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Paul Kagan

Paul Kagan

Interview Date: Wednesday August 04, 1999
Collection: Hauser Collection

KELLER: This is the oral history of Paul F. Kagan, President of Paul Kagan Associates, the real cable guru, the financial analyst that most Wall Street firms and most banks rely upon for information on cable television and he has chronicled the financial history of cable television since 1969. In addition to many other things, Paul is a director of The National Cable Center and Museum, a member of the New York Society of Security Analysts and a fellow of the Association for Investment Management and Research. The commercial is that this oral history is made possible by a grant from Gustave Hauser Foundation as part of the oral history program of The National Cable Center and Museum. Paul, to start with, gives us a little thumbnail sketch of your background prior to getting into the industry.

KAGAN: Well, I was in the newspaper and radio business in upstate New York and Pennsylvania. I started out as a sports writer and sports announcer and radio salesman. I then migrated back to New York City, where I was born, and after having called play by play for the Yankee farm team in Binghamton, New York, which was one of my early dreams, I decided I was not going to be Mel Allen or Curt Gowdy, who were my radio heroes. So, I went back to New York and went to work for CBS. I was also a freelance sports writer for the National Observer and I covered some pretty interesting stories, like Bill Bradley playing for Princeton in the Holiday Festival in New York in l964 when he scored 41 points and the team lost because everybody else only scored about 37. They wouldn't let reporters in the locker room to interview the players because they were so broken up over the loss. But then I remember transiting from sports into the business world because I was working for CBS Radio in publicity and getting very interested in business. After being with CBS and RKO General when they had the first progressive rock station in the world, during the flower child year in 1967, I decided I wanted to specialize in business. I had a concept for concentration on the financial side of the media, which I thought, was very undeserved at that point. So I got a job with E.F. Hutton as an analyst specializing in broadcasting. That was 1968, the year the cable industry had its first public offerings.

KELLER: Specifically, you went for the cable analysis. Why that, was it because it was there and no one else was doing it?

KAGAN: Well, in the beginning there was the heaven, the earth and distant signals. When I first started reading about cable in Broadcasting Magazine back in 1966, it was relegated to little articles way in the back of the book. They would write about Jerrold equipment being sold. I realized there were about 4 million cable subscribers in those days. I knew what the population was; about 70 million households, and only 4 million had cable. Some cities had 1-3 channels. I lived in New York, which had 7 channels, and I knew people who had cable who had 12. And so, I recognized there was something wrong with that system. The FCC had not licensed enough stations to satisfy everybody.

KELLER: That was also at the time of the freeze, wasn't it?

KAGAN: Oh yes. There was a freeze on cable in big cities. It was all economic interests, visited interests, that were lobbying the government to keep a limited number of channels so they could start a commercial broadcasting business and make it successful and make a lot of money.

KELLER: Primarily broadcasters?

KAGAN: TV station licensees, yes. And it was a perfectly good thing to do at the beginning because you wanted to be sure that they did have a head start. It's always been the nature of things to give somebody a head start to be sure that there is a platform on which to build, but what happened with cable, it came along several years after the first stations began transmitting, to bring those stations to people who had none. I often think of Moses coming down from the mountain with the tablets. In those days he was able to broadcast to the whole community just standing on a rock, but in modern times, the community was completely on the other side of the mountain. You had to bring the message up to the top and then bring it down into everybody's home with a cable. It was an easy concept to understand and it was obvious to me that over time, most households in any country would have to have some mechanism for bringing in more signals than over the air wavelengths could accommodate.

KELLER: You saw that that early?

KAGAN: I knew it. I didn't have a vision. It just made total sense to me. It was a freedom of speech issue that you had to allow the public as many opportunities to listen and to watch as you could and I just innately knew that this was going to happen. But, it was to take time. When I handed in my first report at E.F. Hutton on the first five public cable companies, they looked at it and said, "They don't make any money. How can we recommend the stocks?' I said, "They're not going to make any money for at least five years." Little did I know how long it would take for them to make money. In some cases they never made any money, on purpose.

KELLER: By design, yes.

KAGAN: By design. But I said, "They're not going to make any money for at least five years because it's all about depreciation and cash flow and it doesn't matter." They said, "We do not recommend stocks that have brackets on the bottom line." They left me no choice but to start publishing my own newsletter on the subject.

KELLER: Do you remember your first story?

KAGAN: The first newsletter was dated November 10th 1969. In October cable had made the front page of the big city papers because the FCC ruled that cable had the right to originate its own programming. This was an interesting thing because the FCC chairman was from Utah and the only company who could supply origination programming equipment was Telemation in Salt Lake City. The FCC didn't force cable operators into it, but it encouraged them to buy cameras and to have some kind of programming. Until then, their only original programs were clocks and thermometers...

In October 1969, it was an indication that cable was going to be somebody someday. It could be the old "On the Waterfront" line: Cable could be a contender. It wasn't the avenue that was going to work, but it was like wake up, cable is here. I started my first letter at that time, that was the first story. But I remember the second story almost better because it was the first conference I ever went to about cable. I'd been to the national convention in 1968, but the first seminar I ever attended was a Practicing Law Institute meeting in the fall of 1969 and Henry Geller was then the counsel to the FCC and he was railing against cable because he was always pro-broadcasting. Henry never wanted to be thought of as the foe. But that's how he looked to cable operators. There was always a foe in those days for the industry and the FCC had done much to slow down cable progress. He was talking about cable in its place and broadcasting in its place, and I got up and asked the question, "If this medium has such a capacity to get into people's homes with so many channels, why shouldn't it be of interest to the largest corporations in the country? Why shouldn't the large retail companies, the store chains, be interested in using this medium as a way to augment their newspaper advertising, radio advertising, TV advertising?" Nobody could answer the question.

KELLER: There was a problem there with copyright at that point too, whether we paid for copyright or not.

KAGAN: Well there were rules that people worried about. Government regulation was a major part of that. But the real problem was financial. As I had had the problem at EF. Hutton, the bottom lines weren't there. They couldn't make any money the way people knew money could be made. Large corporations were afraid to acquire them or be interested in them because they didn't make a profit, so it would dilute their earnings and they didn't want any part of that. They had no idea that it was going to be 70 million households and how many channels and what a great opportunity it would be. They never got over that problem.

KELLER: But at that time, CBS was already in it in Canada and quite heavily so.

KAGAN: Well, the media always understood it and at different times tried to control it. TV networks and newspapers either hated it or wanted to own it. It was always a media party, but ultimately it was just a cable party. Over the many years that followed, it was the original cable pioneering group that stayed with it and believed in it and made it happen. Not until first Bell Atlantic then AT&T and finally Microsoft, did others truly validate it, from an investment point of view. That validation came very, very late in cable's life, which enabled the cable pioneers to leverage most of the value for themselves. Many entrepreneurs sell out too soon, like the brothers who sold McDonald's for $1 million each. Cable operators, by and large, had phenomenal faith in what they built.

KELLER: Mainly with private capital, in the early stages.

KAGAN: Oddly enough, until 1968 when the first companies went public, the money came primarily from vendors, from equipment suppliers, and a small company called Economy Finance, which was headed by Jim Ackerman. He was the financier for the cable industry. A cable operator would have to pay five to seven or eight points above the prime rate in order to get his money but he had such confidence in his ability to penetrate the market and get subscribers that it was okay. It was what they called commercial finance and it still exists today. Today it's called subordinated lending, junk bond financing or preferred equity.

KELLER: But he recognized the cash flow wasn't going to go to pay dividends so it would go to pay off the loan.

KAGAN: Right. It was a leveraged business. It was very much like buying real estate and building a building and that's the way they were getting their money. In 1968, five companies went public. TelePrompTer was already there from a merger of TelePrompTer and H&B American. Cypress, Cox, Vikoa and TVC, Al Stern's company, and then Bob Rosencrans, with Columbia Cable, all came public in 1968. They raised in that year, between 770,000 and 7 ¾ million dollars each, which was then considered a big sum of money, especially for companies that didn't have any earnings. ATC, Cablecom General, Communications Properties and Cable Information Systems all went public in 1969, TCI went public in 1970. Little by little we had about a dozen pubic cable companies and that was the group I wrote about in the early days.

