Kirch's Picture Just Went Fuzzy

Bertelsmann challenges his lead in digital TV

On a sweltering day last July, German media mogul Leo Kirch seemed to have pulled off the impossible. At the German Formula 1 auto race in Hockenheim, the maverick entrepreneur kicked off his digital pay-TV service, apparently beating out his larger and richer archrival, media conglomerate Bertelsmann, in the contest to exploit the promising technology. With race cars screaming in the background, Bertelsmann officials said they would shelve their own digital plans and cooperate with Kirch.

Nine months later, the odds have shifted in the race to dominate the German digital TV market. It is a big prize because Germany is Europe's largest market, with 33 million TV households. DF1, the Kirch service, has drawn only 30,000 subscribers, far short of its goal of 700,000 by yearend. In March, Australian media magnate Rupert Murdoch backed out of a deal that would have helped finance DF1's startup losses, now estimated by some analysts to go as high as $1.4 billion. Soon after, a $300 million bank loan fell through.

Meanwhile, formal talks between DF1 and Bertelsmann broke off in late March, despite Kirch's 25% stake in Premiere, the analog pay-TV station controlled by Bertelsmann. Kirch's woes have put Bertelsmann back in the running. Premiere, DF1's only real rival, is growing rapidly and is expected to turn its first profit in 1997. Meanwhile, Premiere's limited digital pilot project, started just last month, already has as many subscribers as DF1.

With DF1 losses mounting, the Bavarian mogul desperately needs a new partner. Kirch is trolling for investors in the U.S., although DF1's miserable start and Murdoch's flight will make prospective partners think twice.

If his search fails, Kirch faces two unsavory choices: a lengthy market-share fight with Bertelsmann that would drastically boost his losses, or a pact to work together, with Bertelsmann at the controls. "Kirch is under heavy pressure," says Dirk Reiter, a partner with consultant Roland Berger & Partner in Munich. Should Kirch and Bertelsmann forge an alliance, they'll make it nearly impossible for anyone else to enter the market. Gottfried Smek, DF1's president, says "a [cooperative] agreement would be beneficial to both sides." But that prospect is unlikely since Kirch seems unwilling to cede any control of DF1.

DF1's hasty launch now seems ill-conceived. Kirch overestimated his ability to attract subscribers. Consumers balked at paying as much as $1,200 to install a satellite dish and buy a decoder to unscramble DF1's signal. Kirch also flubbed by not offering leases or financing. In contrast, Premiere subscribers, most of whom get the service via cable, pay $28.50 a month for service and decoder rental. Moreover, DF1 failed to convince consumers that its 13 channels offered any advantage over the 30-odd channels most already get via cable.

Kirch knew it would cost a bundle to launch DF1. He figured on startup losses totaling $600 million and on DF1 breaking even by 2001. But some analysts and Bertelsmann executives now suspect DF1's slow growth will push losses much higher. Fees for Hollywood films and other programming will rise rapidly, say industry sources, since Kirch promised he would deliver large audiences quickly. And Kirch had ordered 1 million decoders from electronics manufacturer Nokia at $535 apiece. Credit Suisse First Boston Corp. estimates total losses at $1.4 billion through 2003.

LEVERAGE. Bertelsmann, meanwhile, has some breathing room. Premiere, jointly owned by Bertelsmann, Kirch, and French media company Canal Plus, has 1.5 million customers, and subscriptions are growing at a 35% clip annually. Bertelsmann says Premiere will make a profit of several million dollars this year.

To be sure, Kirch has some leverage. He holds German pay-TV rights to most new Hollywood films, starting in 1998. He also could try to outbid Bertelsmann for pay-TV rights to the popular Bundesliga German soccer matches when they come up for renewal in 1998. And he is talking with Deutsche Telekom for access to its cable network, which serves 16 million homes.

Even so, Bertelsmann holds the best cards. By yearend, Premiere could have as many as 2 million subscribers, dwarfing DF1. The company can afford to sit back and watch Kirch's losses mount, knowing that every tough month for Kirch just makes its hand stronger.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE