The Fall of Leo Kirch
Early last year, Erwin Huber, chief of staff to Bavarian Prime Minister Edmund Stoiber, placed a phone call to top management at Munich-based HypoVereinsbank, Germany's second-largest publicly traded bank. The subject was Formula One auto racing. But Huber wasn't calling to discuss the previous weekend's winners and losers. He was encouraging HVB to help finance Munich media mogul Leo Kirch's acquisition of Formula One broadcasting rights. Kirch is one of Bavaria's largest employers, not to mention a big supporter of the German state's conservative politicians. Although Huber later denied trying to pressure HVB, he admitted telling a member of the bank's management board that Formula One was of "significant economic importance" to Bavaria's media industry.
Still, HVB balked. The bank had already fronted Kirch $400 million, and his pay-TV unit was racking up multibillion-dollar losses. In most free-market economies, the matter might have ended there. But this being Bavaria, there was another option: Bayerische Landesbank, a lending institution 50% owned by the state government and overseen largely by Stoiber's aides. In short order, the Landesbank lent Kirch some $1 billion--in effect, staking taxpayer money on a venture that local banks considered too risky. "It can only be political influence," says Peter Paul Gantzer, a center-left member of the Bavarian parliament who is critical of the government's dealings with Kirch.
Yet this is how business has long been done in Germany. Sure, political connections count in any country. But in Germany, where state-controlled banks can lend at will and where disclosure of a company's books is rarely a top priority, a tycoon's Rolodex can carry him pretty far--maybe too far.
That certainly seems to be the case with Leo Kirch, one of the most powerful media magnates in Europe. After years of cajoling huge loans from the banks, Kirch has pushed his company to the verge of bankruptcy. Creditors are still groping for a solution, installing partners of a top law firm in Kirch headquarters to represent their interests. His political allies may try to buy him some time through more state loans or pressure on the banks. But executives at other media companies, who are following the situation closely, say they can't see how Kirch can keep control of his life's work. "I don't think he has a chance," says an executive at a foreign-owned entertainment company that has done business with Kirch.
Like any great melodrama, the Fall of Kirch features dozens of players. Banks and business partners are already fighting over the remains of Kirch's television rights library in a frantic attempt to recoup at least $9 billion in bank debt and other obligations. Germany's biggest banks stand to lose hundreds of millions each, possibly hurting their credit ratings. Studio owners such as Vivendi Universal and Viacom Inc. could be out hundreds of millions of dollars as Kirch refuses to honor agreements to pay for the German rights for their programming. Also threatened are Kirch investors Lehman Brothers Inc. and Saudi Prince Alwaleed bin Talal bin Abdulaziz Alsaud's Kingdom Holding Co.
It's a full-blown disaster, one that is prompting deep soul-searching about the business practices that created the mess. The ramifications extend far beyond the German media world, where Kirch's fall could open Europe's largest market to Rupert Murdoch's News Corp. The Kirch affair will increase pressure to curtail the privileges of Germany's semipublic Landesbanks. It will affect national politics, threatening Bavaria Prime Minister Stoiber's chances of unseating Chancellor Gerhard Schröder in the fall. And infighting among German banks about how to cope with Kirch's problems is already corroding the financial, corporate, and political alliance known as Germany Inc. Creditor banks such as HVB are miffed at Deutsche Bank chief Rolf Breuer for publicly questioning Kirch Group's creditworthiness. Leo Kirch, Germany's consummate insider, may wind up helping to bury the secretive, incestuous system that helped create him. "I think the banks will learn again that not doing their homework carefully enough can be very costly," says Christian Strenger, a member of the German Government Commission on Corporate Governance.
There's also something poignant about the downfall of this 75-year-old entrepreneur. Competitors have long resented Kirch's secrecy, his negotiating tactics, his use of political connections. Yet they grudgingly admire his cleverness, his work ethic, and the astonishing appetite for risk that allowed the son of a small-time winemaker from Franconia to build a $5 billion media empire.
Kirch's beginnings are part of the legend. In postwar Germany, 29-year-old Kirch roamed southern Europe looking for films to import, so poor he sometimes slept in his Volkswagen. His first success was La Strada, the sad tale of a circus strongman, directed Federico Fellini. Borrowing $58,000 from the family of his wife, Kirch secured the German-language rights and rented the film to local movie houses.
The profits from La Strada launched Kirch's career as a programming trader. It wasn't long before he was in Hollywood, cutting multimillion-dollar deals to import U.S. shows to Germany. His first big deal, Kirch later told an interviewer, was in 1959 with United Artists/Warner Bros. It was a typically risky and audacious affair. Kirch's main customers were West Germany's public broadcasters, who held a monopoly on the airwaves. They told Kirch they wanted no more than 70 films in the foreseeable future, for which they were willing to pay about $900,000. Problem was, the studio refused to sell fewer than 400 films and wanted $2.7 million. Fearful that Hollywood might bypass him and go straight to the broadcasters, Kirch obtained a loan and bought the whole package. Sooner or later, he figured, the broadcasters would come to him for the rest.
They did. Thus, Kirch set the pattern that was to rule most of his business life, a big bet with borrowed money that delivered huge profits. Kirch went on to become the main supplier of foreign programming for German TV, dubbing shows like Star Trek and Lawrence of Arabia into German, then reselling the programming for a nice profit. A little too nice, some people thought. In the 1970s, public broadcasters came under fire for their near-total dependence on Kirch. He survived that controversy and many others. His political connections didn't hurt, including a close relationship with future Chancellor Helmut Kohl.
