Greg Maffei - President and CEO
John Malone - Chairman
Mike George - CEO, QVC
Bob Clasen - Chairman and CEO,Starz
Chris Shean - Controller
Robert Peck - Bear Stearns
Bridget Wyshar - JP Morgan
Jessica Cohen - Merrill Lynch
Jason Bazinet - Citigroup
Benjamin Swinburne - MorganStanley
Jeff Shelton - Natexis
April Horace - Janco Partner
Doug Mitchelson - Deutsche Bank
Liberty Media Capital (LCAPA) Q3 2007 Earnings Call November 9, 2007 11:00 AM ET
Good day, everyone, and welcometo the Liberty Media Corporation Third Quarter Earnings Call. Today's call isbeing recorded. This presentation includes certain forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995,including statements about financial guidance, business strategies, marketpotential, future financial performance, new service and product launches, andother matters that are not historical facts. These forward-looking statementsinvolve many risks and uncertainties that could cause actual results to differmaterially from those expressed or implied by such statements, including,without limitation, possible changes in market acceptance of new products orservices, competitive issues, regulatory issues, and continued access tocapital or terms acceptable to Liberty Media.
These forward-looking statementsspeak only as of the date of this presentation and Liberty Media expresslydisclaims any obligation or undertaking to disseminate any updates or revisionsto any forward-looking statements contained herein to reflect any changes inLiberty Media's expectations with regard thereto to any change in events,conditions, or circumstances on which any such statement is based. Please referto the publicly filed documents of Liberty Media, including the most recentForms 10-Q and 10-K for additional information about Liberty Media and aboutthe risks and uncertainties related to Liberty Media's business, which mayeffect the statements made in this presentation.
On today's call, we will discusscertain non-GAAP financial measures. The required reconciliations primarilynotes and schedules 123 can be found at the end of this presentation. Nothingcontained herein shall constitute a solicitation to buy or an offer to sellshares of the reclassified Liberty Capital Stocks trading stock with LibertyEntertainment tracking stock. The offer and sale of Libertytracking stocks in the proposed reclassification will only be made pursuant to Liberty’s effective registration,state registration statement.
Liberty Stock holders and otherinvestors are urged to read the registration statement including the proxystatement, prospectus contained therein all by Liberty and the SEC because it contains thefull information about the transaction.
A copy of the registrationstatement and the proxy statements prospectus are available free of charge at theSEC’s website http://www.sec.gov.
At this time, for opening remarksand introductions, I would like to turn the call over to the President andChief Executive Officer, Greg Maffei. Please go ahead.
Hi, it’s Greg Maffei, goodmorning and thanks for joining us today. We remained busy in Q3 and we’ve hadseveral ups and downs over the past three months and I am looking forward tosharing them with you this morning.
Today, I am going to talk alittle bit about those recent events at Libertyand also discuss briefly the operating performance the assets and business hasattributed to the LINTB and LCAPB tracking stocks.
On the call today, we have ourChairman, John Malone; QVC's CEO Mike George and CFO Dan O'Connell; Starz’sChairman and CEO, Bob Clasen; President and COO Bill Myers; and EVP and CFO,Glen Curtis. And we also have several of my fellow senior Liberty Executives whowill also be available to answer questions after the prepared remarks portionof the call.
Our first speaker on the call isgoing to be our Controller at Liberty Chris Shean is going to describe LibertyInteractive's result and Liberty Capital's results and also the liquiditypicture of both of the attributed tracking stock. Then we will have QVC's CEOMike George talk about recent developments at QVC, followed by Starz CEO BobClasen talk about recent events at Starz.
But I am going to highlight a coupleof the other developments at the corporate level and some of you may rememberwe on October 23rd our shareholders approved the issuance of two new trackingstocks.
The first to be LibertyEntertainment has attributed assets that include our expected 40% stake inDirecTV, three regional sports networks those being in the Northwest, RockyMountain in Pittsburgh, Starz Entertainment, FUN Technologies are 53% of FUNTechnologies, our 50% interest in GSN formerly the Game Show Network, and ourapproximately 33% interest in WildBlue satellite company.
In addition the LibertyEntertainment tracker will have about 551 of attributed exchangeable debt andabout $1.87 billion of cash. So thinking about that new Liberty Entertainmentattributed equity I want to first highlight how pleased we are with theexcellent performance at DirecTV. They had a very strong quarter, growth addsup, churn down, net adds up, ARPU up. Clearly, the move to high-def and DVRs isrequiring capital, but it's paying off with high quality subs. And we expect atthe direct management team, that hardware costs are going to continue to fall,reducing the cost of upgrades and that they are working and will be successfulto reduce the cost of truckloads and installs.
The regional sports networks,they were also going to be receiving in the expected News Corp. deal are alsoperforming well. Good ratings of the (inaudible) performance and the Rockies performance. I think most importantly related tothese assets, we are looking forward to closing that deal and moving towardsthe next phase of Liberty Entertainment.
The new Liberty Capital will havethe remaining attributed assets, business and liabilities that were previouslyattributed to Liberty Capital, other than those that I just mentioned that arebeing attributed to Liberty Entertainment. These new trackers are expected tobe issued immediately after the completion of our exchange with News Corp.
Just to highlight again, thepurpose of these trackers is, first, to reduce complexity, particularly atLiberty Entertainment. To allow investors to further focus their capital in theequity that they find most attractive. To create a currency, particularlyLiberty Entertainment, for enhanced dimensional flexibility and to further concentrateour remaining non-core assets at the new Liberty Capital.
Couple of other highlights tonote during the quarter. Yesterday, at FUN Technologies we reached a definitiveagreement to acquire the outstanding 43%. That agreement was unanimously approvedby the independent directors.
Turning now to some of theoperations at Liberty Capital. Revenue growth at Starz and the ongoingreduction of programming costs led to very satisfying increases in OCF. We arevery pleased with that. We are also pleased with strong operating results inseveral of our other Liberty Capital affiliates, including the Braves.
At Liberty Interactive, just tohighlight first we are not yet planning any changes today in the LibertyInteractive tracking stock and they are not impacted. Liberty Interactive'stracking stock is not impacted by any of the creation of the two new trackingstocks at Liberty Capital.