KELLER: Those were all pure plays at that point, right?

KAGAN: Yes, absolutely

KELLER: And the only ones in cable.

KAGAN: Yes, there was no thought that a company would have a cable subsidiary and that that would be a cable company. They didn't mix; it was like oil and water because of the financial equation problem. Although Livingston Oil mixed oil and cable. That was the forerunner of Gene Schneider's United Cable. It was kind of fun because it left me a clear path to try to explain to everybody why they were doing this and how they were doing that and I didn't have to worry about other divisions that complicated the issue.

KELLER: Where did you come up with the theory of cash flow and the per subscriber basis?

KAGAN: Well, I didn't come up with the theory. Cable operators were using it and I was the first to explain it to the financial community. In 1968 when I was at Hutton, I got calls from around the country from brokers in Iowa and in Alabama, wherever Hutton had an office, and they said, "We hear there's a cable stock out. What do you know about it?" That was the only way it could happen in the beginning. So I had to call cable operators and talk to them and in fact, I had been talking to Monty Rifkin, who was in the process of forming ATC with Bill Daniels.

KELLER: And a sophisticated financial man.

KAGAN: Oh, yes. Well, both Bill and Monty were real pioneers in cable finance and I had been talking to them just recently before I got a call from a fellow, I believe his name was Goldbaum, in Mississippi. I remember it because it was so unusual to hear from a fellow named Sy Goldbaum in Mississippi. He wanted to know if I knew anybody in the cable business he could talk to about selling his company. I told him, "I'm heading up to Boston for the convention and I'm going to be seeing ATC and Monty Rifkin," and he went to see him. In fact, we all sat at lunch together and he ended up selling his system, I think for $300 a subscriber, maybe less. Monty could remember this story better. That's how it started. I also remember I didn't get a fee, but it wasn't anybody else's fault because I didn't ask for one because I didn't even realize they were going to do the deal. They were just talking.

KELLER: You wouldn't make that mistake today.

KAGAN: No, not today. But actually, I made an early decision that Bill Daniels was the broker in the industry and the other guys who came along, like CEA and John Waller and the others, and I decided information was my game and so I began to follow the stocks and the economics of the field.

KELLER: You know that Narragansett Capital played a big, big part in the development of ATC and the underpinning of that stock.

KAGAN: Yes, there were venture capitalists who put up real money, in those days. They weren't famous; there weren't that many of them, but they got it started and one thing that I was able to help accomplish was to call everybody's attention to a group, a stock group, that no one else seemed to ever want to write about. There were a number of analysts in Wall Street who were following it; Dennis Leibowitz, who was then at Black and Company, and Coleman and Company, who went on to DLJ and became the leading Wall Street analyst who was then joined by others. So there were analysts at the beginning, but the newspapers didn't want to write about it, the magazines didn't want to write about it and nobody was keeping track of every company. They were all small, so they were below a lot of radar screens. I was able to maintain a database at a time when a database was very much needed and that's how the whole game began. As time wore on, the situation went through changes when events outside the industry came along, usually in hard economic times. In 1970, there was a market crash. In 1974 there was a huge market crash. 1974 was financially the historic bottom forever of the cable industry. This is something a lot of people did not pay enough attention to at the time.

KELLER: Even when interest rates went up to 21% in '80?

KAGAN: That was nothing compared to what happened in 1974. The cable industry was very young financially and when the lights went out in '74 over the oil crisis and you had to line up for gas in the middle of the night for an hour and a half to get gas in your car, the cable industry couldn't withstand that kind of tight money. Interest rates were 12%, even treasury bills, an enormous level at that time. Actually, it still is today, but we had all known 6% and nobody had ever heard of 12%. At my conference in 1974 in New York, Leonard Tow was one of the speakers and I remember clearly that he said "this country cannot long survive with interest rates at 12%."

KELLER: Leonard was president of Cypress, is that correct?

KAGAN: No, at the time when he made that speech in '74, he was with Century. He had formed it.

KELLER: Before he formed Cypress?

KAGAN: No, not Cypress. Leonard was with TelePrompTer and then he formed Century. An interesting story about Leonard, the first time I met him, which was probably in 1968 or '69 when I was either at Hutton or starting the newsletter, I sat down in his office and in those days, my job was to unearth data about the industry. I had to find out how many subscribers everybody had, how many homes passed so I could figure the penetration so I could figure the growth, etc. I said to Leonard, "So how many subs do you have?" And he told me that was pretty common information and I said, "How many homes passed?" And he said, "That's for me to know and you to guess."

KELLER: He didn't know.

KAGAN: Well, I always thought he had a pretty good idea, but I took him literally. I said, "Okay, if you want me to guess, I will." And I began making my own estimates and that's part of what made us what we became, which was a kind of arbiter of the numbers of the industry. But in any case, in '74 Leonard said we can't survive at 12% interest rates and I will tell you that the 12% rates of '74 were worse for the cable industry than the 20% rates of Jimmy Carter's era, or later, because the industry was more mature and it had more things going for it and it could handle itself better, not that great, but better. But back in '74, companies went virtually bankrupt and TCI, among them, had a terrible, terrible time because it was hugely leveraged. They had brought John Malone to head up the company in '73, and in '74 everyone was going down the tubes. TCI's stock had gone from the IPO, at 16, to a high of 37. But, it fell to as low as 75 cents bid in 1974. It was a disaster in the making. The equity market cap of the company was only $3.9 million dollars at the bottom of the market. They began negotiating intensely over their bank loans with the Bank of New York.

KELLER: The bank sure didn't want those systems.

KAGAN: Well, it was scary for the bank, and John successfully, deftly negotiated a restructure that really, to the bank, looked like it was ironclad, because they succeeded in getting the most cash flowing systems to support their loans, and they cut out from the herd everything else and said, you can do whatever you want with those. TCI knew how to bring them around and eventually leveraged them and it was that bifurcated structure that enabled TCI to really grow and leverage the company while the bank was sitting with a certain number of systems that were providing the collateral for their loans.

KELLER: Without taking a cash flow loss on the other ones.

KAGAN: Yes, instead of squeezing them out of the business, the bank actually encouraged them to grow if they knew how.

KELLER: Was there any validity to the "keys" story?

KAGAN: John Malone throwing his keys in? Whether it's a legend or not, my bet is he did.

KELLER: I would guess that's probably true.

KAGAN: I think he threw his keys on the table and said, "Here. You take over the systems you want." But it worked out very, very well because he had the financial engineering genius to know how to make all that work. I will tell you that it was knowable at the end of 1974 that it was the bottom of the market. I determined, just from reading a lot of stuff, talking to a lot of people, watching the markets, I concluded for my own purposes of trying to figure out where we were in life, that we were seeing as bad a market as we could possibly see. The long lines for gas in the middle of the night, the lights out in Times Square, among other places, the companies near bankruptcy, interest rates at 12%--it simply couldn't get any worse unless we were all going out of business and I never believed that would happen and it didn't happen. The market turned around on a dime in January of '75. The actual deal Malone cut with the bank was in February of '76 and the market had already turned around, but in '76 people were still worried about whether the turnaround would stick. My conclusion was that we would never go back to late '74.

KELLER: It was like the '91-'92 turnaround at that point.

KAGAN: Well actually, yes, there were several other turnarounds in history that effected cable later on, definitely in the '90's. So cable took off and they had help in 1975, big help, from HBO going on the satellite. But HBO didn't do well at first and as late as early '77 Time, Inc. was still considering pulling the plug on HBO because they had about a 40 million dollar investment in it and it wasn't showing any return. That's a lot of money for that era and they finally broke the code. They figured out how to program HBO in late '77 and in early '78. In January of '78, I was talking to operators. One of them was Bob Rosencrans, and he said, "We're doing very well in our HBO sales." And there was a clue in his tone, like, "something big is going on." I began to analyze it even more because we had started our pay TV newsletter in 1973.

