ShmoopTube

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principles of Finance a la shmoop how EBITDA was invented John Malone TCI

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I all right well you may very rationally ask how on earth did something so weird [Guy talking next to a presentation screen]

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sounding like EBITDA ever get invented well good question it's not a GAAP term

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it's just made up yep EBITDA which well you'll hear a lot about it

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cocktail parties on Wall Street thrown by your accountant and you really must [People at a party talking in abbreviations]

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get a life if you find yourself frequenting them well if it does just a

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made-up accounting measure but on its own really means a whole lot of nothing [Magician makes some money disappear]

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well here's a little story about how EBITDA was invented or at least

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promulgated to become standard fare in evaluating investments from both a debt [Guy reading a kid a bedtime story]

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and equity perspective alright well there's this guy legendary John Malone [John Malone waving]

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godlike if you ever want to know how the real world works inside a cable

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television and media in general well this is your yarn but let the screen [The front of the TV is removed to reveal John Malone]

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dissolve into a heat wave go back in time to early 1970s there were three

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channels on television Fox had not yet been invented as a TV network [TV remote with 3 buttons]

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anyway audiences were sick and tired of boring news shows and the occasional [Guy on his head balancing the TV aerial on his foot]

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rabbit ear TV channels in the land of UHF way out there on the dial and most

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just swell those stations showed only cartoons because kids were the only ones [Kid next to a TV showing static]

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patience enough to tolerate such bad reception all right well the founder of

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telecommunications Inc or TC I was guy named Bob Magnus

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he had the smart vision that audiences by the masses would pay a little money [Busy street]

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in order to have choice in the television they watch game shows old

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movies sports films so by hook and by crook Bob begged cities to allow him eat

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grass that's the right to climb up phone and phone companies to allow him to [Bob going up a telegraph pole]

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access and keep climbing up and down those tree trunk poles all day long and [He gets elecruted]

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string wires from base stations to neighborhoods and then into homes the [Wires spread out over a neighborhood]

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wires went from a fairly local base station and covered a few miles and [Guy next to a mass of cables all tangled together]

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broadcast playback machines would play through a whole lot of switches and

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wires and eventually the home would get the signal from the server at the

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Central Station there well in the old days the playback machine wasn't that

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much different from the large old VHS tape machines that he can ask your

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grandparents about they were jerky in well they didn't work all the time but

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they worked most at a time and they certainly worked well enough early [Guy holding the playback machine on his head]

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demand for cable was very high and it was high enough so that when the first [People fighting over a TV in a shop]

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few hundred neighborhoods were wired journalists well they wrote about this

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great brave new world thing where you could add a dozen or more channels to

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the three had to watch today what long came a really smart kid from Bell Labs [Newspaper article about cable]

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it was intellectually the Google of its day dr. John Malone newly minted PhD

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knew how the signal propagated over the wires and he had great skill in reading [John Malone with equations floating over the wires]

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data that is he knew how to think about TV programming like they're optimizing

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what people wanted to watch he was also clever when it came to funding like [Malone holding a bake sale]

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raising money from Wall Street people remember this is the story about the

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birth of EBITDA so their company telecommunications Inc

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nobody from shmoop was around to help them give it a more fun name [Guy holding a poop sign over the name]

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well they wired a neighborhood of a hundred homes that wiring and

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infrastructure cost them about 50 grand back then [Pigeon sat on the wires]

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they didn't need more than a flyer on the doorsteps of the homes they wired

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for demand to come in and early demand was sudden in many neighborhoods TC I [Guy is hit by a wave of money]

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got 30% penetration of subscribers almost immediately while at 25 bucks a

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month back then a hundred homes times twenty-five dollars a month meant $2,500

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a month in revenues coming back to TC I or annualized 30 grand a year in [Revenue calculations]

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revenues from cable subscriptions well as the company grew through the early

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80s they also tried to sell advertising but since the three networks colluded

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with the minors of advertising ads were almost impossible to sell on cable in [3 people turn up with baseball bats]

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the early days yet TC I knew it had value there so it started infomercial TV

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programming shows and what became you know the Home Shopping Network in QVC [Woman wearing a giant flossing machine on her head]

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well you don't need to worry about that here just know that from $30,000 they

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received in a given year well they had maintenance costs of about [Tree falls over and knocks the wire down]

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five grand on their wind beaten wires and they paid about 10 grand in

