Street Capitalist: Event Driven Value Investments

John Malone, Liberty Media’s chairman is one dealmaker I’ve been studying more closely these days. He’s really a master at figuring out tax efficient ways of doing deals that create value for shareholders. What I like about him is that in general, investors have made money investing alongside Malone. That’s not always the case when you try to follow other star capital allocators..

Today is Liberty Media’s investor day and you can register for the webcast here. For those interested in the company and some of their business units, these webcasts are very helpful.

For now though, if you look at Liberty Media’s 8-K from the middle of September, you can get some great insights from Malone:

Jessica Reif Cohen – Bank of America Merrill Lynch – Analyst

What is your favorite tracker currently and why?

John Malone – Liberty Media Corporation – Chairman

Well, I love all my children and currently, I think that there are buybacks in two of the three that the company is engaged in, or is authorized to do. The third is really — LINTA, we really are not or have not been buying stock back pending a decision on whether or the separation of LINTA into a separate asset-backed company is going to be okay with the bondholders, but I would say each one is sort of different.

Starz on a multiple basis seems cheap to me. We now have strong operating management. Chris [Albrecht] came over from HBO. We’ve had good success with the first couple of major series that we’ve added to the programming lineup. Obviously, the Netflix deal with Epix kind of demonstrates the kind of economics that might be available for that component of the programming right, fairly big numbers. So I think in the short run, Starz is pretty cheap. [LCAPA] is — a sum of the parts analysis, it’s cheap, particularly if you are as enthusiastic about SIRIUS, SIRIUS XM, as we are and I’m quite enthusiastic about it.

And then QVC just continues to grind out massive amounts of free cash flow, that you’re talking there about a leveraged free cash flow asset with cheap leverage and good tax attributes. So that one looks to me like it’s pretty cheap. So I was explaining to somebody a little while ago that in 37 years in the business, we have never issued equity except twice. Once was in September of ‘87 and we bought it back in November of ‘87 after we issued it at about $0.[60] on the dollar and that was when we bought Heritage Communications.

So generally speaking, we’ve always believed that our company was trading cheap on the public market and we’ve been a net acquirer of shares, redeemer of shares, consistently. We’ve never paid dividends because we think shareholders should have the right to decide whether they want to take capital back or not. So buybacks have always been our preferred method for — and we’ve done tax-free distributions which are involuntary, but don’t involve a decision by the shareholders, so those are kind of our ways of returning capital. So I don’t know which one would be my favorite. . .

Audience Participant

Speaking of Starz, can you talk maybe about how the Epix Networks transaction has maybe changed some of the possibilities (inaudible) what you were just saying there as it relates to a higher value [of some of the entities] as it stands? What’s the thought process in terms of a billion dollar balance sheet, etc.?

John Malone – Liberty Media Corporation – Chairman

Well, of course, Starz is unlevered. It sits with a billion of cash within the Liberty Starz tracking stock entity and we are not well noted for under-levered enterprises. So it’s unlikely that we’re going to sit with Starz paying a full statutory tax load for very long, so we’ve got to do something. Exactly what we’re going to do, I think, is in deliberation right now.

And clearly, the number one question for us is the issue of the bondholders in Liberty at large relative to the question of substantially all in the creation of the QVC-LINTA separation. That is kind of — as Yogi Berra said, “That’s the fork in the road that we gotta take.” So until we know the answer to that, we’re a little bit frozen in terms of what we do relative to realization on Starz, but as I say, it’s highly unlikely we’re going to let Starz sit there unlevered and sit with zero yield on the cash.

I mean, that’s not — that’s no good. So we’ll do something. We probably won’t really be in a position to do something until probably the first quarter of next year to actually execute something, but we’ll definitely do something. And of course, I’m very high on Chris and the kind of energy he’s bringing to that business, so we’ll see, but obviously, that whole industry is going through a lot of transition. Those digital rights that Starz sits on are clearly worth a lot and I don’t think it’s likely that we’ll sit there and be a passive player in the streaming over-the-top world for very long.