KELLER: Most people didn't believe that that was going to be a continuing revenue source. At least some of the banks didn't.

KAGAN: You have to have a certain amount of faith in new technology. I always had faith that the people wanted to have more services. It's very difficult to take them away from them once they have them and that they would have ample discretionary revenue in their household spending to pay for these new services. So I was always waiting for those magic moments when these companies could break the code and one by one they came.

KELLER: When did Bill Daniels finally tap into the Wall Street money?

KAGAN: Well, when you way the Wall Street money...

KELLER: The big banks, the financial houses.

KAGAN: There's a difference between the banks and the investment banks. The investment banks brought out these little IPO's in 1968 and after that it was always one at a time. There was nothing really lighting Wall Street's lights. The stocks did struggle often before the era of HBO, the turnaround and before the mergers. The mergers began in 1977. That's when ATC merged with Time Inc. Earlier they had tried to merge with Cox and the FCC shot it down. Viacom was a target of Storer and Viacom shot that down.

KELLER: Was it the FCC or the Justice Department that shut down the Cox-ATC merger. I think it was the Justice Department.

KAGAN: It was the Justice Department that did it, you're right. They were both in Washington, so sometimes I get them confused. Just kidding.

KELLER: Part of the same mess.

KAGAN: You said that, I didn't say it. Certainly Washington had not done enough for the cable industry, as long as you brought up that point. There was, however, a piece of cable history which is worth remembering. In the 1970-'72 timeframe, the Republican administration became extremely unhappy about the coverage of the Vietnam War done by the over the air broadcast networks. We all remember, those of us who were around, Spiro Agnew, who was Vice-President, railing against the networks and the supposed elitism of the New York journalists. You go back to 1969 when the Nixon era began, and you had the Vietnam War problem, you had the networks sending into these dinner times news shows pictures of blood and gore and some of the definitely most graphic depictions of wartime violence ever brought directly into the home. The newsreels on World War II were nothing compared to this and it was not of the liking to the administration at the time and they began to talk out very strongly against it. At the same time, 1970, you have Dean Burch, a Republican FCC chairman appointed by the Nixon administration, addressing the cable industry and saying, "I know that you have had difficulty in the freeze and in the copyright issues and in getting ahead and I am here to tell you that you're going to have every opportunity to grow." The cable guys at the convention when he made that speech were going "Yes!" as if they had just scored a touchdown, but nothing much happened at first because Congress was still Congress. They had oversight over the FCC and there were plenty of people in Congress who didn't want that to happen. But that Nixon-Agnew attack spread out and it was becoming increasingly clear, they were jawboning the networks to back off. The networks were standing tall because it was their journalistic, free speech right to cover the news the way they wanted. When the economy crashed in 1974, cable was the only real way the administration would have of getting at the networks, creating competition for them. But cable was on the ropes. By then Richard Wiley was the chairman of the FCC. Another Republican appointee. And in some ways, like Burch. The two of them were really straight shooting entrepreneurial oriented FCC people, as opposed to public, low price people, which we saw much later in cable's life. Their object was to further what the cable industry could do and even though this has not really been documented—because there are lots of reasons why things happen—there is no question in my mind that cable was looked more favorably upon in the mid-'70's during those couple of administrations, Nixon and Ford, as a good alternative to what the networks were doing. In fact, it was 1971 that the networks lost the right to own a financial interest in programs, which was a major financial blow to them over the years and it was from those dates forward that cable began to really move ahead. It began in '74 with the Wiley Commission and new rules favoring pay TV and generally not restricting cable as much. Then you get into HBO in '75 and you get into the big expansion of cable with the franchising of the cities in '79, '80, '81.

KELLER: The Second Report and Order came out that allowed the cable industry to bring in a certain number of distant signals into the markets.

KAGAN: There was always the matter of expanding the number of channels they could carry and that they should carry and it was clear to me that the Washington drive was, "let's get more networks out there." The first Turner network, in 1976-'77, and the other cable networks that followed in '78, '79, '80 when you had all of that development of ESPN and the others, was all part of this general new favoring of cable, not overly promoting, just not hindering it anymore. So I think Washington played a major role in getting cable started finally after many years of sitting on it, only to play another major role later, as we'll get to in the history, where they really clamped down on it very hard with the rate regulation in the '90's.

KELLER: Which never really hurt too much

KAGAN: The rate regulation? Oh, we'll get to that. It hurt like hell. It was another issue which is much more germane to what we're going to see going forward. But as you go back to that era of 1979, '80, when they started to give out the franchises, you get a different kind of a climate going on. Now all of a sudden, cities heard that it was a good idea to have cable TV and franchises that were not ever awarded were suddenly all coming up to be given out. It was when we first began to see the competition to get the franchises, that we began to see the pushing of the technology that has become such a major force in the business today. It was in the seeking of the Atlanta franchise that CableCasting of Canada decided to promise the city of Atlanta they were going to 125 channels.

KELLER: What year was this?

KAGAN: This was approximately '79 or'80. There was a long list of franchise applications in different cities and in any significant size city there were a half dozen applicants or more and everybody had a local citizen who was allied with them. Some decided technology would set them apart. In Atlanta, they promised 125, which was a reach, because nobody was close to that. I remember Sruki Switzer, their engineer, was sent around the country trying to find the technology that would produce 125 channels. Well, even though most vendors were just not able to supply it, he believed that TRW in California had the ability, had a chip, that could produce that kind of capacity using a dual cable system. You'd need over 60 channels per cable, nobody was close to that, and he went to TRW and said, "You've got the technology on the shelf. Take it down for us and let us use it." They did get an agreement from TRW that they would work with them; they went ahead and got the franchise and proceeded to spend 160 million dollars in building it and they built a hell of a system, but they built it too well too fast, before the people would sign on for it and they ran into the financial difficulties of the 1982 economic crash. That was a third world nation, bank lending crisis. There were bankruptcies and in August of 1982, the stock market came to a pretty good halt. It was a very volatile moment in history. At that time, the cable industry couldn't sell any equity, nobody could. The debt market had not developed yet. It was beginning to happen right in there, which I'll get to in a second because it was so important to the cable industry. In the meantime, they were selling limited partnerships. Glenn Jones had started to sell a series of them and others as well. The Canadian company had raised its money to build the Atlanta system from Drexel, Burnham, Lambert through what were then called junk bonds, which were high yield notes that were virtually created by Mike Milken and his sales force at Drexel. What was interesting is that they called them junk bonds at that time and they later changed it to high yield, which sounded better, but when Jim Ackerman had financed the industry in the first place and he had gotten 5,6,7 points over prime, 17, 18, 19%, that was in effect a junk bond. It was a junk loan, but it was what we used to colorfully call "the lender of last resort." If you couldn't get the money from anybody, you could go to them and they would basically give you something that looked like an equity investment because they were taking a percentage of the money above what a normal loan would be and that in effect cut them in on the equity.

KELLER: Sometimes warrants also.

KAGAN: Or warrants, and Milken did the same thing, only he did it on a much more grand scale and he ended up financing almost everybody in the media. Chuck Dolan and TCI and the Canadians--Rogers and Cablecasting-- and just a long list of people who were building cable systems and other communications networks. It was a brilliant financing move on Milken's part because it was an industry that had a predictable cash flow. That was always a hallmark of cable. You knew viewers were going to pay month in, month out because they had to see their favorite programs. It was unthinkable that they couldn't see the sports events. So there was a very proven cash flow record there. The regular commercial banks had been there for a while. Alan Gerry was a pioneer in getting bank financing for his systems.

KELLER: In the local markets.