On an operating basis, clearly,we are disappointed with the continued soft QVC. QVC US had weak performance across manyproduct categories in a difficult market. QVC International had goodperformance then UK,quite strong quarter. But, weaker performance in Germanyand Japan,which continue to encounter difficulties.
Mike George will talk about thosebusiness in far more detail in a moment. While we are disappointed with thoseoperations, we remained quite appreciative of the free cash flow generationcapabilities in that Q. During the quarter, driven primarily by that, werepurchased about $500 million of equity since Q2 ended at Liberty Interactive.
Today we estimate that excludingthe public stakes that are in Liberty Interactive and taking those stakes atmarket, Q is trading at above 8 times expected 2008 EBITDA and this doesn'ttake account of obviously its larger free cash flow generation capabilitieswhich are very positive, relative with EBITDA stream.
Since we issued those trackingstocks, the initial set back in May of '06, we bought back more than 14% of thecommon stock at Liberty Interactive. And recently our Board authorized apurchase of up to an additional $1 billion. We still have under 4 timesleverage on a net debt, both trailing and on pro forma at Liberty Interactive.So, we are enthused about the opportunity to potentially shrink more equity.
We also at Liberty Interactivehad saw the operating growth year-to-date at Provide, Backcountry andBUYSEASONS, our three e-commerce businesses.
And lastly to talk about adevelopment at Liberty Interactive, I think we are quite pleased with BarryDiller's plan split up of IEC. I think first that highlights the value of thecomponents there, which we don't think had been fully recognized in themarketplace, and I think it will allow us to begin a dialogue with IC about howwe are going to work together in the next phase of our relationship, not surewhere that's going to turn out, but expect it will be positive.
So, with those comments, let meturn it over to Chris to talk more about the operations.
Thanks, Greg. Let's start bytaking a look at Liberty Interactive. This quick snapshot of the third quarterrevenue and OCF performance, indicates that Liberty Interactive's attributedbusinesses continued at a slower pace of revenue growth and experienced adecline in operating cash flow during the third quarter.
QVC is the principal driverperformance among Liberty Interactive's attributed assets and its performancewas sluggish. This was primarily driven by the continuation of difficult marketconditions, challenging comparisons to last year's strong results from the sameperiod and continuing operational challenges at QVC's international businesses,most notably in Japan and Germany.I'll talk a bit more about this shortly.
Looking more closely at LibertyInteractive, overall, LINTA's businesses achieved 4% revenue growth andexperienced a 1% decline in operating cash flow. As I will discuss in a bitmore detail in a moment. The pace of revenue growth remains slow at QVC andoperating cash flow declined during the third quarter. Provide Commerce andBUYSEASONS which were acquired in 2006, experienced modest year-over-yearrevenue growth during the period had shown solid year-to-date revenue inoperating cash flow gains. Backcountry which was acquired in June and isincluded in the third quarter result, doubled it's revenue during the quarter,I guess as compared to it's pre-acquisition prior year quarter and hasexperienced strong year-to-date gains in revenue and operating cash flow.
As Greg mentioned earlier, wecontinue to repurchase Atlantashares during the quarter we bought back 14.9 million shares for $289 million.This coupled with our repurchases in October brings our total repurchases forthe year to more than 46 million shares and over $1 billion. Since inception ofthe Atlantashare repurchase program, we have now reacquired over 14% of the outstandingshares.
We continue to believe in sharerepurchase as a solid means of enhancing shareholder value and will continue toevaluate opportunity to cost effectively shrink Atlanta equity. To that end,our Board recently approved the repurchase of an additional $1 billion LibertyInteractive stock buyback announcement.
Taking a closer look at thequarterly performance of QVC. QVC experienced consolidated revenue growth of 2%to $1.69 billion during the quarter and 1% decline in the OCF to $364 million.Domestic revenue grew 2% in the second quarter to $1.17 billion. The slowergrowth reflects softness across most major product categories. Total unit shiftincreased 1% for the quarter to $28 million while the average selling pricegrew 1% to $45.89. Domestic OCF increased 2% for the quarter to $278 million,while the OCF margin was largely unchanged at 23.7%.
Dot-com sales continue to grow asa percentage of overall domestic sales, rising from 19% in the third quarterlast year to 21% this year. International revenue increased 2% to $512 millionfor the quarter, while OCF declined 8% to $86 million. The revenue growth wasdue to favorable foreign currency exchange rates in the UK and Germany, partially offset by loweraverage selling prices in all the QVC internationals markets. Operationalchallenges in Germany andthe ongoing affect of changes in the enforcement of Japan's regulation of the marketingof health and beauty aids in that country.
The operating cash flow decline,was due to lower gross margins that were the result of higher productdistribution costs and higher operating costs in the areas of commissions,customer service and SG&A expenses. Excluding the affect of exchange ratesinternational revenue declined 3%, while OCF declined 10%.
QVC Germany and Japan as expected continue toexperience challenges. The German business was affected by productivitychallenges across most categories. Those contributed to a modest decline in theASP, average selling price and a reduction in unit's shift that resulted in an11% local currency revenue decline. QVC Germany also experienced a lower grossmargin and higher operating cost percentage. Lower gross margin percentage wasdue to a lower initial product margin and higher product distribution costs.
QVC Japan experienced a 3.2%local currency revenue reduction as lower ASPs were partially offset by unitincreases. QVC Japan management continue to ship product away from the healthand beauty category to the apparel and accessories categories; home andjewelry, and experienced productivity gains in each of these categories towhich it receive ship the product.
On more positive note we continueto experience improved results in the UK where QVC produced 9.3% localcurrency revenue growth and even larger gains in operating cash flow.
Before I walk through the LibertyInteractive liquidity picture I am going to turn the call over to QVC'sPresident and CEO Mike George who will discuss QVCs operation in more detailand talk a bit about some of the new initiatives the company launched in thethird quarter. Mike?
Thanks Chris. As Chris mentionedI'll provide a little additional background on the Q3 result and then give youa brief update on some of the growth initiatives that we've been driving. Inthe USas Chris described we saw continuation of the soft business trend that began inlate April. With most merchandised categories underperforming our expectations.However, while the sales results were clearly sub par consistent with ourlong-term approach to the business, we avoided turning the pricing orpromotions to artificially inflate the top line. As a result we were able tokeep gross margin rates relatively flat for last year, contain expenses andgrow EBITDA consistent with sales. And even if this soft business trendcontinues we are committed to sustain out of the promotional fray in theholiday season and believe we can maintain stable gross margin rates in thisenvironment.
With the weak retail environmentin the USclearly impacting our result, we need to raise our game to outperform. We arefocused on that, we are focused on continuing to enhance our assortments andbrands, creating engaging programming and dot-com experiences, and mostimportantly, ensuring strong day-to-day execution of the business fundamentals.And of course, we will continue to focus on tight expense and inventorymanagement to avoid any significant fluctuations in our margin rates andprofitability.
Turning to Germany. The results were poor onboth the top-line and the bottom-line. Sales were hurt by our efforts to reducereliance on a small number of core brands that have been over rotated. And ASPsand margins were impacted by some markdowns we needed to take to clear upunderperforming inventory, especially in the apparel zone.
In Germany, as we have discussed onprior calls, we are focused on the fundamentals of cleaning up the inventory,diversifying the product and programming mix, we had been overly dependent on afew categories in the past, and moving our business away from promotional pricepoints. And we remain confident that we will make progress against those goalsover the next several months. However, as I mentioned in our last call, I don'twant to try to predict the timings of a turnaround until we know we can deliveron it. So, we'll stay focused on key milestones and just moving the businesstowards a healthier long-term model for the business.
The Japan story remains largely thesame as the last two quarters. We are focused on replacing the businesses thathave come under increased regulatory scrutiny. When I first shared theregulatory challenges with you in our Q1 call, I told you that I probably wouldanniversary of the issue by next March, which is when the regulatory impactfirst hit us. However, over the course of the summer, several additionalproducts came under regulatory scrutiny. As a result, we continue to withdrawfrom key product lines in our health and exercise categories over the course ofQ2 and Q3.
We believe that as of the end ofOctober, we have addressed all known regulatory issues. Although, we can't ruleout the possibility of further impacts down the road, but we don't think theyare likely.
As a result of these actions, wedid see continued sales erosion in both Q2 and in Q3, and again, we won't fullyanniversary the impact of having pulled out these products, until Q4 of '08. So,we do need to get past October to be completely anniversaried of all these knownimpacts.
Now having said that, I amactually encouraged by Japan.We are making more progress than we anticipated, growing our apparel,accessories, and jewelry lines at accelerated rates to compensate for thesignificant reduction in the help and exercise business.
So, those businesses are growingfaster. On the flip side, the regulatory challenges were even greater than weanticipated when we last talked. So, while we are not seeing it on the top-lineyet, we believe this business is fundamentally healthy and will show strongresults once we anniversary these regulatory issues.
Finally, as Chris mentioned, the UK wasa bright spot in the quarter with solid revenue growth and very strong EBITDAresults.
Looking forward, we will remainfocused on the core initiatives we have been discussing over the last year. Forexample, we will continue to add top-tier destination brands and innovative keyitems into our assortments. Our recent launches of Samsung, Garmin, Acer,Sharp, Oplus blackened in the UShome category, as one example, have exceeded our expectations.
As you know, we launched the newQVC logo and branding in late September to very good reviews and positivecustomer feedback. We believe this is a strong step forward in updating ourimage and broadening our appeal and we'll provide important benefits over thelong-term.
We have been migrating ourcustomers to the new QVC.com site over the course of October. We now have allcustomers on the new QVC.com and while there is always some short-term negativeimpact when you convert customers from a site that they new well to a new site,we are very excited about the new QVC.com. We think it provides a strongfoundation for future growth and we will be launching many new features earlynext year, and including more integrated video applications to continue tobring the value of our video skills to the internet.
Finally, we also announced thismorning that we will be simulcasting our US program in high definition by Q2of next year, and we are currently talking with all of our major distributionpartners about carrying a second QVC channel in the HD tier. Now, we believethis will broaden the range of customers we reach.
And with that, I'll hand it backto Chris.
Thanks Mike. Let's take a quicklook at the LINTA liquidity picture. We continue to maintain a strong capitalstructure with good liquidity the business has attributed to LibertyInteractive. Has attributed cash and public investments of $5.2 billion and has$7.1 billion in attributed debt. The increase in the debt balance during thequarter was primarily the result of ongoing Liberty Interactive sharerepurchases during the quarter.
Excluding the value of theinvestment positions in Expedia and IAC, Liberty Interactive's quarter endingattributed net debt of just under $6.4 billion equates to a multiple ofapproximately 3.7 times annual operating cash flow. As previously stated, we willbe comfortable sustaining net debt levels 4 to 5 times OCF. As a result theLiberty Interactive businesses had significant liquidity to grow organicallyand through acquisition and to continue to shrink net equity as appropriate.
Now lets move on to LibertyCapital businesses. As Greg mentioned earlier late last month we receivedshareholder approval to -- upon completion of the News Corp exchange toreclassify our Liberty Capital tracking stock in to two separate series oftracking stocks, one called Liberty Entertainment, the other Liberty Capital.We believe this will produce reduced complexity, greater focus of assets,stronger currencies for financial flexibility, an increased concentration ofour remaining non-core assets.
Overall during the quarterLiberty Capital reported a 52% revenue gain while OCF increased by robust 438%primarily as a result of some new businesses that we acquired. LCAPA's largestattributed operating assets Starz Entertainment which does not include StarzMedia is continuing to strengthen its cash flow. During the quarter its revenuegrew more than 11% to 282 million while it experience a 96% OCF growth to $88million. I'll take about this more shortly.
Now let's take a closer look atLiberty Capital events during the second quarter. As I mentioned LCAPA'sattributed revenue grew 52% in the quarter while OCF more than a tuple. Revenuegrowth resulted from strong revenue growth at Starz and the inclusion of StarzMedia and the Atlanta Braves partially offset by lower GAAP revenue at trueposition which has been required to differ revenue recognition until itsdelivered all the software features required pursuant to one of its majorcontract.
The sharp increase in OCF isprincipally driven by strong growth at Starz also and the inclusion again ofthe Braves offset by a decrease in OCF at true position and operating cash flowdeficit at Starz’s Media.
