Why We're Betting Billions On TV Microsoft founder Paul Allen and his shrewd moneyman, Bill Savoy, spin the future in an interview with FORTUNE's David Kirkpatrick.
By David Kirkpatrick; Paul Allen; Bill Savoy

(FORTUNE Magazine) – Paul Allen recently figured out the easy way to assemble the nation's fourth-largest cable television operation almost overnight: Simply add cash, and lots of it. To be exact, he spent $6.3 billion in just two years, buying up cable properties. But then, money's no problem when you're the guy who co-founded Microsoft with Bill Gates. In a moment that has achieved near-mythic status, Allen saw a magazine article back in 1975 about a rudimentary early personal computer and rushed to his friend Bill Gates' Harvard dorm room to propose that they start a software company. Allen quit Microsoft in 1983 when stricken with Hodgkin's disease, which was eventually treated successfully, but he remains on the board. His stake in the company is now valued at about $15 billion.

Allen rarely speaks to the press and until now has never talked at length about his cable plans. But FORTUNE recently spent an afternoon with him at his palatial home on Mercer Island in Washington State, and a morning with Bill Savoy, who runs Allen's investment firm, Vulcan Ventures. Savoy does the number crunching and much of the deep thinking. The 35-year-old may look like a kid, but he's one of Wall Street's most prized customers and a major player in the new economy.

Ever since Allen started Vulcan, he has said he's working to enable something he calls the "wired world," and his portfolio of investments reflects a huge work in progress. Allen's Microsoft wealth now accounts for only about half his net worth. He has been slowly selling off the stock so he can spend the money on his vision and on other fun stuff. In February and March he unloaded one of the biggest chunks yet--43 million shares, for $4.1 billion. Over the past decade Allen has bought stakes in more than 140 companies. He also owns sports teams--basketball's Portland Trailblazers and football's Seattle Seahawks. That's not to mention the spectacular houses all over the world, the art collection, the yacht, and the 757. Unlike his less flashy friend Gates, consummate consumer Allen revels in the trappings of wealth.

For years, though, Allen's investing record was unimpressive, and he was often disparaged as Gates' lucky pal, not his shrewd or canny one. He bought 25% of AOL in 1993, for instance, only to dump it in 1994 for a mere $100 million profit. Today that stake would be worth $30 billion. Several small companies he invested in were failures. But as the Internet grew, so did Allen's success. He started multimedia content developer Starwave in 1992 and sold it to Disney in 1997 for about $200 million. His non-cable investments, acquired for a total outlay of $1.2 billion, were valued at around $8 billion at the end of 1999, says Savoy.

Now Allen aims to create a powerhouse collection of businesses for the coming broadband Internet Age. He is the biggest single shareholder in DreamWorks, the entertainment company whose American Beauty was this year's top Oscar winner. He also owns big chunks of USA Networks; Oxygen Media, a startup that produces TV shows and Internet content for women; and ZDTV, a television channel devoted to computer technology. Recently he bought the Sporting News weekly newspaper.

Allen figures people are finally starting to understand what he meant by the "wired world." Both he and Savoy see the acquisition of Time Warner by AOL earlier this year as a vindication of their strategy. Just as that deal aims to combine content with cable systems for broadband distribution to online consumers, so has Allen assembled a panoply of content and distribution assets that he hopes can all work together.

Although his vision may be getting easier to comprehend, the structure of Allen's investments often remains maddeningly intertwined and complex. He took his cable company, Charter Communications, public last November. Charter, two other Allen-controlled companies, and Go2Net, a portal company in which he has invested, then agreed to create Broadband Partners (now renamed Digeo Broadband), which would create content for high-bandwidth cable TV. Then in February, Allen invested $1.65 billion in RCN, a so-called "overbuilder" cable company that installs its lines in regions where other companies already operate, hoping to draw customers away. As part of the deal, RCN agreed to use the Digeo portal. (Charter's stock has performed dismally; recently it traded at about $5 below its November offering price of $19 per share. The idea was to create a currency that could be used to do deals without further cash input from Allen, but as Savoy explains, things haven't worked that way so far.)