KAGAN: In his local markets. The large companies were not using banks because they had been able to go public and they had enough cash flow and they always had financing from vendors and they had some banks as well, but it wasn't a major part of their lives. So the banks were there, but in that 1982 crash, the banks were not there. It was the bank crash of 1982 that spurred Congress to encourage the establishment and growth of savings and loans, and the expansion of savings and loan lending to real estate. Because the banks were not there. It was in that vacuum of capital where the S&Ls weren't quite up to it yet, and the banks weren't doing it at all, that Milken and Drexel stepped in to provide high yield lending. The cable industry used that very well to grow and develop these new franchises through the middle '80's, which were otherwise a quiet time in the U.S. economy. We recovered from the '82 crash, there was a bull market in '83, but it didn't last very long. '84 was a blank year. It was actually a declining year but it wasn't a crash, it was just, nobody ever remembers '84. You get to '85, '86 and '87, leading up to the big bull market of '87 and you have some of cable's finest years, financed by junk bonds. By 1986 they were able to do public equity offerings and Adelphia, Cablevision and Century all went public that year. The cable industry was really now very firmly established with good financial sources of all kinds. Unfortunately, the S&Ls didn't work out and as the S&Ls began to come apart, Washington was getting tremendous complaints against Milken and the takeovers that he had been engineering and they began to investigate his activities. That slowed Drexel down tremendously and '87, '88 and '89, were very good years for the cable industry, which was continuing to be financed by these really great junk bonds, all of which worked out very, very well for everyone in cable. But Drexel went down, and I think the government actually helped them to go out of business, which was unheard of for a 5 billion-dollar institution. I think they just said to the banks, "Don't fund their working capital." So Drexel went away and so did Mike Milken.

KELLER: We used to say, whether it was true or not, that cable never forfeited on a loan.

KAGAN: Well, there were a couple of cable virtual bankrupt situations. The big franchise construction jobs in LA and Atlanta were among those that had to be rescued, but by and large, cable lending has been as successful on a percentage basis as any lending the banks have ever done. I made the point about the Milken story because there's no question that the construction of the new franchises in the l980's that were given out in '79, '80, '81, would never have happened if Milken and Drexel hadn't have been there. The equity markets weren't ready for it, the bank markets weren't ready for it and there needed to be funding. The cable industry has long said that money will find the right place to be invested. We were it and that's what happened.

KELLER: With those kinds of returns to lenders.

KAGAN: Because of the knowledge that within four or five years after the opening of construction, you would have an established penetrated system with reasonable cash flow that could support all the loans, as long as you could get through the first few years.

KELLER: As I remember, most loans had a moratorium on principal payment for the first three to five years.

KAGAN: That was the idea. That was the feature of it. It was great lending for an industry like cable and it was a pity that the people who engineered it, Milken and his people, became so vilified for their activities. They finally were able to sentence him and ended that era and of course blame the S&L crisis on him because he had used S&L investments to make the loans to the cable operators. But they were among the S&Ls best investments.

KELLER: Well, prior to that was the era of the conglomerate, too. I remember Gulf and Western, I think, was in the cable business for some time. Who was financing them, do you remember?

KAGAN: That was a conglomerate that had a lot of pockets and they were able to dabble in cable and media. They owned Athena Cable, which was one of John Malone's early bargain acquisitions. That was the conglomerate era of 1968 that Nixon brought to an end when he came into power. A point that I'd like to make is that every time any government administration or any group of analysts said that debt was not good, leverage was bad, conglomeratization wasn't any good, mergers will never work, every time we ever had that, they stopped, but came back stronger than before. Debt has worked, leverage has worked, mergers have worked, the conglomeratization of America and the world has happened because economies are scaled and size is necessary in order to have serious competition. The government figured that out a few years ago. They figured out that lower consumer prices translate into votes and consumers will be happy. It doesn't matter if they're Democrat or Republican, they want lower prices. But you can't have lower prices if you have weak financial companies. That's one reason why companies need to be larger.

KELLER: It's the economy, stupid.

KAGAN: It's the economy. So you're eventually going to have Time and Warner go together and you're going to have Viacom and CBS go together and you're going to have much larger companies battling for market share because they need the economic base in order to fight the battle. It was inevitable. Bank in 1974 and '75, there were no deals in media, which is the area I cover. The broadcasters weren't merging and the cable guys weren't merging. Everybody was financially immature; nobody wanted to give up his stock yet because it was all venture cap stuff. They thought that the future was ahead and they were right. Mergers began in earnest in 1977 and we are now 22 years later. In 22 years, half of every industry has consolidated, or more, until you get these telephone-type industries where you have five to ten large companies that dominate and a bunch of other companies that have niches within that universe.

KELLER: The telephone companies' story vis-à-vis cable television is a chapter in itself. We have to get into that someday – the telephone companies and cable.

KAGAN: Well, that's a whole other conversation, but we'll touch on it a little bit before we're done. So let me get out of this '80's era, because we're up to '87, and '89 is where I was taking this narrative. In 1989, Time merges with Warner and the cable stocks top out but they didn't top out because of that merger, they topped out because in very late '89, October, November, the Bank of International Settlements in Switzerland decreed that there was too much lending going in on the world, not just in the U.S. but everywhere. Relatively unbeknownst to a lot of people, in late '89 they instituted something called highly leveraged transaction rules, the HLTs, which was like a disease. If you had the HLTs you almost couldn't survive. Basically, it was against real estate, because during that Milken and S&L lending era, white media was the second largest industry to get loans, real estate was the first. A lot of bad real estate loans were made and there was over-capacity in office buildings and these things started to collapse, financially, and they took the S&Ls with them. Congress made the S&Ls the scapegoat, and Milken the whipping boy. The HLTs bit really hard, in the spring and summer of 1990. One by one by one, borrowers were told that "even though you're paying your loan back and even though you're paying your interest, we want to call your loan anyway." It was unheard of. The banks were forced by the regulators to invoke the boilerplate in their loans. They said, "This is a demand loan; any time we want to call it back, we can." And they began to do that and companies began to go down. There was a recession in '90, '91, '92 that is often blamed on prices and demand, but it was clearly manufactured by the bank regulators, tightening money through the calling of loans and reducing the leverage in the entire business system, around the world. It didn't ease up and change until '93 and our research pegged a bottom, the real bottom, at September '93, when the net number of bank loans to business began to work upward for the first time since 1989.

KELLER: Even though many people saw that coming, Malone for one at TCI?

KAGAN: Well, I think the HLTs when they hit, were a surprise to a lot of people. The notion that bank lending was overdone was something that was pretty obvious to people, but nobody wanted it to end. Especially those, like cable that had the cash flow to support the loans.

KELLER: In real estate though, we got thrown out with the bath water, right?

KAGAN: Well, yes, because we know cases where examiners actually said to bank lending departments, "We don't think you should have these loans over here," and they'd say, "Why not? And they'd say, "Well, look, real estate's number one; we know you shouldn't have those. Media's number two, you must be making mistakes there also." Cable got tarred by the same brush and there wasn't anything you could do. You'd say, "You don't understand, the cash flow is pouring in from these companies. There are no problems servicing these loans." And the examiner said, "I don't care. You have too many of them." There was a bank in Rhode Island where the examiners, who were supposed to be looking just at the loans against the equity of the bank, got out of hand and checked the Coke machine and felt that the accounting of the Coke bottles wasn't being done correctly. That's how far down into it they got when they got carried away with the entire examination process. That was published in the American Banker Newspaper. It wasn't like it was a legend, it was a true story. So it was a very, very hard time. It hurt really badly, especially when Alan Greenspan was unwilling to admit a credit crunch existed. He said there was "no anecdotal evidence of a credit crunch" and people were lying on the street with their tongues out for money and everybody knew there was one. During this period, cable companies, small cable companies, were terribly affected and even the large cable companies had difficulty. The leverage was really heavy for some of the largest companies and their bond prices collapsed. My bond fund was able to invest in cable bonds in 1991 for an average yield of 21% and we weren't even as early as we could have been. Had we invested a couple of months before, we could have had an average yield on that portfolio of 25 to 30%. It was unthinkable for publicly traded bonds. All those bonds worked their way through and did fine and got back to par. It was an incredibly horrible period, akin to the 1974 crash, but at least the companies were better established and able to work their way out of it sooner.

KELLER: And it seemed to me, you also had the then Senator, and then Vice President, Al Gore, making all kinds of accusations against the cable industry also.