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royalties to the already existing studios for rental or licensing of their

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video libraries these were reruns of now ancient TV series like Gilligan's Island

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The Brady Bunch and you know art films the profit margins [A couple kissing]

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were very high on a unit basis and an existing cable system would well [Bob's desk is covered by cash]

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basically pay for itself entirely in about three years that is

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the gross profits from the revenues minus the maintenance and the licensing

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added up would pay to install an entire station in just three years

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while TC I didn't own just one system in fact they started with one and they

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started the applications process to buy another system in another and 30 more [Systems spreading out over a city]

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more and so on and they kept buying more and more cable systems if the company [Pins are put into the planet and it deflates]

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had had to raise money giving out equity all the time ie shares of stock or

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pieces of ownership of itself well the founder and his optionally employees

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would have been so diluted that their efforts wouldn't have really been worth [Definition of dilution]

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the 80 hour weeks divorces then we're lousy parenting they [Bob forgetting who his son is]

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suffer though in the process of building this amazing company as if that's ever

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worth it but while we digressed so instead of using equity they used debt

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or loans and many small buckets to eventually build system after system [Loan buckets appearing]

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owned them and control them well the pitch was simple we'll pay you a percent

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or two in interest per year beyond a normal corporate bond like if corporates

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or 6% will pay you seven or eight because yes there is risk and yes we [Bob making his pitch]

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need the money like now before the network television broadcast companies

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would wake up and compete with us or other competition comes in but our [Graph showing high profits with high penetration]

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systems are really profitable with only 30 percent penetration in a neighborhood

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and we think they'll go somewhere to two thirds like 65 percent penetration or

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better by the time were fully penetrated anyway the bank's all Pony DUP and [Sharks investing]

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loaned TCI money and the cable systems performed as expected or better but the [Someone sat in front of their TV wearing the flossing machine]

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company was never profitable why because every excess dollar available to them [Safe opens and there is only a fly inside]

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was deployed to buy the rights to new systems or just buy new systems or build [Hand grabs money from the company and drops it on new neighborhoods]

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new systems every dollar got put to work for growth and then in the 80s and 90s

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to upgrade systems from having only 25 channels to 35 and 50 and a hundred and [Dance show on TV]

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five hundred and with Internet and with DVR and telephony and pay-per-view

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service and so on so that today an average cable bill is more like a

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hundred twenty bucks a month rather than at 25 that they started with but as a [TV is smashed with a sledge hammer]

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company the cable industry didn't generate earnings they were always break

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even on a cash on cash basis because all their cash got reused

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other things and the accounting laws required that they write down the asset

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of their cable plant at a much faster decay rate than the rate at which the [Accountant holding a 0 dollar sign]

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system actually declined in value so the streets love affair with cable ended and

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TCI traded to very low multiples as investors struggled with what the proper

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metric was to value the company and this is where EBITDA in save the day by

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looking at the company from an EBITDA bias it removed the cloud of debt [EBITDA with angel wings]

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bondholders worried that tomorrow everyone would stop watching television [Trader on the phone]

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oh they're a nervous bunch it removed taxes because TC I never paid taxes [IRS man looking confused]

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because well hell it was never profitable and mainly removed the

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depreciation of old cable systems which instead of being treated initially like

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computers which get amortized to be worth almost nothing in three years were [Definition of amortization]

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finally viewed as being fully depreciated after 10 years the reality

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is that many of the systems needed relatively small upgrades to be very

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modern and with the hole in the ground already dug and municipalities wanting [Caveman next to a cave]

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to be sure good internet service existed it wasn't all that hard to take a string [Ground is ripped open and new cable is put in]

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and pull out the old copper wire and replace it with fiber fiber optics well

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what was left was a company that traded at about ten times EBITDA for a very

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long time and it allowed TCI the cushion so that if it ever did get ahead of ['Debt' elephant in a room with an investor]

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itself on the debt side very small amount of equity and shore up

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its balance sheet well eventually the company realized

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that the dumb pipe was fast becoming a commodity and that satellite would cap [Woman watching money fall on her TV]

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the price as they could charge so they invested heavily in each other and they

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also invested in programming think you know discovery shark week CNN a whole [Man gets eaten by a shark on his boat]

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bunch of things the cable industry today owns large chunks of everything from

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time warner and liberty media to ESPN and well you guessed it you know for a

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lot of heart films go EBITDA [Pug next to a pineapple]

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