As we continued our efforts tocomplete the News Corp exchange during the quarter, we do not use any of thesignificant capital resources attributed to Liberty Capital to repurchase itscommon stock.
Since the issuance of the LCAPAattractive stock we have repurchased approximately 8.2% of the LCAPA sharesoutstanding. We continue to hold large cash reserves attributed to LCAPA and afinal issuance of the new tracking stocks will continue to evaluate sharerepurchases as a means of enhancing shareholder value as our liquidity positionwarrants.
As I mentioned a moment ago, wecontinue to work on the completion of the News Corp exchange and hope to closethat transaction during the fourth quarter. We are also evaluating numerousother transactions and report on those as they arise.
Now let’s take a quick look atStarz. Starz continued to experience solid subscriber growth in the firstquarter, as Starz average subs increased 7% while Encore's grew 9%. For thequarter, this subscriber growth along with a higher effective rate due to theretroactive recognition of revenue related to the short-term expense of ourDirecTV contract combined to drive an 11% overall revenue growth.
We had a couple of revenue growthmitigating items during the quarter including changes in the rate at whichcertain customers are paying under expired contracts that are under negotiationfor renewal, and the shift of former Adelphia subscribers to the lower rateComcast and Time Warner contracts.
Starz’s operating expensesdeclined 7% from the quarter largely as the result of a decline in programmingexpense and the reversal on the accrual for moving copy right fees. Thereduction in programming cost resulted from lower effective rates for the movieshown in the quarter partially offset by increased costs from a higher ratio offirst-run movie exhibitions versus library product expenses. Starz's SG&Aexpense was largely unchanged for the quarter.
Now, we've going to have BobClasen to say a few words about Starz Entertainment and Starz Media.
Thanks, Chris. Once again, we arepleased to report that subscriptions to Starz and Encore continue to grow inthe fourth quarter, for the third quarter for the fourth quarter in a rowreaching 16 million for Stars and seeing Encore past 13 million homes. Thesegains coupled with higher effective rates and a continued decline inprogramming costs serve to drive significant operating cash flow gains.
However, we have several expiredaffiliate agreements, the completion of negotiations of new mutually beneficialcarriage agreements that will allow our business to continue to grow, remain atop year jump priority. I am also pleased to report that we are nearing thelaunch of the first original series ever shown on the Starz channels. These twohalf hour comedies at Kayson Hollywood residential will begin airing inJanuary, so be sure to tune in.
Starz Media revenue increasedagain this quarter versus the same quarter a year ago. The company has beganproduction on eight live action made for TV movies and four television seriesfor first-run on basic cable programming networks and it continues to doanimation works for the Simpson's and King of the Hill.
During the quarter, our TorontoAnimation Studio began work for hire on two major CG theatrical films aftercompleting the VeggieTales pirate movie that Universal will release in thefirst quarter of 2008.
Our Overture Films unit continuesto add to its slate with the acquisition of the Visitor, winner at the Rome FilmFestival and announced that it's first film Mad Money staring Queen Latifa,Katie Holmes and Diane Keaton, will premiere in theatres nationwide on January18th. I'd be remiss not to make a quick statement on the writers strike. Asmost of you know the Writers Guild of America initiated a work stoppage thispast weekend. Our current movies and series are fully scripted and either inproduction or set for production, so for the near-term its business as usual atStarz. Should the work stoppage be protracted, we will make adjustments asnecessary, but the impact, certainly on the fourth quarter appears to beminimal.
Now, I'll turn it back over toChris.
Thanks Bob. Taking a quick lookat Liberty Capital's liquidity situation. The LCAPA business has remained in aposition of financial strength. At quarter end, and including our News Corp.stake, LCAPA was attributed with approximately $16.9 billion of publicinvestments and derivatives. This is largely unchanged from the second quarter.
In addition to our publicholding, Liberty Capital has attributed cash and liquid investments of justover $2.7 billion at quarter end. Total cash and public holdings approximate$19.6 billion and are only partially offset by $5.3 billion base amount ofattributed debt. This provides Liberty Capital with significant flexibility togrow its businesses and will play an important role in the strategic directionof these assets going forward.
Now, with all that said I'll turnthe call back over to Greg, who's going to quickly recap the third quarter andtalk about what's ahead for us in the remainder of the year.
So, thanks Chris and thank you,Mike and Bob for the updates on your businesses. So, as you can see it wasanother busy quarter. At Liberty Capital, we had strong operating performancein Starz and most of the other affiliates. We talked about the approvalreceived for the issuance of our new trackers, and we are working to close thenews exchange agreement.
At Liberty Interactive, we weredisappointed with the growth. We believe management has got a firm handle on itand we remain optimistic about the long-term performance of the business. Andwe were fairly pleased with the performance of other internet affiliates. Andas you know, we continue to buyback stock, having brought back almost or morethan 14% of the stock since we issued this trackers.
Looking ahead, I think as youknow we are first going to move to close that news deal. We are going to lookto issue those trackers and we are not continuing to think about ways tooptimize our non-strategic assets over the Liberty Capital. And put togethersynergistic operating businesses at Liberty Interactive and LibertyEntertainment. Create as much financial flexibility as possible to think aboutconsolidating various assets, and above all, focus on trying to growshareholder value.
So with that let me turn it overto the operator and open it for questions.
Absolutely. (OperatorInstructions). And we'll go first to Robert Peck with Bear Stearns.
Robert Peck - Bear Stearns
Hi I have two quick questions.The first, Greg, is for you. Could you give us little more color around the IACspend and what the implications are for Liberty.Are there any sort of tax implication that was going to stop any deal beingdone for a swap for HSN? And could you also talk about how your voting rightswould be applied to be various businesses? Then I have a follow up for Mike.
Thank you Robert. I think to alarge degree many of the answer to those questions are all no. I don't believethere are any tax implications from the spin itself. A question of how weredeemed or traded our stock for positions in one or the other of operatingbusinesses including potentially HSN, it could be more attractive. We can'treally do that before a spin. You can come up lots of scenarios. But, we knowwe played our hand and had our dialog with Barry about potential transactionsprior to the spin and haven't reached provision. So, we'll continue that dialogheading into the spin and see where we end up.
