March 14, 2002

The bigger they are, the harder they fall.

This looks to be the imminent future for Kirch Gruppe, the big German media concern built up by one of Europe's most risk-taking and successful media moguls. Now saddled with debts and liabilities worth an estimated E 9 billion, the music looks like it has stopped for the 75-year-old Bavarian Leo Kirch, but the big question remains: who will pick up the pieces?

Kirch's complex web of TV and film and TV rights businesses, built over the last 50 years, involves a lot of creditors, from Germany's largest banks to Hollywood studios to agreements Kirch made in better times to raise money from partner companies, including publisher Axel Springer Verlag and BSkyB. The problem is that the piper needs to be paid now and these are monies Kirch just doesn't have.

Kirch's bankers, of which there are many, including Bavaria's Bayerische Landesbank, which is half owned by Bavaria's government, and has a staggering E1.9 billion exposure to Kirch Gruppe, may yet figure out a way to buy Kirch some time. The banks may buy out certain assets themselves rather than booking ugly looking losses on their balance sheets. There is also a very real political component. Over his years in business Kirch, who is one of the largest employers in Bavaria, has made friends in high places, including with Bavaria's Prime Minister Edward Stoiber. With an election coming in September, Stoiber would certainly like to keep the economic boat from rocking. The handy media duooply in Germany between Bertelsmann's RTL and Kirch's ProseibenSat.1 has also suited politicians of both parties eager to protect Germany's airways from being sold to foreign interlopers like Rupert Murdoch.

But apart from the possible largesse of the banks, Kirch has little to fall back on. He has put many assets on the sales block, like his stakes in Spanish broadcaster Telecinco and publisher Axel Springer. But attempts to sell Premiere World, the struggling pay TV operation is going to be tough. With estimated losses of E2 million a day, Premiere World will run out of funds by September. BSkyB has said it is not interested in Premiere (largely to protect its share price from the imploding German pay TV business) but Rupert Murdoch has long had ambitions in Germany and might be interested in a deal perhaps through News Corp. However, Premiere, which counts only 2.5 million subscribers after six years in business, may not even survive long enough to be sold off. If insolvency experts hired in February by Kirch to look at his options believe that KirchMedia, Leo's core TV and film rights trading unit, could survive a shut-down of Premiere, the pay TV unit could very well be shuttered.

The tricky bit is that Premiere buys film rights from KirchMedia, which has long-term output deals with most large US studios. A closure of Premiere would force KirchMedia to write off the rights while still facing an estimated E3 billion of obligations for films to be delivered through 2006, which is what the insolvency guys are trying to finesse. Premiere's woes are also the reason why the planned merger of KirchMedia into publically-traded TV broadcaster ProSeibenSat.1 has been put on hold: the public shareholders want to make sure that they do not take on all of Premiere's and KirchMedia's liabilities.

Meanwhile, at least two Hollywood studios --Warner Brothers and Paramount-- are looking at bidding for Kirch Gruppe's 52% stake in ProSeibenSat.1, which is worth an estimated E1.6 billion, and is considered Kirch's best asset. Such a deal would trigger a mandatory offer for the 36% of the ProSeibenSat.1 equity held by the public. If successful, this would mean the broadcaster would be taken off the market to be re-listed when media values improve. Disney is already an investor in two RTL stations in Germany so there is precedent and Disney may even be interested in a piece of Kirch's broadcasting business as well.

Others are circling different parts of the crumbling Kirch empire. Formula 1 promoter Bernie Eccelstone and the main carmakers in the races are looking at buying out Kirch's majority stake in the holding company that controls the broadcasting and other commercial rights to F1 racing. The issue is price. Eccelstone knows he can drive a hard bargain so any offer will likely be far below what Kirch originally paid.

Given that Germany has the biggest TV advertising market in Europe, low pay TV penetration and no restrictions on foreign ownership of media assets, you would think that a fire sale like Kirch Gruppe would be a feeding frenzy and an invitation to outside players. However, the power and incestuous nature of Germany Inc., the nexus of German financial and political power, is still very much alive. Look at the recent failure of John Malone's Liberty Media to gain control of Deutsche Telekom's cable assets. Liberty's E5.5 billion bid was thwarted by a combination of entrenched local interests (including RTL and Kirch's ProSeibenSat.1 who complained to regulators that Liberty, a programming company, would have control over one of Germany's key content distribution platforms), a Byzantine local regulation structure and what Liberty called a "short-sighted" regulatory approach.

Maybe Kirch won't fall as far as we think.