Idea Man

by Paul Allen

  We are excited about our partnership with Paul because his vision and technology expertise complement our interests in film, animation, music and television. Paul Allen was one of the first people in the world to realize technology would bring about a fundamental, positive change in the way people live and work—he’s the perfect partner for a company that is committed to building the digital studio of the 21st century.

  I have no way of telling whether their professed enthusiasm was authentic, but one thing is certain. My creative opportunity would fall short of my expectation.

  The studio took three years to release its first movie, and the television and record departments lagged as well. In 1999, I took a 50 percent stake in a joint venture by DreamWorks and Ron Howard’s Imagine Entertainment. It was called Pop.com, a short-film production company for the Internet, what initially seemed like the perfect Wired World application. The problem was that we overestimated both the adoption curve for broadband and the appetite for short-form videos. Millions were entering AOL chat rooms or downloading songs from Napster, but less than one in ten households had high-speed connections. Without one, a six-minute short could take up to an hour to load. Pop.com closed a year after it opened. Like SkyPix, it was hatched before its time.

  I had great moments with DreamWorks. When American Beauty won the Academy Award for best picture and I met Kevin Spacey at an after-party, he was over the moon, clutching his Oscar as though he’d never let it go. Then there was the time Spielberg invited me onto the set of The Lost World, the Jurassic Park sequel. For hours I observed a laborious sequence of takes and retakes and camera setups. For someone uninvolved in the process, it was like watching beautiful paint dry.

  Katzenberg periodically ushered board members to dog-and-pony shows at the studio, but he seemed resistant when I suggested that he shift completely from cel-based animation to the computer-generated format used in Shrek. (He got there a few years later. Today, all DreamWorks animated films are made in 3-D computer-generated imagery, or CGI.) I did make one aesthetic contribution, however. At a Shrek screening, I had the nagging sense that something was wrong. Then it came to me that the title character’s footsteps weren’t disturbing the ground. I pointed it out to Katzenberg, who told me later that he’d gotten it fixed.

  Its thoroughly modern image notwithstanding, DreamWorks treated investors in the Old Hollywood tradition: Give us your money, and we’ll introduce you to some interesting people. But we really don’t want your input. The board’s input was minimal. Katzenberg would outline the company’s plans and tell us that everything was good, and tomorrow would be even better. DreamWorks was 180 degrees from the self-flagellating culture I’d known at Microsoft.

  By 2003, with record companies devalued by file sharing, the studio’s music division had been sold. Plans for interactive computer games and other Internet ventures were shelved with the dotcom crash, and the live-action division continued to falter. The studio came back to me periodically for cash, more than $200 million in all, and my stake grew to 24 percent. After a series of bombs, notably Sinbad: Legend of the Seven Seas, my investment was under water. By the terms of our agreement, I could soon exercise my option to start cashing out. It no longer seemed prudent to wait.

  In 2004, after hammer-and-tongs negotiations, DreamWorks agreed to spin off its animation division—its one consistent source of profit—in an initial public offering. I divested slowly to avoid destabilizing the stock, and got another chunk of my investment back when the live-action division was sold off to Viacom in 2006. The following year I resigned from the board.

  When the smoke cleared, I wound up more or less doubling my money. After a dozen years in the glamorous, high-wire world of film production, I would have done about as well with a certificate of deposit. I just didn’t mesh well with Hollywood. I could never tell how much of what people told me was real.

  Even so, DreamWorks failed to sour me on the art of moviemaking. I continued to work with Richard Hutton on my own film company, Vulcan Productions. We followed a distinctly non-Hollywood formula of bare-bones budgets (as little as $1 million or less for live-action releases), creative freedom for directors, and generous revenue-sharing deals. Our documentaries (notably Evolution and Rx for Survival: A Global Health Challenge) won three Peabody awards, as well as an Emmy for Outstanding Informational Programming. The U.S. Defense Department will be distributing 200,000 tool kits with This Emotional Life, our series on human psychology, for returning servicemen and their families.