KAGAN: Well, ironically, and this was total coincidence, at the time the HLTs hit, Senator Danforth from Missouri had begun hearings on the fact that cable was charging too much for its services. This had originated apparently, with Al Gore's father who complained to his son, which led to the stringent FCC regulation of cable in the Clinton-Gore administration.

KELLER: It was a great populist cause.

KAGAN: Well, this was the business about the votes. The whole claim of re-regulating cable, which started in '89.

KELLER: '86, when all regulation was off, and then '92 it came back.

KAGAN: Well, sure, because cable had lobbied well and was able to get the right in the 1980's, to raise its rates. Unfortunately, it overdid it and raised the rates in some systems too much or too often. That helped spur this congressional oversight.

KELLER: How did the market view that oversight at that time?

KAGAN: For a few years, no one noticed, because it came at the same time as the HLT's. When the stocks topped out in October 1989, after the Time Warner merger and the bank loans topping out, as the HLT's became apparent to people and tight money looked like it was coming, they began to sell the stocks. So the financial community just had no choice but to suddenly turn a deaf ear to cable's inquiries. Some of the best companies in the business were told to just back off for awhile: "We can't make any new loans, the examiners won't let us." Some of the finest banks in the business were totally shut down from lending, and the total number of loans to business plummeted over the next two years. They just kept wearing away. They weren't writing new loans on a net basis and so the cable industry suffered.

KELLER: The European banks were writing at that time though, weren't they?

KAGAN: Foreign banks saved cable's bacon to a certain point because with the Americans having their problems, first the Japanese were helping out, the French banks like Societe General and the Canadian banks. These were the ones that were more ready to invest although they were also to a degree under their own restrictions. But they were more aggressive than the American banks could be, because the American banks had that S&L real estate crisis to deal with.

KELLER: But we also know that the Canadian banks were far more aggressive in financing cable systems then the American banks.

KAGAN: Well, you have to remember anecdotal evidence. In 1991 the Fed closed down the Bank of New England. The Bank of New England was a major media lender and their portfolio was taken over by CIBC and Bank of Montreal and the Royal Bank, the Canadian group who were there for the media industry more than the American banks could be. You know, the way the credit crunch started, the examiners first went to Texas and they leveled Texas banks, and when they were finished in Texas, as they were closing up their briefcases, they said, "Okay everybody, let's go on to Boston." And they invaded Boston and they just leveled the Boston banks and that was where so much of the cable money was – The Bank of New England, Bank of Boston, Fleet and Shawmut all were big media lenders. Texas had a few, too.

KELLER: The Bank of Boston had much of the loan for Bud Hostetter, didn't they?

KAGAN: The Bank of Boston was one of the founding fathers of cable lending, and Bank of New England and so many good banks. Chase and Chemical and Citibank, Manufacturers Hanover, and Bank of America, Nat West, Mellon and Bank of New York. These were the people who, when cable finally got going with HBO doing so well in the 1980's, they were all there. By 1989, it was decided they had to stop doing this because of all the other problems they were having. I know for a fact the banks didn't want to do that but they were ordered to by the regulators. It wasn't all in the public press, you had to really talk to borrowers and lenders to get a good picture of it and we followed that very, very closely.

KELLER: We touched on the Canadian Bank financing, but by that time there was a history of major markets along the Canadian border and the United States.

KAGAN: And they got cable before the Americans did.

KELLER: Because they were able to import it.

KAGAN: Because they needed it.

KELLER: They were able to import U.S. signals. The Torontos, the Montreals, the Vancouvers were being built.

KAGAN: Toronto was a big city, but in cable parlance, it was a small town far away from American TV signals. Just far enough to need cable. So Canadian cities got penetrated a lot faster than Americans did and the banks went along with it.

KELLER: Paul, let's back up just a little bit about the advent of programming in the industry and the impact it had.

KAGAN: That's the juice that goes through the pipes. My friend, Sruki Switzer was once asked about programming and he said, "I'm an engineer. I put in the

pipes, I don't really care what you flush down them." I guess someone has to make those pipes useful.

KELLER: Malone built the input into the pipes into the company who was programming, what they did call Peter Barton's company, Liberty?

KAGAN: Liberty Media, sure.

KELLER: Which he's still using as a programming source right now.

KAGAN: Sure, but that was another story. Because of regulation that was a good way to go. That was an unregulated area. The content for cable was always HBO and Showtime and then The Movie Channel and Cinemax. That was cable content besides the over the air signals. It was clear in this post Vietnam era of increased cable networks, originating networks, that there was a demand, there was a need for new specialized services that cable could uniquely carry thanks to people like Ted Turner and Getty Oil and Bill Rasmussen and the other people who started ESPN, and many of the other program oriented people in the media. You had this rush to put cable networks on. The cable networks had their own terrible start up period from, let's say, 1979 until 1982. Through the crash of '82 on into the '85, '86 period they turned the corner, and they were like true venture capital companies – six years of blood, sweat and tears followed by six months of utter euphoria, when you make it. It used to be you got an IPO, you went public after six years or so, but in the case of these companies, they didn't go public, they just became successful, thanks to the cooperation and the patience of the cable operators, who were willing to pay them for their programming, even while letting them sell advertising. Thanks to things like the cable operators, in 1987, bailing Ted Turner out of his acquisition of MGM in 1986.

KELLER: Primarily Malone and Time Warner.

KAGAN: Malone led the way and got all the cable operators together and said, "Look, if Ted isn't financed, then Kirk Kerkorian is going to own CNN, and we would all rather work with Ted." So they raised about $550 million, which was an absolutely huge amount of money. Many of the operators weren't sure it was ever going to work out, but it turned out to be a fabulous investment, as have so many other cable networks. These networks came along throughout the '80's and established themselves, and it was fascinating to see that, despite the fact that their share was no more than a quarter or a half a point, the cumulative viewing tendency to keep turning into CNN or to keep tuning into ESPN was making up for the fact that their share was so low. Cumulative audience was what counted and people got used to watching it. An interesting sideline about the cable industry was that the networks were slow in developing, slower than they should have been, because the advertising community lived in the biggest markets and they didn't see cable. And it wasn't until Bob Rosencrans, Chuck Dolan, and others, who built the metropolitan New York area and put cable into Connecticut and into Westchester County where the advertising agency people lived, that they finally woke up to what it was all about. That would be in the early to mid '80's and they came to understand it. So in the second half of the '80's the networks began to get advertising and people began to support what they were doing. The audiences were there but the ad agencies developed an interest slowly. By the time you get to 1990, the credit crunch was exacerbated by Saddam Hussein's attack on Kuwait. They seem to be two totally unrelated situations that converged. That was the real first convergence that we had in this business. In October of 1990, the world went to hell in a hand basket and junk bonds collapsed, more so than ever before, and that's when you could buy these bond portfolios with these high yields. You had a situation that was fascinating for American and world history and media history. It was so scary to so many people and if you can remember the dates, the Russian revolution was the fall of '89 and the Iron Curtain was coming down, the Berlin Wall came down. But in October of '90 peace was no fait accompli. And the public worried that maybe the Russians would come in on the side of Iraq and we'd have World War III.

KELLER: I remember that very well.

KAGAN: This is why everyone's momentum stopped, and as we prepared to bomb Baghdad in January 1991, world activity had come almost to a stop. There was fear of Iraqi terrorism, there was fear of World War III, there was fear of everything. People stopped shopping, people stopped traveling, it was really, really scary. It was very similar to the darkness of '74 when without the oil, people stopped driving, you couldn't go anywhere. It wasn't that oil was too expensive; you couldn't get it. What happened next in 1991 was on the eve of the bombing of Baghdad, when everything had stopped. You could call it the bottom of the market. In fact, the actual bottom of stock prices was in October, but nobody was playing in January, either. We bombed Baghdad and everyone watched it on television because of cable, because of Ted Turner and CNN with its announcers stationed in Baghdad (Bernard Shaw, John Holliman and Peter Arnett), reporting directly under the bombs. My analysis of the situation, as I looked back on it, was that the awesome technology that we put into place, both in communications of the war and prosecution of the war—the pinpoint bombing—so enraptured America that it went on a technology-buying binge. And the stock market began to rise even in the midst of a credit crunch.