As far as where our super votegoes and where Barry's proxy goes, it's complicated. It's somewhat related towhere Barry is still CEO and what we negotiate with him. So, I have to tell youthat I think we are going to a negotiation phase, and where we come at theother side, I can't predict which businesses will be ultimately owned,consolidated, held at all by Liberty or frankly by CREs.
So, I think the fact that it'shappening will create opportunities, but I don't know exactly where they aregoing to go in from the relationship. Mostly, I think it's going to show andcontinue to increase the value at IAC and that's a positive for us. John, youwant to add anything on that.
No, I think it's terrific for us.Each one of these businesses will now have clear dependant management for themost part and whether we increase, decrease or what relationship Liberty has with each oneof these units will be determined, I would guess, over the next six months.But, I think it represents great opportunity for Liberty and frankly for IAC shareholdersgenerally to focus their investment and their interests in the areas that theythink closer than the most. It also creates the possibility of capitalstructures in each one of these businesses to take advantage of theirparticular cash flow and tax faster.
So, I think it goes a long waytowards resolving much long time than the mild disagreement between Mr. Diller andmyself about the appropriate use of leverage in each of these businesses.
Some of these clearly will havesuperior economic returns based upon leveraged balance sheet.
Robert Peck - Bear Stearns
Okay, great. So just to be clearthan post spin with HSM, with any HSM deal therefore then be taxable?
Well, I don't think so. Other wayto look at it would be to say that there would be more trust issues related toa change in either involving or equity ownership in excess of 50% from theexisting shareholder group, since we already have 56% I believe as above.
Take it now 58 but it issomething like that, yes.
We can't violate more stress bychanging our voting relationship. We might be to some degree limited for someperiod of time and how much of the equity we could own in a cash transaction,but who knows that it depends on the capital structure with which this businessis ultimately expand.
Robert Peck - Bear Stearns
Shifting gears for Mike then,Mike in HSN actually had a pretty good quarter up about 5% or so, could youtalk a little about the differences that QVC is seeing and do you think you canstart from emulating sum of that growth rate you are sensing?
Compare with HSN I asked, wedon't know any more details than you all know in terms of what’s behind that.We also had a very strong record of growth for number of years and we had avery different place in terms of our profitability rate which is roughly fourtimes HSN. So have chosen our path that we think is the most positive for theshareholders which is to maintain ourmargins and avoid heavy promotional activity is attraction of HSNs and we thinkthat’s best for the long-term.
When you are in a period of copythe number of year's of high growth and in a period where there is someskittishness in the economy and in retail spend as we saw with yesterdaysannouncements. Yes, it will have an impact on us. We haven't been able to riseabove it, so we are just going to stay focused on our business. We think thereare enormous growth opportunities we have in front of us in terms of productcategories and then in terms of great day-to-day executions. So we rip apartthe business everyday. We try to find ways to create more exciting experiencesfor the customer, bring in new brands. We think that's right for the long-term,but when the business is fundamentally healthy we don' think we need to go tothe pricing lever, we'd rather just keep working on as a fundamentals ofexciting that core customer with great product. And I think we will over thelong run we are very comfortable that that will get us to growth that we need.
Yeah. Robert, I'd like to -- thisis Greg. I'd like to comment on the some of the premises of the questionfrankly, because if you are -- and look we are big shareholder and I see I hopethey could see it very well but the comparison of somebody who has had veryweak comps for long period, invested heavily in a lot of promotional items, ina lot of promotional inventory and then when that bar is lower enough hurdlesover it at least only in the revenue line but doesn't reach at anywhere nearlyon the profitability or free cash flow line it’s a little bit of an unfaircomparison to say wow homerun. So I think we would be very happy and are veryhappy with the relative long-term performance and continued cash flowgeneration capabilities at Q relative to H.
Robert Peck - Bear Stearns
And we'll go to Imran Khan withJP Morgan.
Bridget Wyshar - JP Morgan
Hi this is Bridget Wyshar in for Imran. Quick question aboutdomestic QVC, given that weaken retail environment and your non-promotionalstands have you seen any changes in your inventory levels there?
Yeah, Bridget I think we havebeen actually very pleased with our ability to manage our inventories. We arealways challenging when the sales come in below your expectations but we havebeen able to keep inventory on plan and for the most part we feel verycomfortable with [Technical Difficulty] inventories.
Bridget Wyshar - JP Morgan
Great. And then a question on Japan.Can you give us any insight into how much of the business is now underregulatory environment in terms of product percentage?
Yeah. Clearly the biggest impactis in the health category. Health category we will give feel for that. If youlook at that combined, the combined health category fell from about 21% of ourbusiness a year ago to a little less than 9% this year. So what was, you know,not quite a quarter of the business that is reduced to less than half of itscurrent size. There are some impacts in a few of the home categories, primarilyin the exercise fitness area. And so that's having an impact, but it's asmaller impact.
Again, as I mentioned earlier,what's encouraging to us is we had 20%, 30%, 40% kinds of growth rates inapparel, accessories and jewelry, although it's a more airtime. So we feel goodthat those businesses are growing, but we've got about a quarter of thebusiness that really is in a very challenged state.
Bridget Wyshar - JP Morgan
Great. Thanks a lot.
And we'll next go to JessicaCohen of Merrill Lynch
Jessica Cohen - Merrill Lynch
Thanks and also QVC relatedquestion. I was just wondering back to HSN, if you could be more specific on thepros and cons of combining with HSN from both a revenue and a cost perspective,because we've heard previous QVC management have -- we've heard many viewsexpressed on that? And then, also could you comment on how much jewelry is ofthe business right now and the impact with gold prices increasing?
Sure. On jewelry, of course, thejewelry is about a quarter of our business in the US. As we've mentioned on priorcalls, the gold component of that business has continued to struggle. Andunfortunately, we thought we might see some stabilization, but obviously, goldhas reaccelerated and we don't see any end in sight.
So our gold business is innegative territory, and gold is roughly a quarter to a third of the totaljewelry business. There are other parts of jewelry that are doing reasonablywell, gemstone business is particular strong. So, while gold is a bit of ananchor in the business, the rate of decline has probably slowed and there areother things working in jewelry, so that we think over the long-term we canmanage around that issue.