  Among our feature films, Hard Candy and Where God Left His Shoes won outstanding reviews, while Far from Heaven, with Julianne Moore and Dennis Quaid, earned four Oscar nominations. Films like those reminded me of the magic of great acting and directing and screenwriting. And how much I enjoy sitting in a dark room, watching a great story unfold.

  CHAPTER 19

  FAT PIPE

  Prescience is a double-edged sword. If you’re a little early, you might hit the jackpot with Altair BASIC or Starwave. But if you’re too far ahead of technology or the market, you can wind up with something like Metricom.

  With the advent of digital cellular technology in the early 1990s, it occurred to me that the Wired World “pipe” for the global network of the future might not be wired, after all. The appeal of wireless technology, named untethered access, was obvious. Because most people move from home to work to shops and restaurants in their daily lives, I thought the Internet should travel with them. Who wouldn’t want to surf the Web when riding in a car, or check e-mail in the shoe department at Nordstrom’s?

  In 1993, I bought my first shares in Metricom, a broadband mobile data provider with national aspirations. At the time, it was the one reliable wireless avenue to the Web. A Metricom customer could Velcro a modem to a laptop and get consistent digital service throughout a wide area network, or WAN, from the corner coffee shop to the airport gate. It was a grand idea, and soon I’d built a controlling interest. But Metricom’s business model was strategically flawed. The company tried to get too big too fast, in too many markets at once. As installation lagged behind manufacturing, piles of very expensive equipment filled our warehouses and drained our working capital. Given that Web browsing was still a novelty (our national subscription base peaked at around 51,000), a fast-tracked rollout was an act of hubris.

  As Metricom’s losses mounted, financing dried up. Telecom investors were among the first to hit bottom in the dot-com bust, and they had little left to invest. Meanwhile, mobile phone companies began to pour billions into their digital 2G wireless networks, with cell-based systems and cheaper chipsets.

  Metricom filed for bankruptcy in July 2001. Just one year later, the BlackBerry smartphone would confirm my intuition that people were eager for mobile data. Five years after that, the iPhone would help establish a mass market for it. But consumers weren’t quite ready for our product, and inept management was the coup de grâce. Metricom demonstrated the many pitfalls that lie between an idea’s genesis and its execution.

  ON AUGUST 9, 1995, Netscape doubled the opening share price for its initial public offering to $28 then watched the price soar to $75 by the end of the day. As the Internet continued to gain traction, I could see that it would soon swamp walled gardens like AOL. There could no longer be any doubt about the essential platform for the Wired World: It was going to be the Internet. By 1996, 36 million people were using the Web regularly, more than double the total from one year before.

  For me, just one question remained. What pipe was best suited for bringing data streams into the home, to accommodate both the Web sites of the day and the more demanding content of the future? In 1995, twisted-pair phone lines ran analog networks at 28,800 bits per second (bps). DSL, which piggybacked on the copper lines, was rated at 128,000 bps. Satellite broadcast operators offered a broadband signal at a more competitive 12 million bps, but they were hamstrung by going predominantly one way, from operator to consumer, which made Internet service impractical.


  That left cable TV, the poor-relation delivery system best known for mediocre video quality, terrible service, and a lethargic monopoly mentality. Even so, it held the most promise for the long term—you could tell by the capacity of its pipes. Coaxial cable carried 10 million bits per second; optical fiber cable, the distribution backbone, 2.4 billion. A hybrid fiber-coaxial system, which some operators had begun to deploy, was hands down the fattest pipe around.

  My excitement over cable had less to do with television service and more with the other things that could flow through it, from home shopping to streaming video. It seemed like the best bet for two-way, high-speed, affordable data, the most logical platform for Starwave and Ticketmaster and a thousand other applications. While not as ubiquitous as the telephone, cable was already in people’s homes. By the end of the nineties, 65 million households would be subscribers. Just as the personal computer revolution had flowered with software applications like word processing and spreadsheets, cable was primed to become the interactive foundation of the Wired World.