KELLER: And you just couldn't live without CNN, and therefore, cable.

KAGAN: Cable was very, very popular going into the Gulf War. It had established itself. In 1978 HBO had established itself; we're now talking twelve years later and so cable was already a force in America. A lot of people were watching it. The Gulf War was not the first cable program they ever watched, but it was the biggest one. All the people who didn't have it, made them realize how vital it could be. Let me go back one step. I mentioned the Russian revolution of 1989. A lot of people don't give MTV enough credit for that and everybody laughs when I say that and they say, "Come on. Rock music and blue jeans did not create the Russian revolution." I think it contributed to it. The Voice of America on radio could not truly penetrate the Iron Curtain. I mean, it did because you could get radio signals in there, but it didn't have the impact. When the TV pictures went in from Western Europe into Eastern Europe, and the people in Czechoslovakia and in Poland and in Hungary and in Romania and in Russia began to see pictures coming off the satellites, they saw what Western people had, especially young people. They literally, en masse, said, "I want that." And even though the Russians had shot people trying to crawl under or jump over or get around the barriers from Eastern Europe into Western Europe, they weren't able to shoot everyone walking across at once. Somebody got the idea to stage a massive protest demonstration. If 30,000 people try to cross the border all at once, they can't shoot 30,000 people and that's what happened. In even bigger numbers. Everybody walked out of Eastern Europe and they were basically walking toward peace, toward prosperity, toward Western civilization and Western media communications and consumerism. They wanted the jeans, they wanted the food, and they wanted the cars and all the things they could physically see on the TV pictures. They wanted the freedom. Actually MTV was a more free kind of content than most because it broke a lot of rules and it was avant garde and it said a lot of things you couldn't say on other channels. So people got the idea that there was freedom of speech and there was stuff to have and they just walked out of those non-media countries.

KELLER: When did you start tracking cable around the world?

KAGAN: Well, we began our first world media newsletter in 1988. That occurred because I made a trip over there and was lucky enough to meet with the government regulators in Paris and in London, and they both told me they were welcoming American finance into their markets in order to build cable. So I came back and sat in this boardroom and told my staff that we had to have coverage of Europe because they want cable, they're going to have it. There was already cable there. Narrowband systems in Benelux countries, Germany had a developed cable system but England had zero and France almost zero.

KELLER: Ireland had cable at that point

KAGAN: Yes, a little bit. Even England had a little bit of narrowband but there were no real franchises being awarded. There wasn't competitive franchising, there wasn't the kind of development that we had here. They said they were going to have it and I believed it, and I also knew that even though in '88 they hadn't walked out from behind the Iron Curtain yet, I knew that ultimately the same thing would happen to the Europeans that happened to the Americans – that demand for more channels, for more media options was going to happen because I didn't believe those people were different from us. Many Americans came from there. They would want their freedom of speech and they would want their choices of entertainment and information, just like us.

KELLER: The Pacific Rim the same way?

KAGAN: Sure. I think people are in many ways the same all around the world no matter what color they are, what religion they are, no matter what kind of culture they live in. It tends to be reactionaries and governments who try to maintain the status quo. They feel that media can be a form of revolution in a country and it actually was in the Eastern European countries. I think it's a kind of neat revolution, if it is one, because it's not militant. It's just somebody saying, can I have that orange drink, can I have that steak for dinner, can I have some clothing to wear, and if you really look at who walked out of Eastern Europe and what they were wearing, they were already wearing jeans and Reeboks and things they could get through the black market.

KELLER: And young people.

KAGAN: As the population got younger and younger, more of them would want to have what other people had. Some people in some cultures and some countries would say this is all wrong and it shouldn't be foisted on people if they don't want it, but this is the kind of thing that people chose. It was free choice. In fact, that's what cable's been about all along: Let me choose what stations I watch. Don't make me watch only three. And that got us up to 1991 and with all that history of program networking and then the war being a kind of catalyst for business to begin again and to begin at a much faster pace, as you look at the stock market and how it followed the Gulf War, there were then no impediments to world trade. By 1993, you've got Bell Atlantic making the move on TCI and you were in true convergence where you had Al Gore and the information superhighway. It was funny that Al Gore started the very thing that would crimp the style of his own superhighway concept at the very beginning. As we leave this era behind, we're up to '93, and in 1993 with Bell Atlantic wanting to buy TCI and be a major communications competitor against all the other companies, the hearings that had gone on and created the Cable Act of '92, which re-regulated cable, took hold in 1994 and by the time they took hold they were anti-climactic.

KELLER: Before we end that there, and I think the next era is going to be the era of mergers, media mergers, all the way through, but when Malone made that 500 channel statement...

KAGAN: 1992.

KELLER: He was derided for it then and some time later, that the industry wasn't able to produce.

KAGAN: Well, if you go back and look at the stories, you'll find that the telephone companies were lobbying hard against cable.

KELLER: Because they wanted in.

KAGAN: In 1992, to soften them up, to get in. They were working cable over at the banking level and they were working them over in Washington and the message was, cable's a monopoly and we really need competition and cable is not a good business because it's not a good business to finance. Ray Smith and Bell Atlantic were very, very vocal in that time frame about their coming to get cable and when John Malone made the statement about 500 channels, number one, he was taking up the battle. If you look back you'll find out the phone companies were the ones, and Bell Atlantic primarily, that were promulgating the super channel systems and the interactivity and the convergence. They were doing more hype of it than the cable operators were. The cable operators knew how much money they had to spend and how much they should spend and that the potential revenue wasn't that great for it. But when John came out with the 500 channel idea, he was partly responding to the telephone threat and he was partly envisioning the way it was really going to go and one problem the public has always had, especially in the newspaper reports on the cable industry, is that the newspaper reporters and articles tend to want things to happen in the next 6 months to a year. On Wall Street they want things to happen in the next 90 days. They live by the quarter, right? And the newspapers don't give any quarter. They want things to happen. If you say, "we're going to do it," they want to know six months later "why didn't it happen already?" When Malone came out and said, "there's going to be 500 channels," he didn't mean next year. He meant "until we get the boxes, until we get them deployed, until we get the programming, until we figure this all out, ultimately this is where we're going to go." I was a major, major supporter of Malone's vision throughout, because first of all he has a tremendous credibility rating. The telephone companies were not delivering what they were saying; the cable operators had delivered what they always said. It was like in the case of HBO. They started in 1975, it took them three years to figure out how to do it right, the money was right and the demand was there, they were going to give you whatever service you wanted because unlike other media, who are restricted to a limited amount of bandwidth, they could do whatever was economically feasible when the time was right.

KELLER: Everybody has had a comment on why the Bell Atlantic-TCI deal fell apart. What's your take?

KAGAN: I think that's easy to know. Bell Atlantic was serious about being the number one cable company in the country, as serious as AT&T later became. Ray Smith had the right idea and he should have acquired TCI when he had the chance, but as he was preparing to do it, that deal was announced in October '93 and the law was taking effect and the regulation was coming and Reed Hundt was the implementer of the law at the FCC. His instructions from Al Gore were to make sure that cable rates came down. So they promulgated tougher rate regulations then the phone companies ever conceived.

KELLER: And the numbers didn't work?

KAGAN: What happened was, the stock market perceived rate regulation properly and they hit cable stocks and they hit Bell Atlantic stock for wanting to take over a cable stock. Ray Smith had the problem of defying his stockholders, who were dividend collectors; they always say widows and orphans but they're institutions, too. Then there was the culture shock problem. The phone company coming into the cable company and finding out how it operates and it's totally different than the telephone company and you have to be prepared for it.

KELLER: One of the theories I heard is that Smith finally, in due diligence, found out that the TCI systems were not up to the technical capabilities that he thought they were.