On HSN, I guess I'll make acouple of comments, and then Greg wants to add to it. What we've said in thepast on HSN is, at the right value, we certainly think there is some benefit toownership of the two companies, but we don't think the hard synergies aresignificant. By hard synergies I mean clear cost takeout. So you'd have to runto largely independent businesses and the real costs are around the product andthe operation of the channel.
So I think you'd see fairlymodest hard synergies and wildcard or kind of the softer benefits of being ableto perhaps counter program the two channels, leverage, share vendors in theright way, or other approaches to sort of present a more unified phase to thecustomer. But those are fairly untested. So you certainly wouldn't want to paya premium to get those benefits. So at some costs, we think there is value inHSN. But the hard synergies are just not that significant.
And our next question will comefrom Jason Bazinet with Citigroup.
Jason Bazinet - Citigroup
Thanks. Two quick questions. Canyou just go back to the stated objectives with the new trackers of LibertyCapital? I'm still sort of hung up on this 551 exchangeable over at LibertyEntertainment, because it seems like there is a risk that it reduces the amountof Holco discount that will be reduced by sort of muddying up the story a bit.And so my question is, is that designed to give you the flexibility to convert toan asset-backed security at some point in the future? In other words, is thatwhy you put that there at all?
And then my second question on Qand H, do you think there is an opportunity to sort of -- if you get control ofthe asset to go after a very different demographic at H as opposed to sort ofgoing after the same demo, which I think you are broadly today? Thanks.
Well, Jason, I'll kind of thefirst one, and then let Mike handle the second. Obviously, we hope not to muddythe water, and given the amount of cash that we sent over with theexchangeable, I don't think that is an issue. There were some, I would say,relatively tax motivated reasons we thought that it would be better to leavethe exchangeable within or rather put it in the new tracker.
I would actually say it'sprobably the reverse of what you're suggesting in terms of a hard spin, becausewhile one doesn't know exactly how our hard spin would work if one did a hardspin, that 551 via comp exchangeable is an obligation of the parent, whichreally is old Liberty Capital and would likely either need to be transferred orattributed back or paid off depending on whatever set of circumstances you canimagine. So Liberty Entertainment is unlikely, if it ever were hard spun, everend up with that debt per se.
Jason Bazinet - Citigroup
So I don't think that's themotivation. Hopefully, we'll be able to walk through and explain in claritywhat the balance sheet of Liberty Entertainment, which is very underleveraged,theoretically, it looks like, given its got net cash of about almost $600million, $550 million, hopefully, we would be able to walk through and explainthat. Mike, you want to address the second?
Sure. That is a kind of a generalstatement. We've found that it's hard to be too targeted or too narrow in thedemographic reach that we go after and get the kind of revenue level that youneed to support a national channel. Our approach has always been to try toappeal to the broadest range of demographics that we can. And we do find evenwith in Q that the demographics for Bare Essentials beauty hour is wildlydifferent as you might expect than a NASCAR hour to pick two extremes.
So, typically the way ourbusiness works, and I suspect H is the same way, it needed diversity ofprogramming that appeals to a broad range of demographics. And then thedemographics vary a lot throughout the course of the day or week or month. Thatsaid, there is some opportunity to more sharply differentiate the two formatson some dimensions. There might be, I can't honestly say that I have studied itcarefully to give you a really thoughtful response. So, there certainly maybesome targeting opportunity. But as a general statement, you typically need toreach for fairly broad audience to drive the kind of revenue we need to makethe format work.
Jason Bazinet - Citigroup
That's great. Thank you verymuch.
And we will go to BenjaminSwinburne with Morgan Stanley.
Benjamin Swinburne - Morgan Stanley
Hey, guys, its Ben Swinburne. Howare you?
Benjamin Swinburne - MorganStanley
Hey. Couple of questions. Greg,you made a comment upfront. I just wanted a get a clarification on the LCAPA,you didn't buyback stock in LCAPA during the quarter. Was that due to arestriction? Or just by choice?
And then on the QVC business,Mike you talked about at the Analyst day or Investor Day about new markets. Anychange or update there based on the performances in Germanyand Japanon sort of where you are focused and what the timing might be?
And then maybe lastly for Johnand Greg, you guys could give us your completely unbiased view of the cable andsatellite results this quarter, I would appreciate it.
Why don't we do the Q first, thenI will go right into the LCAPA and SAT versus cable. Do you want to talk aboutQ international markets Mike?
Thanks Ben. No new news oninternational expansion. As we did talked at Investors Day we remain interestedand are in active, I would characterize it as active discussions with potentialpartners in a few different markets. And as I mentioned, there is nothingimminent on the horizon. And to the point you called out, Ben, we would becautious about taking on another market until we are confident that not only dowe have the right opportunity, but we have the management depth to take it on.
Clearly, David Fry and ourinternational leadership team are very focused on addressing the issues in Germany and Japan. We want that to be thereoverwhelming focus and we don't want to create a lot of distraction by tryingto start another market. But having said that, we are in active discussions,and if the right opportunity presented itself to us and we were confident thatwas a good long-term opportunity, we would go after it. But, we will do it in ameasured way and make sure that it doesn't distract from driving the kind ofresults we need to see in the three existing markets.
So, Ben, on the stock question. Idon't think we call out what did or didn't usually did it, or drove rather ourpurchase or lack of purchase decisions.
I think we've been relativelyconsistent in saying Liberty Interactive has an enormous free cash flowgenerating assets in QVC. So, one would expect, all things being equal,systematic shrink is the most logical way for us to do that. To the degree wedon't have opportunity that we see to add synergistic e-commerce and brandassets and brand businesses, which we've done some of, but typically we can'tconsume all that free cash flow. It's likely that we will continue torepurchase stock, and given especially, under leveraged really above, the factthat we are sub 4 and we believe four to five is achievable on a net debt basisand manageable. It's likely we'll continue to shrink systematically to get tothat target and take advantage of that free cash flow.
Alright. Now at LCAPA we havedone one big shrink in the form of a self tender, but our progress there hasbeen what we call episodic. Meaning, if there is a transaction which generatescapital and frankly in 2006 and in 2007 we had several of those including, theTime Warner exchange, the sale On Command, the sale of Court, we'll considercash flow utilized or utilized in a cash rather from those transactions thenrepurchasing stocks, but there is no sort of episodic or rather there is nocontinuing shrink there. And frankly, there was nothing in the quarter that wedid which generated significant cash at Liberty Capital. There was the freecash flow generation at Starz, but it is relative to the scale of what Q doesand relative to the scale of Liberty Capital it's not the same.
So, that's where the logic andmentality of it. And frankly, until we know where we end post the subsequenttrackers or new trackers, we are going to probably watch and see how thosetrade and we are going to watch and see the free cash flow generationcapability that Direct has what our access to that capital is and how weutilize that probably before we make any dramatic moves.
As far as the progress ofsatellite versus cable, I think we are very gratified on several levels. Webelieved when we were looking at becoming shareholders in DirecTV that themarket probably had overreacted to the power of the bundle that mentioned what clearlybundle has positives but much of what it could do and how it would hurtDirecTV, with already being absorbed and DirecTV had ways to go directly tocustomers and create bundles with telcos that will provide an effective meansto get into customers.
And offsetting that we saw and weendorsed what management was doing with it's focus on HD. It's focused on goingfor the best customers in the marketplace for video or in the DVR segment aswell. And it's focused on the TV experience and content. And I think we aregratified that they have executed very well in that plan. They continue to showupside and they appeared to have run rooms, satellite appears to have run roomin the marketplace.
We believe that competing on thatdifferentiated experience; better video, more choice in video, more choice incontent, a great TV experience. All of those are very attractive and they'regoing to give us some run room here. Will it be forever? Who knows, but I thinksatellite has got several more quarters of good growth relative to the cablechoices and we are gratified that it's working that way. John do you want to adanything?
Yeah. I mean, just looking atquarterly results, the cable guys are still eating into the telcos and datatelephony. The video side seems to be favoring satellite at the moment. I thinkprimarily driven by more choice in high definition which is clearly an edge atthe moment in virtually all markets, so DirecTV over any of its competitors andI think also Direct has done an excellent job of differentiating itself in thesports. So now if they have high-def sports but have -- they can -- itsactually the high end, it's at the high road in differentiated sports, sowhether its investment in Sunday ticket or what they do on NASCAR in terms ofmultiple channels, when the races are on. They have done an excellent job ofexploiting differentiated content, Hi-Fi definition that’s given the publicrather accelerating take up of high definition now on a larger screen itspretty clear. I use the analogy the other way, I have got a treadmill and mywife brought me a large screen TV that's three feet away from the treadmill andDirecTV which we have at home is currently offering most of their high-defchannels back-to-back with their standard definition channels, so you can byclicking back and forward you can see the football game in high-def fromstandard def and its dramatic to the point where, if I could only watch atstandard def I probably would be very unhappy and thus seek an alternatesupplier. And I think that that is starting to impact the high end of themarketplace in favor of DirecTV and as Greg says, it's hard to project how longit will take cable to be able to come up with something equivalent.
But I don't believe that switchdigital which is essentially the technological solutions that the cableindustry is hanging their hat on will be adequate to close the gap andcertainly not adequate on ubiquitous spaces. So that these opportunities todifferentiate on high def wire power will persist for an extended period oftime and at least part of the country and it's satellite will be able toexploit that and simply DirecTV.
So obviously, we are thrilledwith current results and we think that they press which is pretty strong potentialin the exploitation of video. I wouldn’t try for the cable, I mean they aredoing extremely well, with higher margin of products that they are eating intothe telcos.
And going forward, I guess going back, we had a period wherewe see cable had a big advantage because of bundle and they do. They, as Johnnotes are generating lots of RGUs even at a perhaps with slow rate versustelcos, but they generate a lot of RGUs and taking telco share. During thattime people were quite negative about DirecTV, many people and we saw andfrankly followed what the management team there did. We are not going to claimcredit, but we saw they were doing endorsers of it in terms of their bet on thevideo capabilities and the video experience, and we see that paying off. AsJohn notes, how long that will go on, this is the constant game of innovation,and the key is to find niches where you can be the leader and be providing adifferentiated experience. And we think Direct's got lots of room to do that.For now in HD, and I think down the road, in content and the TV experience,what they have planned could be very interesting and very powerful.
The last thing I'd note is the opportunity created by havinga national business, the one offset that we appreciate. And I think if theDirect team, it's management team is smarter, we can help is way to think aboutexploring the fact that we have national business. The guys who are hurryingthe most are the ones who ended buyer from the strongest telco product and wherethe telcos have been strong, and obviously, particularly where they have files,that is a tough product to compete against, particularly given the amount ofmarketing and dollars that is being invested by the telcos. And we're lucky tohave a balanced business that can absorb, a), one of the areas where we werestrongest, DirecTV; b) we have an ability to grow another market.
I think I would add to what Greg is saying about ubiquity.When you have a national business, your services are ubiquitously available. Itgives you enormous opportunities in content that frankly TCI and cable neverhad because of the vulcanization of the cable footprint. So that is a veryimportant ingredient long-term that favors the satellite footprint over thecable footprint; i.e. the ability to make a decision on content and have thatcontent available ubiquitously across the whole country.
A cable operator, even one as big as Brian, I think youknow, is still limited to a footprint that may be 35% of the country. And then,only if all of these facilities are equally capable of adding an incrementalservice as DirecTV, if they have room to add an incremental service, itautomatically is incrementally available on a national scale. This is a hugeadvantage for satellite over cable. And really when I've been on the other sideof the equation, I used to worry about that a great deal.
Cable has lots of advantages by being regional, and they aredoing quite well. And the best case for everybody would probably be if peoplegravitate towards their respective strengths and to some degree that'shappening. We'll see how it plays.
Benjamin Swinburne - Morgan Stanley
And we will move next to Jeff Shelton with Natexis.
Jeff Shelton - Natexis
Thanks. Just one quick IAC follow-up question. At this pointdo you guys have any hard blocking rights over the ultimate IAC spin-offstructure?
That's a legal question.
Yeah. I think we would argue that there are restrictions onwhat IAC can do and not do, but we'll have some of that dialogue with IAC.
But as announced, the answer is yes.
Jeff Shelton -Natexis
Does there need to be another Board vote or not?
