the other, and the cable operators running around the center of the ring attracting lightning from all sides. What I want to know is, who's building the damn information superhighway?
Us. We're the guys building it. We've got 35 percent of the country done right now. By the end of this year, we'll be 55 percent done. And by the end of '96, we'll be completely done in terms of fiber and coaxed deployment – the terrestrial network that is the superhighway.
With compression capable of carrying ...
Five hundred channels, interactivity. We'll be done except for the terminals.
You mean the set-top box?
The set-top and whatever we put at the central location to do the server activities, which we're testing with [Microsoft chair] Bill Gates.
And what about switching technology?
Well, for telephony, we're doing it now. Now if you're talking about switching multimedia traffic, high-data-rate traffic, that's ATM [Asynchronous Transfer Mode] switchers. It's a pretty well developed technology. We pretty much know how to do that.
So switching for true interactive, two-way multimedia communication is not a big technological hurdle?
No! The only big uncertainties in my opinion are the actual functioning and capacity of the servers and the costs of the in-the-home device – the set-top box. The terminal in the home is the one you gotta make millions off of, right? But we've got a gazillion vendors that are proposing those. As for the server – the device you're gonna need, one per city or one per metropolitan area – it has not been fully invented yet. We're talking about a system that is more complex than anything that's ever been designed, probably by close to an order of magnitude.
Than anything that's ever been designed?
Yeah. The combination of the operating system and how it interfaces with all the applications, the services running through it – yeah, you're talking about more instructions than any integrated system that's ever been designed for anything. I mean, shit. The whole system for the space program is small compared to this. The hardware's easy. It's the software that's tough, and it's important that it be open – that the protocols be open, the architecture be open and interactive – so that the whole industry will be able to develop applications right from the get-go. We've got four vendors basically – Gates, Silicon Graphics, Oracle, and IBM – that are all proposing server systems.
Gates, huh?
We're going initially with Bill, in terms of testing, but we're not committing to him on deployment. So far Bill's proposal is far and away the best from a financial perspective that we've seen.
And the concern from people like [former Silicon Graphics chairman] Jim Clark?
That he's locked out?
That doing a deal with Gates means he'll gain control. Lock you out or else lock everyone else out. That sort of thing.
[Laughs.] I see. The big concern is, Is Bill Gates a bigger monopolist than I am? And if I get together with him, is that going to be the worst thing that ever happened in history? Yeah, that is the concern that has been expressed to me by a lot of people in the software industry. Everybody in the business is warning us about how not to get suckered. To me, it really comes down to, if you decide to use Bill's stuff, what kind of a deal do you get? Our deal with Bill, the details of which we haven't disclosed publicly, is essentially that if we pick him we have a preset maximum price. It's nonexclusive, and he's free to market it to anybody else he wants. And we have a "most-favored nations" deal, which just basically says if he sells it to anybody else for less, then we get the lower price, too. Basically we spec it, he builds it, and then we use it if it's the best deal. If he doesn't give us the best deal we don't have to use it, and we get price protection and most favored rates, so it's very open. It's purely a vendor-customer relationship.
According to Clark, this time last year you almost struck a deal with SGI for servers, until Gates got wind of it and, in Clark's words, "raised his skirt" to you. What was the problem in your negotiations with SGI?
A house divided.
So Clark was saying yes, but [CEO Edward] McCracken was saying no?
[Shrugs.] We're still very interested in Silicon Graphics being involved. It's a wide-open field right now, and anybody with skills in this area is certainly invited to come in and demonstrate their wares. But what we want is the most cost-effective server structure, from a software and a hardware point of view, aimed at full deployment by '96.
So it's not the '80s anymore, and you're not IBM?
No. I think if Bill wins, he's gonna win because he's gonna have the best product.
Tell me about the set-top boxes.
Our deployment scheme is, if you're a customer and you want it, you're gonna incrementally finance it to put it in your home.
Do you have a ballpark estimate of that yet?
We're hoping that the cost to do everything, the whole megillah, you're looking at maybe 500 bucks a home. That's incremental. An addressable analog [set-top box] right now is 150 bucks. A digital box that does everything should be about 500 bucks.
Which will be amortized, right?
Yeah, we'd finance it. If we think it's got a life of five years, then it's a hundred bucks a year. We're talking about, what, seven bucks a month? And you're already paying us three or four bucks a month for the old box, so for this new device it's another three bucks a month. But now you can have an expansion of channels and movies-on-demand. You can have video telephony and multimedia services. You can have load control. You can play Sega games. You can have digital music. You can have high-definition TV. You can have wireless telephony in your home. So we're really not talking about back-breaking economics here. And when you pay that extra amount you're gonna get certain services free as part of that. You'll probably get a navigator for free. And I think we can easily finance it against the growth in the revenues. The servers – if Bill is right in his projections of capital costs – are not gonna be that burdensome. So I don't see any big impediments for us rolling this thing out and having a true, full-service network out there by the end of '96, available to most homes.
Once it's built, where will the big entrepreneurial opportunities be in the network?
In programming, a special kind of programming. It's got to really add value to all the content that'll be out there. It'll need strong branding. If you're talking about news, I as the subscriber have to ask, "Whose editorial services do I want?" I can't possibly stay informed of everything that I'm interested in, so why don't I subscribe to the Kline Editorial Service, and he'll ask me one time what I'm really interested in, and from that point on I'll have a customized information and news service that takes a half an hour a day, that hits and focuses on the things that I'm interested in, right? To me we're gonna go very much into a customized world. It's not one-size-fits-all. These technologies are gonna allow us to make TV very personal. That's the really tremendous area.
Individuality will be emphasized. That's what I mean by an electronic community. Your own perspectives, your own individuality, will be amplified by your ability to reach sources that are of interest to you.
And the whole interactive home shopping business is also going to be tremendous, explosive. That's why [General Magic's] "agent" thing is exactly right. You send your smart agent out to look for a stereo, and it'll research Consumer Reports, give you feedback, find the best deal.
You say you'll have the network installed by the end of '96? So you never really needed Bell Atlantic, did you?
No, only politically. We have enough internally generated capital to build it ourselves. All the deal did was commit us to a very accelerated capital deployment. I mean, year one in our draft contract they were kicking in an extra billion dollars to our capital program, so we were gonna take our capital program for '94 from $1.1 billion to $2.1 billion. Which really meant we were going to be able to move full deployment from '96 up to '95. We were looking at getting most of the terrestrial job done by the end of '95, which we were all quite excited about. So were the vendors. But that's not possible now. We're back on our original '96 deployment schedule. And I believe we're gonna get there.
God and the FCC willing.
Yeah, well if it helps, I'll make a commitment to [the vice president], OK? Listen Al, I know you haven't asked for it, but we'll make a commitment to complete the job by the end of '96. All we need is a little help . . . you know, shoot Hundt! Don't let him do any more damage, know what I'm saying?
For the record, maybe you should say you're kidding.
Not about getting the highway up by the end of '96.