KAGAN: There's no question that he found that out, but it's a popular notion that that was the deal breaker and I don't think so at all, because there shouldn't have been too much of a surprise with that. It was going to take several years to make this all work anyway. You have to ask yourself: what would have been the prime motivating factors and I think there were two. The tremendous hit to the stock price; that's something to kill any deal. That alone could kill a deal and there is no question that Bell Atlantic asked TCI to lower the price. There's no question that Malone said not a penny less and that's what he wanted. He was going to get 34, 35 dollars a share and the price had come down to 27 or 28. He didn't want to sell out for that. I can't say I blame him, especially since I saw how it worked out later. But the combination of the crack in the stocks because of the regulation and the regulation itself undid the deal. One phone company executive said to us, "They made cable look like another phone company. What did we want to buy one of those for?" They were already too heavily regulated as far as they were concerned. They thought cable would be less regulated than they were.

KELLER: That was the '92 act that came in there?

KAGAN: Yes, well I'm talking about February of 1994 when the whole thing busted up. It was then that those rules actually were formally put into effect or it even became publicly known how bad they would be. February of '94 as the stock prices are coming down. The weight of the regulation and the weight of the fall in the stock price and TCI wouldn't adjust. If they had adjusted down and said, okay, let's do the deal at lower prices, I think it might have happened. But I don't think it was purely the culture shock because I think they're grown up guys and they could have figured out how to all live together. What they missed in not doing it was the opportunity to acquire John Malone or to be acquired by John Malone. Either one would have been fine and here was a chance where he said, I'll sell. And we all knew in Wall Street one day that TCI would probably want to sell.

KELLER: Well, it's been in play for a long time.

KAGAN: John had never made bones about it, neither John or Bob Magness. They had said, "If a good enough offer is made, we'll sell this company."

KELLER: He predicted many, many years ago that it would be a telephone company that would finally make that offer.

KAGAN: Well, we all thought it was AT&T in those days, but AT&T couldn't make it work under Bob Allen and what was going on at AT&T at the time. So TCI ended up doing a deal with Bell Atlantic. After the deal broke up and we went through a couple of years, the 1994-95 period, of very rough times for the cable industry. What the bill of 1992 did is it robbed cable, or let's put it fairly, it took from cable about a billion and a half dollars in revenue per year and it gave it back to the public. That's what Al Gore accomplished. The sad part of it all is that the meaning of what they were doing at that time was "we the politicians, we the government, are going to save you, the cable consumer, two bucks a month off your cable bill for the rest of your life. Because if you're paying 40 dollars now a month you should be paying 42, if you're paying 35, you should be paying 37." That two dollars came off from those rules and they didn't get them back. Now it happens that cable has too many arrows in its quiver to be completely stopped by that kind of nonsensical regulation, and it was nonsense because the only way you can get more programming is if you pay more money for it. At one point the FCC said, "We don't care if you get less programming as long as you pay two dollars a month less." That was a short term thing. They just wanted to prove a point and they did. They penalized the cable industry a certain amount of money and they had one flat year in there in 1995 and then they went back to their growing ways because they began to figure out how to sell more boxes with more services and raise the rates, which is inevitable when you do sell more programs and put in more equipment.

KELLER: Did you ever determine what AT&T paid per subscriber for TCI?

KAGAN: Sure. Just under $3,000. Our estimate at the time was 13.7 times year-ahead cash flow.

KELLER: Is that all?

KAGAN: Well, they got in cheap. Always, the best time to buy a cable system is yesterday. The second best time is today and the worst time is tomorrow. Paul Allen bought cable systems for $2,700 or $3,000 a sub and people say they were too expensive and they turned out to be cheap.

KELLER: Well, as we determined at the last break, the average monthly rate today is about $40 and I've got to assume that there probably...

KAGAN: It's more than $40, actually.

KELLER: They're probably throwing off cash flow in the neighborhood of $15, $16 per subscriber times thirteen is going to bring...

KAGAN: The industry's average is about 45%.

KELLER: Well, not with the programming costs, I'm not sure. Maybe with TCI but I don't think most cable companies are.

KAGAN: Well, if you're getting over $40 a month, we generally figure you're doing about 45% of that in cash flow. So that would be $20 against a $44 a month sub.

KELLER: At 13 times?

KAGAN: Well, the 13 is not even a multiple anymore, because now they're up to 16, 17, 18 times. It's all because we've been talking about the past here, and the past has now become the future. When Malone talked about 500 channels, that is going to come to pass, but in ways different than people expected. It isn't that you sit down with a remote control and try and page through 500 channels; through video on demand and through the new digital services, you may only really see a couple of hundred basic channels.

KELLER: Let's hold that until our next tape, and I do want to get into the merger, presently the mergers, and what this means to the future in our next tape.

KELLER: Paul, we're into the merger era right now. We just touched on the AT&T TCI merger. So many of those have come since then. Can we talk about the impact that these mergers are having?

KAGAN: It's interesting to know that the AT&T-TCI deal is now ancient history. We've come a long way, baby. To understand what happened, we would take on one more piece of history. The rate re-reg did its work in '92, well the bill was '92, it did its work in '94 and '95. By '96, the industry was improving again and it was increasing rates and adding services but something else came on. This was an industry that was brutalized by the credit crunch and then it was brutalized by the rate re-regulation and you would think after those two battles, it was entitled to a rest, but it didn't get it because in early 1996, AT&T, of all companies, bought 2% of Direct TV, as the satellite competitor. With that, Wall Street's anxiety about cable sanctity came back again. They learned to live with the rate re-reg and they learned to live with the new balance sheets from the credit crunch. Now they had to learn to live with the satellite threat and all through '96, cable stocks languished because of that. It was compounded by the resurrection of the notion of the Death Star, which was the satellite deal of all time to come and clobber the cable operators. This was going to be from Rupert Murdoch. It was called ASKY-B, because he had BSKY-B in England and then he was going to call the American one ASKY-B and it was going to come in on top of Direct TV and on top of EchoStar. It was going to rain signals down on America. In February of 1997, and really this period of February to April of '97 is another cornerstone of cable's history. In February of '97, News Corp., Murdoch's company, holds a press conference with the analysts, it was both a press conference and an analyst meeting, in Los Angeles in which they announced their ASKY-B plans, plus a merger with EchoStar to make this all powerful competitor to Direct TV and to the cable industry. And in that meeting they warn cable that they're "sending Dr. Kevorkian to come and get you." They're basically saying you need euthanasia because you've had it. The day they did that, the average cable stock dropped 5% in one day, which is a huge drop in any index and the feeling on Wall Street was numb about cable because it was just one too many antagonistic stories. Soon thereafter, the talks between EchoStar and Murdoch began to sputter and they weren't able to pull off their deal. Murdoch began to talk to Malone and others in the cable industry about carrying his cable channels and lo and behold, by the spring, by late April, ASKY-B was a dead issue and the Death Star was a thing of the past. Echo Star was still around, Direct TV was still around, and they were competitors. AT&T later pulled out of Direct TV. Murdoch pulled out of DBS, and the rate regulation was now a distant memory because we didn't have that anymore. I remember at my spring cable conference in 1997, I was doing what they call on Wall Street "pounding the table." That is to say that you on Wall Street who are not paying attention, you're missing the point that with the regulation abated, with the Death Star threat abated, and Murdoch now a pal of the cable industry, because he wants his networks carried, well, cable's got a really bright future ahead of it." They still didn't fully believe it because the stock prices only jiggled up a little bit in April and May of '97 but then in June of '97, Microsoft invested a billion dollars in Comcast. That was the ballgame. The Microsoft investment validated the cable platform as the convergent platform of the future, the broadband cable, and everyone began to get on board. The same day that Bill Gates did that, TCI did a deal with Cablevision in which they swapped a whole bunch of subscribers for a third of Cablevision's company. That deal woke up a lot of people as to value because both TCI's subs and Cablevision's stock were deeply discounted in that deal and it made it look like they were both doing a bad deal. One was selling cash flow for 6 times, the other one was selling stock for $32 a share; everybody knew both were too low. When they woke up to it, they realized something which both Chuck Dolan and John Malone understood: that they were going to, in unison, in this new, better era, lift their values and they weren't fighting each other, they were actually going to help each other develop. And so cable stocks took off and they began to rise and it was not long thereafter that Mike Armstrong left Hughes, AT&T got out of Direct TV and he commenced discussions with John Malone about their merger, which was announced in June of '98, one year after the Microsoft investment. That brings us to the question you brought up about mergers. The AT&T deal changed the cable landscape forever because it involved changing technology, adding telephone directly into the cable mix, something that was being done in England but had not really been carried over to the U.S. except by Cox, which was a lone voice in the cable universe saying we really ought to be in the phone business.

