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COMPANY TOWN | THE BIZ

TCI's Malone Uses Complex Tool to Beat IRS

June 26, 1998|SALLIE HOFMEISTER

John Malone, the visionary cable maverick who built Tele-Communications Inc., has never made a secret of his loathing for government regulation. He alluded to that obsession Wednesday in explaining to Wall Street analysts the merger of his company in a complicated $46-billion transaction with AT&T.

He told them he worked at the telephone giant early in his career and when he left in 1966, at age 25, he recommended the company figure out a way to reduce its huge tax bill.

Now, Malone has figured out a way to take advantage of that tax rate for himself and Liberty Media Corp., the programming arm of TCI that he will continue to control if the deal is approved by shareholders and regulators.

Malone's top priorities were to retain TCI's valuable programming assets while selling the cable operations and certain related interests to AT&T without incurring a huge tax on the $5.5 billion in cold hard cash that was part of the purchase price. Generally, a seller of an asset must pay the IRS taxes on the profits, or capital gain, from a sale.

Malone accomplished both his goals by drawing on a relatively obscure financial vehicle called the tracking stock. And their use in the proposed TCI-AT&T merger is one reason the deal is convoluted, difficult to follow, and disliked by investors in AT&T.

Tracking stocks are used mostly by large companies with discrete operations that have varying growth rates and risk levels. Companies such as US West and General Motors Corp. have issued such stock to remain attractive to their core investors after buying into new and riskier businesses. For instance, when US West bought into cable, it separated those debt-heavy assets from its prosperous and predictable phone operations by issuing a new stock that tracked only their performance.

Malone is a master of the tracking stock, having created them at TCI to track the performance of its distinct operations such as programming and high-tech ventures.

But his application of the concept in the proposed deal with AT&T may be the most unusual to date. Under the deal, AT&T will technically own Liberty Media, but John Malone will control it through the use of the tracking stock.

"It's a new design; we are in unexplored territory," said Robert Bennett, the president of Liberty. "It's unusual to have a tracking stock in which the shareholder controlling the assets is not the corporation of which it is a wholly owned subsidiary."

Better yet, from Malone's point of view if not the taxpaying public's, retaining Liberty as a tracking stock allows it to receive $5.5 billion from AT&T without paying taxes on it. The payment is for Malone's controlling interest in the @Home online service and a chunk of AT&T stock received from an earlier deal. The transaction is tax-free because assets can be shifted from one tracking stock to another within a corporation.

Although AT&T will not have any economic interest in Liberty, Malone said he will make investments that will ultimately help fuel the phone company's new cable and Internet businesses. And in the ultimate nose-thumbing to the government, Malone has struck an agreement with AT&T under which he can take advantage of the telephone company's heavy taxes and draw upon the IRS to underwrite his future growth.

Under the pact, AT&T has agreed to pay back to Liberty any taxes it saves the phone giant by investing in startup enterprises that lose money. That would mean that every $100 Liberty invests in a money-losing business would reduce AT&T's tax bill by $40 and reduce Liberty's costs to $60.

"Our investments would be subsidized by the IRS, through AT&T," bragged Bennett.

Malone has made a career of turning money-losing propositions into valuable enterprises. Neither TCI nor @Home makes a penny, though the cable company generates a huge cash flow and both have the promise of breaking even.

In announcing the deal, Malone compared the new Liberty with GE Capital, a vehicle General Electric has used to generate tax losses and shelter income.

Bennett said Liberty would look to invest in businesses with growth potential such as Internet programming startups. Financing the equipment costs such as an advanced set-top boxes needed by the cable industry is another objective of Malone's.

Malone has pushed for the convergence of cable and Silicon Valley, resulting in the advanced set-top box finally being close to a reality. The trouble is it will cost roughly $350 a home, and the cable industry is loath to buy them outright for fear of loading up their already debt-laden balance sheets.

"Cable companies don't need the losses but we do," said Bennett, who said Liberty could help speed the rollout of the boxes and thereby help its programming assets and AT&T's ability to charge higher prices for new cable services.

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