Doing business deals doesn't occupy all of Allen's time. He just recorded a rock album with his band, Grown Men (learn more at PaulAllen.com). And a fabulous new museum called the Experience Music Project is due to open in June in Seattle. Allen paid for its collection and its Frank Gehry-designed building with $240 million entirely out of his own pocket as a gift to the city. The museum celebrates music in the Northwest, especially Allen's idol Jimi Hendrix, with extensive exhibits and hands-on activities--including studios stocked with instruments that visitors can pick up and play.

The shy and private Allen approaches a press interview as if it were a trip to the dentist--a necessary but hardly enjoyable experience. During the two hours I talked to him at his home, known as "the estate," he was only really relaxed when we took a break and stepped outside to a basketball half-court, where he shot a few respectable baskets. (Another full-sized indoor court was nearby.) Savoy is Allen's methodical alter ego--more concrete in conversation and more eager to explain.


Has your strategy changed in the past few years as you've moved so aggressively into cable?

ALLEN: High-speed communication channels combined with computing power are a new platform. We have broadened our vision to include more aspects of the platform. If you can participate in that new infrastructure and build things on top of it, that's pretty exciting. Broadband cable is the base that I think has the best potential.

Why cable?

ALLEN: The great thing about cable is that the systems are able to both send and receive huge amounts of content. So you can think about services that are high bandwidth going both directions. In the future, many more services will involve higher-bandwidth two-way connectivity. We're going from a world of 30 channels to, eventually, 1,000 channels. There is a huge opportunity for new kinds of content and new niche-oriented services. You'll start seeing streaming video and streaming audio on Websites, and those will start to appear more and more like television channels.

Watching TV now is passive, and using the Internet is much more active. A hybridization of those is going to take place. When you are watching an e-channel, you will be able to conduct transactions, buy products and services, get more information about the show, or maybe defer watching till later. Sometimes you will sit back and watch, and other times you will engage in transactions or do searches or ask for related things to be displayed.

Will the end-user device be more like the TV in your living room or a PC?

ALLEN: The same kind of capability should probably exist in both places, whether you want to browse the Internet on your TV or you want to watch video on your PC. Eventually the user interfaces for these things are going to converge. It's all going to end up feeling like the same thing.

The PC today is a general-purpose device. It can do anything: word processing, e-mail, order tracking, entertainment, play music from MP3 files. Da-da-da-da-da. I don't see that suddenly changing into something else. The general-purpose PC still has a long run in it.

The TV will evolve more than the PC. TV today is primarily for entertainment, and hasn't been a general-purpose platform. It hasn't had any computing power. But the TV with a set-top box really is a computing platform, which is not all that different from the PC.

How will the way consumers experience this stuff change?

ALLEN: In the future, anyone could participate in a TV show or other kinds of interactive entertainment. They could be a game-show contestant or call up ZDTV to ask about a software problem. Or a bunch of people could form an affinity group--it becomes video chat. That's going to become very commonplace.

Do you think anything in today's conventional wisdom about technology is fundamentally wrong?

ALLEN: I don't know if people yet appreciate the power of what these broadband systems are going to be. If, when they first came out, you looked at the original IBM PC or the first Apple II, you'd have said, "This thing is kind of okay, but what's the big deal?" If you look at what the PC can do now, at all its capabilities, and then imagine taking all that and hybridizing it with the TV, that's pretty darn exciting. With so many companies in your portfolio, how many do you get directly involved with?

ALLEN: I tend to focus more on the companies where we have a majority stake. But I also focus on the ones with a smaller stake that are strategic in terms of our vision. They're going to add value to a particular area, and we can take a minority stake and help them grow. So as we think about more channels, we've become partners, for instance, with Geraldine Laybourne at Oxygen Media. It's not only an investment; it also helps us understand what she is doing there. And our involvement helps her.

From the outside, if you're looking at our basket of companies, it may be difficult to find the common thread, but there is a thread there. We look for a company that is well positioned for the future, that has some synergies with other things that we are doing and has a management team we are excited about working with.

Do you see any institution or individual or venture capital firm out there doing something comparable?

ALLEN: Others may focus on a particular area, but our overall wired-world vision is, I think, a larger vision, and a more technologically driven vision than most areas.