Starz is one I’ve posted about before back in July, so far I’ve been pretty happy with it. At the time, it traded at $53 which I thought was pretty cheap considering the potential up side from their plan to break into original programming now that Chris Albrecht (from HBO) is running the show. In August though, we got a bit of a bonus from the fact that Netflix signed their deal with Epix at a much higher multiple than what they currently pay Starz. If you adjust for that, LSTZA is probably trading around 5x 2012 EV/EBITDA which is not a bad multiple for a company that still has potential to grow and is totally unlevered.

At a more recent conference, Liberty Media CEO Greg Maffei discussed the cash on LSTZA’s balance sheet:

Jason Kim — Goldman Sachs – Analyst

Okay. And as a follow-up, as of the second quarter, Starz had about almost $1 billion of cash on the balance sheet and virtually unlevered at this point paying cash taxes. So what do you think the appropriate use of the cash is right now? Would you consider levering up Starz going forward? And if so, what do you think would be the appropriate leverage for a business like Starz?

Greg Maffei — Liberty Media Corporation – President and CEO

Well, I think you know that Liberty’s history is probably to put more leverage on companies than zero and so it is likely over time that we will add leverage to that company. One of the questions we have had is what is the right configuration for Starz both in terms of the capital side. Obviously the right-hand side of the balance sheet and looking at leverage but also what other assets, what other kind of partnerships do we want to be in? And we have been contemplating and looking at a variety of those.

We have a relatively new CEO as I mentioned in Chris, and led by him but in conjunction with Liberty. We have been looking at ideas about how that asset, how that service would be best positioned for the future and would that require more capital?

And that is why if we have had a hesitation in purchasing stock, in levering up Starz, and those kind of structurally balance sheet questions, that has been in part because looking at the left-hand side, what other assets, what other kind of partnerships did we want?

In addition, we have noted there have been certain milestones along the way to give us confidence in the business, some of which we have hit. The reattribution of Starz Media, the signing of our biggest distribution partner, biggest by number of subs in Comcast. Completion of other partnerships is still out there. Those were all probably important milestones that will give us confidence in the business and a better sense of what the long-term leverage ought to be.

Some people speculated that maybe Netflix would not renegotiate the contract, but I doubt it. They are in the process of dramatically expanding their margins with the shift towards instant streaming and are planning to use the cost savings to acquire digital content rights. Malone’s planned hard spinoff of LSTZA (rather than the current convoluted tracking stock structure) should help clarify the story a bit and get market participants to take notice.

There are some other businesses under Malone’s control that are worth looking at. QVC within LINTA with its free cash flow is pretty impressive when you consider the fact that only 10% or so of audience members are actual customers. If they can figure out a way to increase their conversions, the company could generate a ton of FCF. Then there’s Liberty’s stake in Sirius. Here’s what Maffei has to say:

Unidentified Audience Member

Question regarding the rationale for splitting Liberty into two companies. Isn’t at least over time most of the taxable income generated by the LINTA entity that will be separated from the other two tracker stocks, at least in a corporate form?

Greg Maffei — Liberty Media Corporation – President and CEO

Yes.

Unidentified Audience Member

And if that is the case, isn’t splitting the Company into two taking away part of the future potential benefit of if you were to buy enough — have enough of a serious stake that you could accelerate the use of Sirius’s NOLs?

Greg Maffei — Liberty Media Corporation – President and CEO

That is a great question. It is one of those ones you can look at and say if you were to own tomorrow 100% of Sirius, $9 billion of NOLs, wouldn’t that be a benefit and wouldn’t you want to keep the whole company together? That is a great question.

It is one of those ones probably that is more theoretical than realistic. Just if you look at the structure of our contract with Sirius, if you look at the Sirius earning capabilities, you look at the issues around making them go [solely], these NOLs. It is just probably a thicket too hard to get to imagine that we would get there. And if you ever did consolidate it, which who knows, there is probably enough other kinds of income at LCAPA that we could potentially shield like our shore against the box and some of the other things that when you look at that combined with the earnings of Sirius, it is just a bridge too far.

You are asking to hold that and say I won’t do a split we believe is beneficial and it is also by the way another issue is who is getting these tax benefits, which group of shareholders? There is just a lot of moving parts there to think about. But it is a great theoretical question.