  Early on, I invested in companies that would prosper as high-speed data networks expanded, like Go2Net, a broadband Internet portal, and ZDTV (later TechTV), a network that covered the latest developments in technology. For greater impact, though, I thought I needed a pipe of my own. Cable was a big gamble. I’d have a smaller footprint than established powers like Time Warner and Comcast, and the price of admission was exorbitant. But I wanted to put my Wired World vision to a real-world test. And I felt sure that I could add value with innovative technologies and interactive content, key ingredients for the computing of the future.

  As I hunted for a point of entry, a sequence of developments turned the industry upside down. The Telecommunications Act of 1996 opened cable-franchised areas to television service by satellite and phone companies. To stave off competition, cable operators responded with massive outlays to upgrade from analog to digital. They had a long and expensive way to go—by the end of 1997, only one in ten cable customers had access to digital TV. These pressures set off a furious wave of consolidations. Stronger companies swallowed weaker ones and swapped systems to concentrate their customer bases. The timing seemed perfect for someone with new ideas and lots of capital. But as Fortune observed in 2000, after I’d joined the cable fray: “As with any new technology wherein lots of players chase a limited pool of would-be subscribers, someone’s bound to go down. Hard.”

  IN APRIL 1998, I paid $2.8 billion for Marcus Cable, a Texas-based operator with more than a million customers. That transaction, I told the press, culminated a long-standing dream: “Over twenty years ago, even before I helped to co found Microsoft, I saw a connected future. I called that future the Wired World. By investing into Marcus Cable, I will finally have some wires for my Wired World.”

  My pivotal buying opportunity came three months later with Charter Communications, based in St. Louis. The tenth-largest MSO (multisystems operator) in the country, Charter had 1.2 million subscribers. It was the number-three cable provider in the balkanized Los Angeles market, which I saw as a potential anchor. Factoring in $1.9 billion of debt, Charter would cost me $4.5 billion, or fourteen times its projected operating cash flow. The Los Angeles Times called it “a rich price even by the standards of the merger-crazed cable industry.”

  Responding to that perception in a July 1998 e-mail, Bill Savoy optimistically advised:

  It is also important to note that Charter has the best performing cable properties in the industry, as measured by both growth and by cash flow per subscriber. So a 14x multiple is not outrageous, we paid almost 12x [actually 11.1x] for Marcus and AT&T paid 16x for TCI.

  What Savoy failed to note was that I was buying at the top of the telecom boom in a notoriously cyclical industry. In three months, I’d spent more than $7 billion.

  Scale and density are make-or-break factors in the cable business. I set a goal of 5 million customers—music to the ears of Jerry Kent, Charter’s CEO, who loved making deals as much as Savoy. Over the next nineteen months, after merging Marcus with Charter, we acquired a dozen more cable businesses in a $23 billion spree. In 1999, to subsidize our rapid expansion and help upgrade our systems, Charter raised $3.7 billion in one of the largest IPOs in U.S. history.

  It was a dizzying ride. None of us sufficiently scrutinized how well Charter’s new pieces fit together operationally or, more important, whether the company could survive its mounds of debt if its growth curve were to flatten. Cable is a capital-intensive industry that borrows heavily to extend and upgrade infrastructure. During the boom of the late nineties, when bankers lent freely to operators, conservatively managed companies like Comcast and Cox were leveraging at around four times their operating cash flow (earnings before interest, taxes, depreciation, and amortization, or EBITDA). But within months of the Charter acquisition, our debt multiple stood at more than nine times EBITDA. We were wildly over-leveraged. (I can still hear Bill Savoy saying, “Jerry thinks nine times is what we should go with.”) Our heavy debt service created negative cash flow, making us vulnerable to interest rate hikes, bumps in the economy, or corporate missteps. If all went well, our leverage would boost our stock price, but if something went wrong. …

  That was my blind spot, and my first big mistake with Charter. My second: In deals to buy other systems with Charter stock, I guaranteed that the former owners could sell their shares back to me at a prenegotiated price. If cable values fell and the stock slumped, that price would be grossly inflated. The sellers were protecting their downside at my expense.