Yeah. There will have to be many Board deliberations at IACbefore the actual spin-off can be implemented, and it will have to be aresolution of these open issues relative to the relationship between Barry and Liberty.
Jeff Shelton -Natexis
Maybe two more questions.
Okay. We'll go to April Horace with Janco Partner.
April Horace - JancoPartner
Hi. Thanks. Quick question on QVC. I was wondering are youguys exploring, moving to more of an interactive platform, similar to what HSNdid with Dish, and do you think that would add incrementally to the revenuestreams?
April, we do explore it. We had tested interactiveapplications a few years ago, and didn't see a lot of benefit at that time. Asyou may know, we have an interactive application in the UK, which we've had for over fiveyears. So we can't pioneer that concept in our UK business. And so I think we knowa fair amount about it from our learning's in the UK.
At a high level, we don't see it being much of a revenuedriver. And certainly, our five years of experience in the UK as well as our testing that we did in the US, inneither of those experiences do we feel that it materially added to revenue.But it can save some expenses, depending on whether people use that applicationversus a live operator or an automated voice response unit or the internet. Sodepending on what ordering mechanism it substitutes for, there can be a modestcost saving.
So we remain interested in it, and as the technologiesmature and as it becomes an easier experience for customers, I think it'sprobably likely that we will adopt interactive application. For us, the upsideis to look down the road and to see whether beyond just simplifying newordering mechanism, there are really value-added applications that create asuperior experience for the customer, and I don't think that technology isquite there yet. But it will probably come.
We're going to be testing a number of really interestingapplications in our UKbusiness next year on this platform. That will basically give the customer achoice of watching the live show, or watching a video-on-demand channel, orwatching shows that had aired earlier in the day, so that it gives the customermore choice and control over what she is watching on TV.
So, obviously that platform is different in the UK than what we have in the US market. So, long we are saying,we think it's interesting, we know quite a bit about it. At the right time inthe USwe'll probably do something. Do we see it as being a significant revenue adder?Maybe in the long-term if some of these value-added applications are merged.So, not yet, but potentially down the road.
I think one of the most interesting potential applications,as you know DVRs are exploding in terms of take up rate. The ability to pushvideo into the DVR and make it randomly accessible by the consumer could wellbe the application that ultimately benefits QVC in terms of broadening itsaudience and giving better access to selected products or something of that nature.
So, I have longed been proponent of interactive television.If the opportunities are still there the technology has not quite matured onthe video side, the way it has on the Internet side, when it finally does, Ithink the ability to sell products to mass audiences on an impulse basis willturn out to be huge. The only place that we've ever seen it demonstrated arewhat you call per inquiry type adds, which is actually a pretty big industry bythe way of somewhat [sloppy] products and still generating some huge amount ofrevenue both for network owners, as well as for proprietors. And that's sort ofa demonstration of the fire power if you can put an offer in front of the largeaudience. And the opportunity to do that which may not be QVC's specific asmuch as it is a benefit say to do DirecTV eventually or anybody who can networkand preload make video-on-demand a reality on a real-time basis and then crosspromote it. I think it still remains unexploited, but very large opportunity.
Great. Last question please.
And your last question will come from Doug Mitchelson withDeutsche Bank
Doug Mitchelson -Deutsche Bank
Yes, good morning. I wanted to know, if you could talk alittle bit more about Starz Media. How big the feature film slate is going tobe, the impact on OpEx and synergies other parts of Liberty?
Hey, Bob do you want to comment?
Sure. Overture Films is looking at 40 titles, a whole slateof films over the next five years, so eight to 10 each year. They've alreadyannounced the first eight films and we would expect that there will be aboutseven or eight released in 2008. And again, these films are typically in anegative cost range anywhere from $5 million to north of $50 million. Although,our focus is acquiring only US rights. And so as we've reported we are lookingto have an average acquisition price or production price of only about $15million. We are actually thrilled with their initial slate that includesRighteous Kill with Al Pacino and DeNiro, very highly anticipated, and justwrapped. We are just finishing an Emma Thompson, Dustin Hoffman film in London,and of course, the Mad Money story is almost everywhere from People Magazine toOprah. So, there is an awful lot of excitement about that that will be releasedin January.
Our view of this, of course, as we have said before, is thatStarz Entertainment acquires about a 110 new output titles each year to fuelour viewer ship on the Starz channels. And that buying eight or 10 of those ayear from ourselves and our affiliate companies seem to make a lot of sense,and we think there are other synergies to our home entertainment businessthrough Anchor Bay, that will distributing these domestically as they come tothat market, also digitally.
We have a company now that division within Starz Media thatsells to everyone from Netflix to AOL to Amazon and we will be very active,moving product to the new digital technology, so they become available. So, wethink it works very well on an integrated basis, and will give us very highquality films to anchor our entertainment channels. And then of course go intoour library after they have gone through their broadcast window and so on andthey will be available for us over the next 10, 15, 20 years.
Doug Mitchelson -Deutsche Bank
Do your current suppliers feel any kind of competitivepressure from you at all?
Well, that's a great question. Iremember for the first time meeting, with Universal a few years ago, and theyactually took the other position at Universal and I think that Sony. We thinkdifferently, if you also produce product as opposed to just being a passivedistributor, and our relationships, I think, with most of our major studiopartners, and the Disney lawsuit aside, are very positive and there are anumber of studios who are concerned, obviously, about status of their pay TVdeals. And we have become over the last few year the largest acquirer ofindependent films because of all the channels we have to fill for the premiumspace and are looking to actually acquire even more rights for those for yourhome video and even for domestic television which will give us another spinanchored by our ability to put them on a pay television service. And I thinkthat we are exploring with the number of the other studios, things that wemight do together on a production basis that would give them some access toStarz pay business but also give us an opportunity to leverage their tremendousproduction capacity and creative environments. So, I think the synergies arekind of popping out all over the place frankly.
Well I think Overture and StarzMedia open up a whole bunch of options. Bob has noted that I think we are justbeginning to explore hopefully over the next couple of years we really be ableto take advantage of.
Doug Mitchelson -Deutsche Bank
Hey. Great thank you.
Thank you, operator and everybodywho listened in and asked questions and we look forward to talking to you atthe end of Q4, if not before.
And that does conclude today'spresentation. Thank you for your participation and have a great day.