Many times we take the overall vision and focus it down to a particular area, and then we try to go out and find specific opportunities. Take the digital VCR. A number of years ago I said, "Hey, there should be a VCR that has a hard disk in it." First we started Interval Research [a basic research center in Palo Alto that Allen closed last month] to look at that kind of thing. When we found TiVo and Replay coming down the pike, we invested in both of them.

Because of the unique scale of your resources, can you take risks others can't?

ALLEN: Certainly there are cases where I can be more fearless. But that's probably less true today than previously. Earlier I could take a flier on Transmeta [a hot, new maker of Intel-style microprocessors] or Metricom [a provider of wireless Internet access] because I have the resources and other people may not see the opportunities. Now everybody sees them. But if I see an opportunity where other people are scared off for whatever reason, and where I still have the conviction it's going to be significant, I'm not going to be afraid. I tend to think longer term and ask myself, "What is this going to look like five years from now?" I don't think, "How soon can we do an IPO?"

Has it hurt to hear yourself described in the past as an "accidental zillionaire" in articles calling your investing strategy aimless?

ALLEN: It's puzzling when I'm thinking over the horizon and I know things are going in this direction, and someone says, "Oh, this guy just does a bunch of stuff. Who knows what his strategy is?" At some points what we did derived from an unproven theory. Now people say, "Oh, you mean the Internet combined with this or that!" Nobody's vision on any of these things is perfect. I focus on a lot of different areas, so things do slip through. That just encourages me to think harder about communications or infrastructure or whatever.

Some say that if you'd left all your money in Microsoft, you would have come out ahead of where you are. Is that something you think about?

ALLEN: Look, every investor at some point has to make a decision. In my case, 90-some percent of my personal assets was in Microsoft stock. There's the "keep all your eggs in one basket and just see how many chicks hatch" theory. Certainly, if you look at Steve Ballmer, he completely believed in Microsoft's stock. He doubled down and bought more stock, and that's proven to be a spectacular approach for Steve. [Ballmer now owns more Microsoft stock than Allen.] He deserves a lot of credit for that. My approach was to try to diversify and work on my strategic vision at the same time. I think I've done pretty darn well with that approach.

What do you think about Ballmer's becoming Microsoft's CEO?

ALLEN: I've known Steve since he started at Microsoft. In fact, I knew Steve before that, back at Harvard when Bill and I used to talk about his math classes and math problems at dinner. Steve is a very dynamic, hard-nosed, take-charge, fearless, pragmatic guy. He is not shy about his opinions. If there are problems, he will address those--boom-boom-boom. Bill gave Steve more responsibility as time went on, and Steve showed that he could do a great job. It's a great opportunity for Bill to focus more on the product areas and the challenges of deploying a new strategy for Windows.

Could you do other deals in the next year or two on the scale of your multibillion-dollar deals with Marcus Cable and the other pieces of Charter?

ALLEN: Oh, yes. My resources both with Charter and my investment ability give us a lot of scope. We are always looking at everything from very early-stage startups to acquiring companies or merging companies we already have.

What about starting companies up? Starwave worked out well, but Asymetrix [now Click2learn] maybe not quite as well.

ALLEN: Mercata used to be part of Asymetrix. One day I had a meeting with a group there, and I said, "Hey, you've got a great team here, but we should do something in the dot-com area. Come back to me with some ideas." So we were able to put the assets there to new uses, and now Mercata is a very promising dot-com company.

You recently announced you were closing your think tank, Interval Research. Why?

ALLEN: Today you have to take ideas and turn them into products or Websites very quickly. That's just reality. When we founded Interval we wanted to have substantial impact, spinning off startups and potentially changing the industry. We came from a very pure, high-minded place, but it always comes down to the particular ideas you have. I do believe in fundamental research, and may still do some things with universities. Everybody who invests in research, Microsoft or Bell Labs or whatever, takes a bit of a flier. Only a small percentage of research that gets funded generates any return.

Why did you shave off your beard? Did you want to change your public image?

allen: (Laughs.) I just felt it was time for a change. Some people encouraged me. And once you get used to shaving, you're used to it. You get up every morning and you shave. I haven't felt a craving to go back. It was in no way based on the desire to change my perception. It wasn't a business decision.