KELLER: In Omaha.

KAGAN: In Omaha and in San Diego and other systems too, soon thereafter. It introduced the real telephone wired/wireless combination story. It introduced a new phase of interactivity and all versions of broadband development and it made people realize, "wait a minute, we have to be larger as well." It had a similar effect as when Time and Warner merged years before. That eventually led to Viacom buying Paramount and Disney buying ABC and these other mega-media mergers. That was the impact – if AT&T was going to have a position then everyone else had to line up either with them or with partners and it spurred the further consolidation, what some people call the ultimate consolidation, of the cable industry.

KELLER: How's Armstrong going to handle the "little old lady syndrome" with the dividends that he's going to have to forfeit?

KAGAN: Well, this is the toughest thing they're wrestling with as we speak, here in October of 1999: the fact that AT&T stock today is the same price that it was 15, 16 months ago when they did the TCI deal. It was a $65 stock then. Today it's $44 and that's after a three for two split; it's still the same price and that's because the investment community is dominated more by conventional investors, mostly institutions who like dividends and they like steady earnings and they worry so much that this new mix with new media is going to interfere with that totally. So they've been dragging the stock down. At the same time, the cable investors have not been counterbalancing that. For one thing, they're not large enough as a group and for the other thing, they don't like the hybrid company either because they feel that the new media part is being weighed down by the old media part, or the old communications systems.

KELLER: Everyone understands that AT&T is going to have to put a bundle into revamping a lot of those systems.

KAGAN: I haven't been overly concerned with the capital expenditure needed in this. I'm of the school that believes, and I think this is what Mike Armstrong has been trying to tell us and I believe it, that the potential savings and revenues and services that come from this kind of a merger plus the cash flow that AT&T generates, which it does not need to put back into its base business, is more than enough to handle what has to and needs to be done, should be done, to advance this new system. I haven't looked at it as a financial analyst; I haven't looked at the capital aspect of it. This is a perception.

KELLER: Why did they not separate the companies – the cable company and AT&T.

KAGAN: They didn't separate the companies initially because the board of AT&T and its old investor group was not happy enough to do that. It was obviously an idea of John Malone's because he had done it with his own company and in fact, it has turned out that John has been correct in his perception that if you split it out, you will keep your new media investors, who were in cable before, who have sold AT&T stock because they don't like the combination. You will probably keep your institutional investors who were in AT&T before because they haven't camouflaged that by the new media.

KELLER: It just seems to make sense.

KAGAN: It's difficult. AT&T has been thinking that the older business, which is losing market share to competition even though it maintains a tremendous revenue and cash flow base, they've been hoping that cable would pull the other division up by its socks. That hasn't happened.

KELLER: But they did allow the programming arm of TCI to separate.

KAGAN: Well, they had to do that because AT&T does not see itself in the content business at all. And that's impacting current discussions that are probably going on as we speak about Excite at Home, which is one content piece that remains with AT&T. AT&T probably needs to be out of the content business; they've already said that.

KELLER: Common carrier type issue.

KAGAN: This is a real delicate issue because I don't think anything they acquired is of a common carrier nature. They worry about open access. Their concern is that the cable system should have open access because they don't want common carrier regulation for cable.

KELLER: I realize that.

KAGAN: They're dealing with that problem and it's difficult. The common carrier issue is probably going to be the single biggest regulatory problem that comes up and right now the FCC is against forcing them to have open access.

KELLER: The one time they start both telephony and television signals going down the same pipe, there's got to be some kind of a common carrier discussion going on as to what's going to happen to it.

KAGAN: I'm sure there will be a discussion going on, but I think they have to be careful because when you really think about it, the old common carrier notion is fading. There are so many suppliers of telephone service why should anybody be considered a telephony monopoly? I don't see what monopolies remain. One by one they've fallen; the government wants it to be like that and it's working out like that, so I think this whole issue of open access in the end is going to pass because in the end the people with the fastest service and the best content are going to survive and you can't force bad companies to be in business just because you want them to be.

KELLER: Now, in his keynote speech in Atlanta, Mike Armstrong envisioned some kind of new gadget that would combine all of the services in a single piece of equipment – telephone, television, computer. How do you view that?

KAGAN: The technology community will find all kinds of ways to do things like that. In fact, that's one of these things that you shouldn't look for this year or next, we'll be working on it and developing it over time. The various constituencies of the media do things in different ways, so there are couch potato viewers and there are interactive viewers. There are voice telephone users and there are data telephone users. There are television watchers and there are computer users. There are a lot of different constituencies that don't necessarily ever converge and so I think you can expect years of usage of devices that people like, regardless of what else somebody wants to make. But there will also be people who are omni users. They'll use a universal device that will have a screen in it and it will have information in it and it will be a remote control and it can be a telephone. If you look around and you see people using Palm Pilots, these are handy devices that have just really developed in the last few years and there are people who wouldn't be caught dead without one. The idea of taking that Pilot or that telephone or this TV or that computer and making it the single device that everyone will use, A) is not necessarily needed and B) it will be a lot of fun to show at the CES show, when people are looking at what the next new electronic gizmo is. And we'll have them. We'll have one of everything, I mean we'll have lots of everything. I just don't think it's the golden issue of the moment. The real burning issue is how many of the competitors will survive because if there is so much competition and there are no monopolies, guess what? You need economic scale to be able to compete. We're going to see which of these MCI World Com-Sprints versus AT&T – TCI Media One versus Viacom – CBS-question mark, how many of these companies develop in ways that will survive and serve the population.

KELLER: Now you've got Qwest and US West.

KAGAN: You've got lots of different combinations. Who's Bell South going to end up with, who's Ameritech going to end up with, will they end up with each other? SBC, how far out will they branch? These are wonderful questions to posit, but there's no question in the end that 10 or 20 companies are going to be the dominant companies in media.

KELLER: You think that many?

KAGAN: Oh, sure. Oh, yes. Companies like Cox prove that. They don't need to merge with anybody and Cox is not in the same league as Disney-ABC or Viacom-CBS or AT&T-TCI.

KELLER: Because they don't want to be.

KAGAN: They don't need to be. They're a very, very large company. They're sort of like a mom and pop telephone company that has become huge.

KELLER: It was even surprising to me when they went public.

KAGAN: But they were wise because they understood how to finance best. That's where you get your best financing and how to reward your employees. Almost everybody's public because all the employees want stock options. So I think that we see worldwide at least 10 or 20 really large companies and then a lot of niche suppliers and providers and smaller competitors. This is not going to be only 10 or 20 companies. You'll still see a hundred companies, of which 70 will not be anywhere near as large as the top 10 to 2 dozen.

KELLER: I think Paul, on that note, and I know you have a time problem right now, I think we should end it at this point.

KAGAN: You mean, we should start it at this point, because we'll have another fifty years to do.

KELLER: We should start it at this point another time, yes. Paul Kagan currently publishes 25 separate newsletters in all phases of the entertainment business, from movies to TV law to VCR newsletters and so on and I direct the viewer of this to go to the Cable Museum library to look at some of the data, the detail of the data, that Paul has been talking about because Paul has graciously agreed to contribute his past newsletters to The Barco Library. It's going to be a tremendous, tremendous resource for anyone viewing this and I direct people to do so.

KAGAN: Can I get in a commercial for http://www.pkworldmedia.com?

KELLER: You just did. This has been an interesting session. We've covered everything from the very early days in the financial history of cable television up to the present merger scheme. Today's date is October 5, 1999. We are conducting this interview in the offices of Paul Kagan Associates, Inc. This oral and video history was made possible by The Hauser Foundation Oral and Video History Project of the Cable Center Oral and Video History Program. My name is Jim Keller, the interviewer. Thank you, Paul.