For those of you that don’t remember, When XM Sirius was teetering towards bankruptcy, John Malone came in and infused the company with $530M of much needed capital via convertible debt, which also gave him a 40% stake in the business. That stake is now worth about $1.89B. Not a bad return in only 1.5 years. Liberty cannot accumulate more than 49.9% of Sirius until the second anniversary of their deal (Feb 2011). I’ve seen some speculation that the company could try to make an offer for the rest of Sirius in 2011 and then use it for a hard spin of LCAPA because it would give the company real operating earnings. Maffei seems to be arguing against such speculation though.

I think that going back and looking at some of Malone’s moves are worthwhile for investors, especially ones that are looking to get better at identifying potential special situations. Looking back at the complicated tracking stock structure that Liberty currently uses, it’s easy to see that an actual hard spinoff would probably unlock some value. And I think if you start thinking about potential balance sheet events, before they happen, when analyzing companies — you’re in a good spot.

Finally, I wanted to include this hour long interview Malone did with CNBC. It’s awesome.

Sorry for the light posting lately. I’ve been tied up with a couple of projects and have had to travel a bit. I should have a regular stream of posts coming up soon.

John Malone is renown as one of the best dealmakers in media and entertainment. He recently gave an interview with some of his thoughts on the industry:

WSJ: What are the big risks and opportunities for cable operators right now?

Mr. Malone: Cable has come through technologically in great shape relative to its competitors. The telcos, unless they’re willing to spend a massive amount of capital—like [Verizon Communications Inc.'s] Fios has—have run out of steam in terms of the speed of their Internet capabilities. The real issue I think for cable right now, at least in the U.S., is regulatory.

WSJ: Does Liberty want to invest more in cable?

Mr. Malone: We’ll undoubtedly hold our position [in Time Warner Cable]. And we may choose to increase it if we think cable’s undervalued. That would be a good way to play cable. Just own some more Time Warner Cable.

That would be the only way I could see us playing in cable networks domestically. Internationally, of course, Liberty Global is always in the hunt and has a pretty good pipeline of potential acquisitions. Hopefully we will find some good M&A opportunities, but outside the U.S., in cable.

WSJ: What do you mean?

Mr. Malone: It is entirely feasible that government may choose to open these networks up. They could come in, for instance, and tell cable operators they can’t bundle broadband with video, with telephone, that they’ve got to sell them all a la carte and they can’t do any deep discounting, no exclusionary deals and so on.

And [as they review the Comcast-NBC deal] they can set the pattern that they would later enforce on the industry at large through rule-making.

Malone Is Fired Up By Cable And Ready To Buy (WSJ)

For investors looking to partner up with Malone, there are a few options. Liberty Media Capital (NASDAQ:LCAPA) operates as Malone’s hedge fund. Valuing LCAPA takes some work. The company invests in public and private businesses, which adds complexity. You really want to try to look at it from the perspective of net asset value (NAV) but the problem is that some businesses are extremely difficult to value. This is particularly evident in the company’s ownership of the Atlanta Braves and certain debt/mezzanine investments. Ultimately, I think that this creates opportunity for investors, especially when the markets turn volatile.

Some of Malone’s other holdings are more straightforward to value. Take Starz (NASDAQ:LSTZA). Starz is a premium movie channel that is available to most cable and satellite subscribers. I like this company because it is almost like a tollbooth. Starz basically licenses content from movie studios and then sells it to the cable companies. There’s really no risk of content production costs. A subscriber might elect to go with a plan that gives them HBO, Showtime, and Starz because they are already pre-bundled.

I would value Starz using an EV/EBIT multiple. The company has about $1B in cash with virtually no debt. That brings enterprise value (market cap + debt – cash) down to $1.75B. Using the TTM EBIT figure, we get $330M. That gives us an EV/EBIT of about 5x. To me, that is pretty cheap. Yes, media companies face a good amount of competition, but the tollbooth like nature of the business means it is worth at least 7.5 to 9 times. With the current price around $53, it should fetch a per share valuation of $80 to $95 per share, or a gain of 51% to 80%.

Liberty appears to think the business is undervalued as well:

Share Repurchases

From January 30, 2010 through April 30, 2010, Liberty repurchased 539,970 shares of Series A Liberty Starz common stock at an average cost per share of $47.40 for total cash consideration of $25.6 million. Since the introduction of Liberty Starz on November 19, 2009 through April 30, 2010, Liberty has repurchased 1.1 million shares at an average cost per share of $48.06 for total cash consideration of $53.3 million. These repurchases represent 2.1% of the shares outstanding. Liberty has approximately $446.7 million remaining under its Liberty Starz stock repurchase authorization.

Quarterly Press Release (Liberty Media)

So what might be causing the company to remain undervalued?

1. Starz is a tracking stock, which makes analyzing its financials a bit more complicated. I don’t think many investors are used to dealing with tracking stocks so they might just ignore the company.

2. There seems to be an overall bearish sentiment towards media stocks. Investors might be critical of Starz because as we transition towards consuming more television over the internet, the barriers to entry come down. Starz aggregates content that is created by studios like Disney and some analysts have questioned whether the internet will “cut out the middlemen”. Instead of watching Disney movies on Starz, we will watch them via Disney.com or a video site made in partnership with content creators (such as Hulu.com). So far this has happened with TV programming but not films. Plus, Starz retains the digital airing rights for the content that they license. That is what allows you to watch Starz on Netflix. Over the longer term, I do think there is potential for their business model to be eroded by direct connections to the content creator. I think it will be important to monitor how successful the premium Hulu Plus service is in order to gauge that potential.

3. Investors might be nervous about investing in a business that is so controlled by John Malone. So far though, Malone has been really savvy in the media business and I don’t expect that to cease any time soon. The greater risk might be increased inter-group lending where Starz uses cashflow to provide loans to other Liberty Media units. I think that is probably the greater risk but that it is still pretty limited. The appointment of Chris Albrecht, who used to run HBO indicates that Liberty is serious about making Starz into a competitive pay TV network.

I think that if you are interested in examining the businesses within Malone’s empire, Starz is a good place to start. The business model and structure is simpler than others and the current valuation is pretty attractive.

(Update: the interview is up now over at Charlie Rose)

A while back, when talking to a friend of mine who works in advertising, I mentioned that I thought Hulu would be an amazing place to work at in this point in time. Hulu is one of the rare cases where you see traditional media companies “getting it” where they embrace new technologies that work really well. Hulu has had huge success and recently its been reported that advertisement buys on the website are most costlier than buying space on TV. My guess is that this is the beginning of a long-term relationship between Hulu and its viewers. So far the company is creating great brand equity by providing online users with a place to view high quality online content in a really enjoyable manner. I don’t see their model eroding anytime soon.

As value investors, we spend an awful lot of our time looking at distressed sectors of the economy. I’ve spent quite a bit of time looking at media companies and found myself a bit confounded. Take a company like News Corp. Rupert Murdoch is arguably one of the savviest media operators in the business. In general, News Corp boasts a more robust digital portfolio of businesses than others — but still they face some trouble. The company’s large newspaper holdings have seen declining ad revenue and even their big media acquisitions like MySpace have faced troubling headwinds as Facebook erodes their user base.

Hulu though, seems to be a prime example of a new online business that knocks it out of the park. Originally started a joint venture between News Corp. (27%) and NBC (27%), Hulu now includes Disney (27%) and Providence Equity Partners (19%). Basically every major TV network except for CBS and The CW.

When I look at media companies, especially in this environment, my first aim is to normalize earnings. It’s tough because the way we consume media is shifting and the new methods of consumption aren’t always monetized well enough. It used to be that you couldn’t count on online monetization because media companies hadn’t figured out but now I think that’s rapidly changing.

CHARLIE ROSE: What is going to be the business model for the monetization of content on the Web?

JASON KILAR: I think it’s going to be a number of things. You know, clearly, when you look at Hulu today, we have a free ad-supported model, and I think that happens to be the biggest. If you take a look at the way the premium content is monetized, there’s a lot of different models out there. Sometimes you pay for an individual episode, for example on iTunes. Other times you pay for a
subscription. And other times it’s free ad- supported.

And if you look at just in the U.S., it’s about a $57 billion industry with regards to ad-supported premium content. That’s the biggest pond.

CHARLIE ROSE: And what is defined as premium content?

JASON KILAR: Premium is — the way that I define it is, it’s done by people who do this for a living. Which doesn’t necessarily mean that it has to be on television. There’s a great example of premium content called “Dr. Horrible’s Sing-Along Blog,” which is created by a guy named Joss Whedon, who created “Buffy the Vampire Slayer,” he’s doing “Dollhouse” right now. He did that on his
own, on his own dime, during the writer’s strike.

That’s premium content. You won’t find it on television, but it’s absolutely premium.

CHARLIE ROSE: Right.

JASON KILAR: So with regards to the business models, I think you’re going to see a lot of different flavors of it. There is going to be free ad-supported, which I happen to think is the most ubiquitous one and the largest one in absolute dollar terms, but there’s also a lot of other models that will be a part of monetization on the Web, including a la carte, subscription, and variants thereof.

The content monetization model that Kilar talks about is akin to the freemium model that’s tossed around a lot by people like Fred Wilson where there isn’t just one system of pricing. Instead you see these tiers, the lowest being free and then it scales up from there. I think that freemium has a tremendous amount of potential, the trick though is to make it so there are real incentives for users to opt for the premium offerings.

One of the really great points that Kilar brings up is that now, media is becoming more of an impulse response business:

JASON KILAR: At one source. So there’s — I’m a big believer that media is an impulse business. You don’t need “30 Rock” to live another day. It’s not like food and clothing and shelter. And I love “30 Rock,” but it’s discretionary. And so the fact that it’s an impulse business means that to me, if you can make it easier to consume, people will consume more of it. So I think the a-ha moment for consumers… was that basically they could consume “30 Rock” when they wanted. When it was convenient after the kids went to sleep or in the morning when they had a break. And that’s very liberating, it’s very empowering, and I think at the heart that’s a big part of the Hulu value proposition.

One of the things that I think is a real feat on the part of Hulu is creating a really well designed and easy site. I originally had the opportunity to beta test it and told everyone I knew about the service and how awesome it was. Sure, some people remarked that they already used similar sites online but typically these were hastily put together and often made the user experience frustrating. Hulu looks and works really well which makes it perfect for this shift towards impulse consumption. The easier these are, the more likely users are to use them.

CHARLIE ROSE: Are we moving to a point where there will be no sort of appointment television, no real-time television?

JASON KILAR: If we were to fast forward, I think that programming is always going to be a healthy mix of event programming and on-demand programming. There’s certain things like scripted dramas that — they’re either topical or such water-cooler moments that I think that they’ll be consumed within 48 hours. You don’t have to consume them at 9:00 at night, but you want to consume them within the first couple of days so that you can talk to your friends about it. The Susan Boyle phenomenon on “Britain’s Got Talent.” You needed to consume that within the first 48 hours to be in the know.

And so I think that for high-quality scripted content, that will be sort of an on-demand environment.

But you look at a lot of programming today, there’s a move to having it be an event program, because there’s value in that. “American Idol” is a great example. The finale of “American Idol,” that’s event television. And the Super Bowl, that’s event television. So, it’s not just sports, but there’s also, I would argue, a big swath of entertainment that’s also event television.

I think that Kilar nails it on what is going to happen with TV viewership. Certain forms of content like sporting events are always going to be consumed live. Shows like Lost where you have a cultish following are likely to be consumed the instant they air, just because their viewers are constantly awaiting their next fix. Other forms of content may not be consumed when they air. I see this being different for everyone though. I think that the lower you value a TV program, the less likely you’re to watch it the instant it airs. If you think about it though, this is going to be beneficial for content producers because it increases the likelihood of their mediocre offerings to be watched on demand with services like Hulu. Whereas before, the program may have been cast aside for lack of interest, now you’re more able to obtain followers. In the long term this is a definite benefit for media companies because it means the playing field becomes less cutthroat and that viewership actually increases (as should ad dollars).

On Newspapers:

JASON KILAR: You know, now that said, there’s a lot of smart people working on the newspaper side of the coin to develop new models.

CHARLIE ROSE: What’s your best guess the way that will end up?

JASON KILAR: So, I think that there’s going to be devices. The Kindle gets a lot of press right now.

CHARLIE ROSE: It does. So — go ahead.

JASON KILAR: Deservedly so, in that they are creating a model that has people get a very valuable thing– which is newspapers like “The New York Times” and “The Wall Street Journal”– on a device whenever people want to consume it, whether on the subway or what not. And they charge people for it. So that’s the beginnings of a business model. I know there’s a lot of contention about well, who gets what, how much does Amazon get, how much does the newspaper get?

CHARLIE ROSE: Well, the contention is not so much who gets what, it’s how much Amazon gets and how little they get.

JASON KILAR: There you go.

CHARLIE ROSE: As you know, because you were there.

(LAUGHTER)

JASON KILAR: I’m very aware of both sides, it turns out. And so that will play itself out, and I’m sure there will be plenty of drama, but these things do sort themselves out. And so I think that there — there’s good news, by the way, in that future.

So Kilar basically has two positions. Keep in mind that Hulu does not produce any of the content on their site and they don’t plan to ever start producing content. They just try to make it so that the content is easily seen which benefits the producers and earns them a cut of the ad fees. He thinks the Kindle is probably the future for newspapers. This might be because of his past experience working at Amazon. I think though that if you change the medium, people may be more likely to pay for news.

What I mean is that people are probably more likely to pay for a paper newspaper than a website subscription. Still though, we see paper subscription rates declining. What a device like the kindle would do is cut out a lot of huge capital intensive costs. The machinery and staff needed to do the actual printing and physical distribution would be cut.

The trick, like Kilar rightfully points out, is figuring out the balance in payments between the newspapers and Amazon or the other device makers.

Monetizing social networks:

JASON KILAR: I think that is fair to say. That is fair to say. And I think
the two — there’s nuance between the two. They’re not — and this is just my assessment. I think you would certainly need to ask them for their thoughts on the topic.

When I take a look at it, the situation is, as you say it, which is an enormous audience, but not an enormous advertiser reception yet, with regards to those companies.

On the one side with YouTube, I think a lot of it has to do with the environment and the content, in that advertisers tend to want to be associated with a certain type of content, which is that they know very well it has a certain quality associated with it that, quite frankly, that quality has a halo effect to their brand and their brand message.

CHARLIE ROSE: And that’s the window that you guys found? This opportunity you guys found?

JASON KILAR: And that’s exactly what we focus on. And so that’s the distinction there.

On the Facebook side, I think it’s a bit of an evolution, in that that company, which has clearly done amazing things, was, I believe, as an outsider looking in, was founded on a culture that was obsessive about the users. And they built a service that is very valuable for users, and that is to be
applauded.

I think challenge for Facebook is to develop a culture that has the advertiser and the ad service be as strong a part of their culture as the user obsession is. And that is a trick, because cultures are not very easy to change. They’re sometimes almost impossible to change. But that is I think the challenge
that they’ll have to.

CHARLIE ROSE: So, what’s the way out for them?

JASON KILAR: The way out is literally for Mark Zuckerberg– and he’s doing it, I believe– is to make sure that that’s a part of the culture, that the quality of the advertising service and the efficacy of the advertising service has to be talked about as much internally as the user experience. Only when you have that sort of obsession over both of the customers that are actually a part of that business, well, I think you have great, great traction on the advertising side.

I have a feeling that sites like YouTube and Facebook have a long term trend in their favor with their users that’s going to force advertisers to evolve. Right now, they’re very conservative about putting ads on YouTube or Facebook because it’s really unlike any other place they’ve worked before. But I remember hearing another ad executive on a podcast with the Economist say that advertisers are always nervous about new technologies. In the end, they end up embracing it.

Will Hulu start producing their own content?

JASON KILAR: … I’ll describe a little bit of Hulu, for example, a day in the life of Hulu.

We have three customers. We have users, we have advertisers, and we have content partners. We have three customers. We don’t have one customer, we have three. And we make all of our decisions in a balanced way. And, by the way, our rallying cry as a company is to make sure that we deliver a service that users, advertisers and content owners unabashedly love, which means that the design of the service has to delight advertisers as much as it delights users, and we’re not willing to settle for less than love, to be quite frankly — to be quite frank.

And so that’s an entirely unique culture, because it means that you’re boxing your decisions, in that you have to make sure that the design of the service is very aesthetically clean for users, but also focus for advertisers. And I’m not saying it’s easy, but we constantly live that delicate balance between our three
customers and not sacrificing one out of the three or two out of the three. And that’s a huge part of our culture. If you ever stop by the office, I think you’d feel that advertiser focus. You`d feel that user focus and you’d feel that content focus…

We’re very — a big part of our culture is that we’re humble, which means that we’re very self-aware, I guess you could say. We fancy ourselves pretty good at Web site design and pretty good at technology, very good at creating advertising services that work. We happen to think that we are uniquely unqualified to create content. We don’t write scripts. We don’t produce television shows. We are uniquely unqualified to do that. So I don’t see that happening. We certainly don’t have the capability today, nor do we have the ambition to do that. I think that there’s so many talented people out there that should be doing that, as opposed to a bunch of technology geeks, which is what you’d find at Hulu.

I really like that Kilar is very willing to contain the company’s culture and core competencies. Many business failures arise when management ventures into areas where they have no real experience. They end up hiring plenty of consultants and outside expertise at a great expense and waste capital which could be allocated better by sticking within their current business.

What I also think is great is that the company seems to be employing a kind of equity ownership program among employees. This is often found in a lot of start ups, but because Hulu is this joint venture between media companies I feel like it’s pretty different. Kilar mentions that it’s one thing that sets Hulu apart from its larger owners:

JASON KILAR: If you were to take a look at the culture of Hulu and the setup of Hulu and the, you know, it couldn’t be more different than the cultures of NBC Universal and Newscorp. Now, the cultures of Newscorp.

CHARLIE ROSE: In every way.

JASON KILAR: In every way. And by that I mean that the cultures of NBC Universal and Newscorp are ideally suited to their mission, but Hulu’s mission is very different, which by saying that it necessitates a very different culture.

We all fly coach class. We eat popcorn. Like, we have cardboard boxes that hold up our monitors. We are very frugal. That is needed for the culture. And the other thing is, everybody at Hulu is an owner in Hulu. That is so different than the cultures in traditional media. But that culture.

CHARLIE ROSE: How is everybody in Hulu an owner? Meaning all the people — all your partners are owners? All the people who provide the content are owners, or?

JASON KILAR: No.

CHARLIE ROSE: No, you mean the people who work at…

JASON KILAR: My assistant is an owner, my assistant is an owner in Hulu. And that’s the way it should be. Because if we’re fortunate to create upside and to create value for Hulu, I think everybody at Hulu should participate in that upside.

In general, I think that these ownership cultures tend to create environments of hungry employees who are really committed to their product. But it’s always a bit of a risk:

CHARLIE ROSE: OK. Why did they take the risk? I mean, is it because what you are offering is down the road or in the near term offers extraordinary opportunity for income? Is it because it offers an opportunity to build something? And what is that something that they think they’re building?

JASON KILAR: I’m very sober and a realist when it comes to answering this question. And I think if you were to get to know our team, the vast majority of folks, if not all of them, are at Hulu because they see the promise of a service that they so dearly wanted themselves growing up. You know, there’s something very powerful about what Hulu can do in terms of making media available on your terms. And to me, that’s why the people are at Hulu.

There is a kicker to it, which is if we’re able to create a truly special company, there should be a financial benefit and a significant one if we’re able to create something truly special. But I think that the financials, if that’s what motivates you, you should go work on Wall Street, not work at Hulu.

I really like the bit about the frugal culture at Hulu where they fly coach and use cardboard boxes to hold up monitors. It may not be as glamorous as their counterparts in other companies, but it certainly helps keep down a lot of upfront costs and allows them to invest more in their business. Many successful startups are a result of the founders solving a problem that they themselves had or thought needed to be solved for people they knew very well. I think that’s the case here. Before Hulu, streaming media was often found on illegal sites that were often shut down within months. The sites were sometimes slow and the video quality wasn’t the best. Now, with Hulu you end up with a site that is well designed that works really well. You want to pour your hours into it and hope that they increase their library of content.

The conversation finally ended with a discussion on monetizing Twitter. At first I was pretty skeptical about Twitter, but I find myself using it more and more as a means of sharing interesting articles I find throughout the day that don’t really warrant a post on the blog. If you’re interested in that, feel free to follow me on Twitter.

CHARLIE ROSE: So is that an economic model?

JASON KILAR: Not yet. And I say — I stress yet. I can tell you that it is a business that has tremendous utility. I use it at least 20 times a day. It’s.

CHARLIE ROSE: What do you use it for?

JASON KILAR: What I do is I go to search.twitter.com and I search for the name “Hulu,” and I do that about 20 times a day, because the name “Hulu” gets written about on Twitter about 2,400 times a day right now. And by.

CHARLIE ROSE: But you can’t read 2,400 times of material, can you?

JASON KILAR: It turns out you can, as long as you look at it every 20 minutes. And so I have a BlackBerry, and I look at it every 20 minutes. And I’m not the only one. Almost everybody at Hulu looks at search.twitter.com for the word Hulu.

The reason why we do it is that it is real-time feedback on the quality of the customer experience that we’re delivering. So, we’re able to know if we’re doing something right and double down on it. We’re able to know if we misspelled a word on a Web site…

CHARLIE ROSE: And you’ll know instantly.

JASON KILAR: And we know instantly. So there are many occasions where at 11:45 at night, I’ll see a tweet about, say, a word that was misspelled, for example, on the Web site, and I’ll be able to send that to our CTO Eric, and he and I will have a conversation at 11:47 at night, and the site will be fixed by midnight. That’s a 15-minute turnaround, where without Twitter, that wasn’t
possible. It’s an amazing transparency engine.

CHARLIE ROSE: So, what will Twitter be in three years?

JASON KILAR: My prediction is that in the same way that Google is an intent revealing service that can be monetized that way, I would think that if I were at Twitter, I would focus on the search aspect of Twitter, because people are revealing intents when they do a search. That’s very valuable to marketers. So obviously I’m just commenting as sort of a sideline observer of it, but there’s
something valuable in the fact that I’m using it, quite frankly, for a lot of searches where before I did not.

CHARLIE ROSE: It is an interesting phenomenon. You’re here, we’re talking about Hulu, Twitter is on the cover of “Time” magazine. We did a show with them. I mean, it is — the level of curiosity about all of these things, whether it’s YouTube or Twitter or Hulu or so many other new Internet expressions is
extraordinary. And it’s beyond — I mean, clearly it is the province of the young. But it’s expanding in a — I find just a fascinating number of ways. Not just in terms of the ideas, but in terms of the consumers.

JASON KILAR: There’s no better time to be living, I think. I’m biased, of course, but we live in interesting times. And as a person that has this odd combination of technology passion and media passion, this is the best — this is the golden age of media, I think, because it’s leveraging technology to make it better and easier to consume. It gets back to that impulse business.

I think Kilar really nails it with where Twitter will have to go to monetize. The service’s real time search capabilities are extremely powerful for not only advertising but also things like data mining. While other media execs like Barry Diller seem to think that it is a service too difficult to monetize, I feel like it will again be a situation of the advertising model adapting to a new environment. Getting to know where people at any point in time, especially with unique locations like one particular store in NYC seems like it would have a lot of utility to an advertiser and the companies that are buying ads.

I know the interview wont give you any new investment ideas, but I think it gives you a really good take on where media is going, especially with these new technologies that seem to be disrupting the space. I thought that some of the views, especially on monetizing services like Twitter were pretty enlightening when contrasted with the more traditional media voices we heard from the Sun Valley conference a short while ago. I can’t wait for the Charlie Rose site to get updated with the link to the video and transcript so you can read the full interview yourself.