  My third error was underestimating the importance of critical masses of customers. While other MSOs had been building out systems in major cities for years, Charter’s acquisitions were mainly weighted in far-flung rural networks with relative handfuls of subscribers. Though we had substantial segments in St. Louis and in Fort Worth, Texas, along with a good share of Los Angeles, we never gained control of a top market. Our strategy to become the dominant operator in L.A. foundered when we were outbid for Adelphia and Century Communications.

  What’s more, our largest acquisitions were second- and third-rate assets. Most of Falcon’s systems were in remote areas of Southern California and offered only thirty-five channels, barely a third of the industry’s norm. It would take a huge capital investment for Charter to catch up, and a lot more to upgrade the company’s infrastructure. Even after doing so, our returns would pale next to those of more urbanized operators.

  In October 1999, hungering for a presence in New York and other major cities, I invested $1.6 billion in RCN, a high-end, fiber-optic “overbuilder” that tried to poach customers from entrenched cable franchises. The problem was that RCN couldn’t get enough customers to justify the expense of building out its network. Plagued by steady losses and crushing debt, the company eventually filed under Chapter 11 in 2004. It emerged from bankruptcy with new management a few months later, but my investment was essentially wiped out.

  As I pursued my cable vision into the new century, all the ingredients were in place for me to be in over my head: an over-leveraged company, stiff competition from satellite providers, a wheeler-dealer CEO, and my own lack of experience with the industry’s financial variables. Then, in 2000, the tech bubble burst. Charter’s plan for a secondary public offering, a much-needed capital infusion, had to be canceled. With Wall Street eyeing cable balance sheets skeptically, the company’s valuation crumbled.

  We were hanging by a string.

  * * *

  IN A CABLE WORLD interview published in November 2000, Jerry Kent was asked, “What’s it like to be the anchor of Paul Allen’s Wired World?”

  Kent replied, “When an individual entrusts a management team with a $7 billion investment … it means we have an awesome responsibility to execute and perform.”

  But while he said the right things in public, Kent behaved erratically behind closed doors. In the fall of 2001 (just after 9/11), in a decision that seemed impulsive and bizarre at the time, he
announced his resignation.

  One year later, Charter’s subscription base peaked at 7 million customers. But as the tech slump became a crash, cable operators were hit hard. Adelphia collapsed into bankruptcy, leading Wall Street to downgrade its outlook on the whole industry. The value associated with each subscriber shrank by a third or more. Highly leveraged companies like Charter were valued at less than ten times operational cash flow, considerably under what I’d paid. The company’s share price, as high as $25 a year earlier, tumbled by 80 percent.

  That summer, I learned that Charter management was under federal investigation for accounting fraud, which led to the indictment of four top executives. With our reputation in tatters, the company’s share price fluctuated wildly, sometimes dipping below a dollar. Charter’s debt climbed to $17 billion. Jerry Kent’s sudden resignation began to make sense to me. One could speculate that he saw serious problems heading Charter’s way.

  When I told David Geffen what was going on and described the guidance I’d been getting, he said, “You have been so poorly served.” Then he wheeled into advice mode: “Here’s your best chance to fix this. You’ve got to go to New York and find the best attorneys, the best restructuring guys—the people who really know their way around.” I hired the New York law firm Skadden, Arps to guide Vulcan through our legal issues, and Miller Buckfire for strategic advice. Separately, Charter brought in Lazard Frères, a top advisory investment bank. In this dire situation, we finally had the right people on our side.

  An outside financial analysis was both sobering and hopeful. Of Charter’s $20 billion value, 85 percent was debt, a load that continued to gulp our cash flow and then some. But with most of our capital upgrade complete, the analyst concluded, the debt leverage should recede to more acceptable multiples by 2010. Some of my old optimism returned. Once we stabilized the financial operation, I felt confident that we could speed the innovations to lift the business.