Who are your best advisers in thinking through the big questions, aside from Bill Savoy and your employees?

ALLEN: There are a number of people. If it was an entertainment-related thing, I would instantly pick up the phone and call David Geffen. I talk to Barry Diller occasionally. I've been talking to John Malone. And obviously, Bill Gates. If there was anything that involved working with Microsoft or about where computers were going, I'd ask Bill what he thinks. He's a legend. We've always had good ideas together.


The last time I was here, three years ago, you were managing investments in 40 or 50 companies. Today it's around 140. Why has the number grown so much?

SAVOY: Paul's vision was that the world appeared to be moving toward a ubiquitous network that people are always connected to, and to make a series of investments tied to that. When we started in 1990 it wasn't clear whether the network was going to be wireless, satellite, online services, or some technology that hadn't been developed yet. But when Mosaic was released in 1993 and ultimately became Netscape, it seemed maybe the World Wide Web was what people would gravitate to. By 1997 it had become clear that the Web was the platform of choice.

From our standpoint, the cable infrastructure had been developed to where it could be the point of deployment for the Web as it went toward high-bandwidth content. So we got even more focused. It's a sharpening of our field of view, if you will.

What kinds of companies are you investing in nowadays?

SAVOY: We have identified five types of dot-com investments. The first is the blending of old media and new media. Examples in our portfolio include CNET [a Web and TV information company], ZDTV [a technology news channel], and Oxygen Media [a TV and Web content provider for women]. These are all about television's benefiting from the Web and feeding viewers onto the Internet. More recently, print publications like the Sporting News that can send content up the food chain to the Internet.

The second, and relatively small, set of investments has been in businesses that work to boost the efficiency of the Internet's infrastructure. There are a tremendous number of Web-based technologies that will drive an increase in the productivity and efficiency of businesses. It's about building the freeway and the road signs and the tollbooths to make sure that everyone is driving on the right side of the road. But we are consumer-focused, and we try to keep really focused on the user, so I see this category of investment as a small part of the portfolio. It helps us be smart about the other businesses that touch end users.

We can leverage it across the third category of opportunity, which is traditional electronic commerce. Our opportunities there are all about demand aggregation. Real-world retailing is about inventory aggregation, meaning, build a big box somewhere and fill it with office supplies, home-improvement supplies, toys, books, and so forth. Online retailing is about aggregating consumers with a common denominator, like a demand for a given product.

There are two bookends in demand aggregation. One in our portfolio is Priceline, which shows that a single buyer has the ability to impact price when the value of the inventory is affected by time. A hotel with a vacant room or an airline flying with an empty seat loses that revenue forever. For that kind of product category, Priceline is a perfect model. Someone can go to a Website and say, "For $200 I want to fly from Seattle to New York." Any airline that has got that one fungible seat can participate or not. That's one bookend.

The other bookend in demand aggregation is a company like Mercata, where consumers know they want a specific product but as individuals have no ability to impact price. Mercata aggregates consumers when the common denominator is a specific product. Then it represents that group of consumers to the manufacturer or the distributor to try to reduce the price.

The fourth category of our investments is community. If your group of users is large enough and their interests are similar enough, the value of that audience to advertisers is huge. Take a business like BabyStyle [part of eStyle]. Give me 10,000 expecting new parents, and I'm sure that I can find advertisers that are interested in that demographic.

The fifth set is investments in companies providing experiences unique to the Web. If you're not online, you can't buy postage or software or music electronically. You can't chat. You can't have instant messaging.

Using these five investment categories isn't a strategy. This is tactics now. We can determine more quickly whether or not a particular company fits in our investment profile. I'm able to make many more investments and be much more efficient.

Nevertheless, cable is where you've made your biggest bets. Why?

SAVOY: It's the best infrastructure in place to deliver those things to the customers. There are many competitive threats to cable on the horizon, many of which I have investments in. But the guy who has the best infrastructure is the cable guy. We can protect our position by bringing new services to our customers, like a broadband portal, telephony, and ISP services, as well as video.

You've paid a very high price for your cable properties--some say too much. And won't you have to pay an awful lot to upgrade these systems for two-way broadband Internet?

SAVOY: Many people pointed to the Marcus Cable transaction in April of 1998, where we paid 12, 12 1/2 times cash flow, and said, "Oh, my God, that's the most money ever paid for a cable system." But now cable multiples are 14 to 18. You also have to look not only at the amount paid per subscriber but also how much you have to spend to upgrade to a full two-way system.

So by those calculations, you feel you haven't paid more than, say, AT&T paid for MediaOne?

SAVOY: I definitely didn't pay more in the aggregate than they paid. We have to look in totality at the collection of assets. In the year 2000, we will save some $100 million in G&A [general and administrative costs]. That's headquarters, CEOs, salaries, etc. I lost 11 CEOs along the way. That's a lot of money to be saved. I'm not paying for five or six jets now. I'm not paying for hundreds of senior executive automobiles.

The long-term value of cable increases as markets consolidate. In the past two years there has been a mad land-grab. It was a huge consolidation, but now everybody owns widely dispersed assets. We're sitting there with two million customers in the Southeast, 1.4 million in the upper Midwest, half of St. Louis, half of Dallas-Fort Worth, and a quarter of L.A. The good news is, we're not alone, right? There has to be some horse trading. We are in active negotiations on trades all the time.

There are important tax issues at work here too. When people critique our transaction skills in cable, they fail to take into consideration that primarily, I purchased limited partnership interests in entities that own cable assets. A unique characteristic of Paul Allen as an individual acquiring LP interest is that he personally gets the tax benefit of the losses generated by the businesses. Capital-intensive businesses generate cash flow. But for some period of time after the capital expenditure, as it is being amortized on a P&L statement, they lose money. So for some time, no matter how successful the business is, it's going to show a loss. And if you're Paul Allen, an individual, and you paid 13 times Ebitda [earnings before interest, taxes, depreciation, and amortization] for an asset, you benefit personally every year on your tax return. It doesn't take you long to earn down that 13 to a number that can't be met by any of the other cable operators.

So why has Charter been such a disappointing performer since the IPO?

SAVOY: One reason is that the marketplace has had a hard time seeing that picture in its totality. The investment community does not understand where Charter fits into the bigger picture of the wired world. The second thing is that in the face of going public, we had two interest-rate increases by the Federal Reserve. Cable companies are highly susceptible to interest-rate adjustments.

How do you feel about the AOL/Time Warner deal?

SAVOY: It's a very good thing for my portfolio. It means that high valuations of new-media companies, where we have a tremendous amount invested, can be used to acquire and consolidate preexisting media assets. It also is a full endorsement of Paul's vision of the wired world and our tactics of getting aggressive in cable the past couple of years.

How are you integrating all your properties?

SAVOY: Our plan is to try to integrate them as much as we can without disrupting the businesses that these largely independent management teams are building. The next logical step is to take those companies that are consumer-focused and integrate them into our cable broadband portal product offering. If Priceline and Mercata and Drugstore.com aren't a part of that, we haven't done our job.

What's different about your broadband portal from what Excite@Home and others are developing?

SAVOY: Excite@Home is focused on bringing connectivity to personal computers across the cable plant. Digeo Broadband [a portal developer with strong ties to Allen] wants to bring interactivity and the best of the Web--personalization, your ability to build your own unique persona and your electronic identity--to the television. In my opinion the television becomes the information appliance in the home.

That's a big gamble.

SAVOY: If you look at the assets that connect at the television set, that should be the point of broadband deployment. Then it can evolve into wireless devices, into Webpads, into telephony, into home security, into all kinds of other things. But the technology connects to the consumer at the television.

How do you and Paul work together?

SAVOY: My job is to work with Paul to see that his vision gets delivered against the asset base in a financially responsible fashion. When Paul says, "I want to become a player in cable," I go and find prudent deals to do on behalf of my principal. I don't spend a lot of time investing in areas that don't bring value to Paul's wired-world vision. He must have been right, because we executed as tightly as we could against his agenda, and the returns came. I'm proud that over time we've been vindicated.