In most of Germany, the secretive Kirch was demonized as a monopolist getting rich on public money. In Bavaria, though, Kirch was hardly seen as a public enemy. His company came to employ nearly 10,000 people, rivaling the likes of BMW and Siemens in the Munich area. Some Kirch protégés struck off on their own to create companies and jobs in the area. One was Thomas Haffa, who founded media company EM.TV--itself a tale of boom and bust.
Yet those who have met Kirch describe him as charming and cultivated, a classical-music aficionado who was friends with Leonard Bernstein and helped bankroll the conductor's televised performances. "Many people who had a bad opinion of Leo Kirch changed their minds after meeting him," says Norbert Schneider, chairman of Germany's State Media Authority's Directors Conference and longtime Kirch acquaintance. A workaholic, Kirch was a fatherly boss who would share a bottle of red wine at 10 p.m. on a Friday with anybody else still in the office at that hour, former employees say.
Nor is flaunting the trappings of wealth Kirch's style, say people who have been close to him. Rather, he still often retreats to a modest office in Munich he has used since the start of his career. On Sunday afternoons, part of Kirch's workweek, his top managers typically gather there, waiting patiently for a few minutes with the boss. "That's your destiny if you want to be a senior manager at Kirch," says one former executive.
By the mid-1980s, Kirch was among Germany's richest men but suffering vision problems brought on by diabetes. Although he was nearly 60, however, retirement wasn't on the agenda. In 1984, the government gave up its monopoly on television, creating a huge opportunity. Soon after, Kirch was among the founders of Sat.1, one of Germany's first private broadcasters. He also began building up a 40% stake in Axel Springer Verlag, publisher of Bild, Germany's biggest newspaper. In 1996, Kirch made his grandest bet of all on digital pay TV, which would deliver superior sound and images as well as interactive programming. The dream was to control a promising technology and generate new markets for his films.
The reality was that Kirch was setting the stage for a disaster. Tellingly, in its first year, Kirch Group's digital-TV service attracted only 100,000 viewers, a fraction of what it needed. Pay TV cost Kirch $2.8 billion through 2000; currently, it bleeds some $1.3 million a day, according to WestLB Panmure, the investment-banking arm of Dusseldorf-based Westdeutsche Landesbank. Last year, Premiere World, the main channel for KirchPayTV, added just 110,000 subscribers for a total of 2.4 million, far below breakeven.
What went wrong? Everything, say industry execs and ex-Kirch employees. The set-top decoder cost $500, and Kirch stubbornly tried to pass the cost onto subscribers. He had little expertise dealing directly with subscribers or developing technology, yet he drove away partners who could have provided such knowhow. "He wanted it all to himself. This was his big mistake," says Michael Dornemann, Bertelsmann's former entertainment chief, which eventually bailed out of a partnership with Kirch.
Underlying pay TV's woes were the huge sums Kirch paid for rights to films and sporting events. His deals with foreign media companies obligate him to pay some $2.6 billion for films through 2006, WestLB estimates. Vivendi is just one of the companies embroiled in litigation as it seeks to collect some $200 million from Kirch. Industry insiders believe he owes Paramount $100 million on a 10-year, $1 billion deal signed in 1996.
Amazingly, Kirch managed to keep raising money, even though German publications such as Manager magazine started warning of his alarming indebtedness as early as 1997. Why, in hindsight, did the bankers dig themselves such a deep hole? Part of the answer lies with Germany Inc., the government-business nexus that once ruled the land and isn't quite dead yet. Top bankers concede privately they faced subtle but effective political pressure to keep the credits flowing. His TV duopoly with Bertelsmann serves both parties, which have long wanted to keep any foreign companies from owning German media assets.
And part of the explanation for the banks' faith in Kirch is Kirch himself. "Kirch is a fascinating, charming, magnetic, persuasive person who is convinced he will win the day," says a top bank executive. For bankers whose usual clients were machine-tool makers or real estate developers, Kirch was a door to the glamour of show business. And they had few objective ways of judging the worth of Kirch's film library, which he often put up as collateral. Most important, Kirch had a 45-year history of borrowing big, betting big, and winning big. It was hard to imagine he would fail.
In pay TV, fail he did. The crisis became acute in January, when AxelSpringer Verlag moved to exercise a put option worth $670 million--an agreement obliging Kirch to buy back Springer's stake in a joint venture. That's only the first of the ominous deadlines Kirch faces this year: Murdoch wants to exercise a similar option his British pay-TV company BSkyB has with Kirch between now and October.
Such is Kirch's mystique that many people still believe he'll find a way out. "There's certainly a chance," says Hans-Joachim Mertens, a member of the supervisory board of ProSiebenSat.1 Media, which is traded in Frankfurt though controlled by Kirch. However, Mertens concedes: "It won't be easy." In fact, the banks are still trying to find a solution short of bankruptcy. Some speculate the creditors will do Stoiber a favor and avoid a collapse until after September's elections.
Whatever the outcome, involved bankers say a radical restructuring is inevitable. Murdoch might take pay TV off Kirch's hands. Kirch's stake in commercial broadcaster ProSieben could be floated on the stock market. Carmakers may be interested in Formula One rights. "Most bankers still think the group can be saved in a slimmed-down form," says a bank official.
If Kirch were to declare insolvency, it wouldn't just reverberate in the financial world. It could choke off the $480 million that Kirch's rights-trading arm owes to German soccer clubs. That would threaten the clubs' finances and catapult the Kirch affair from the financial pages into couch-potato land. As Stoiber stumps Germany trying to become chancellor, he could have a lot of explaining to do--not an easy task for the Establishment's candidate.
For creditors such as Deutsche Bank and Dresdner Bank, the only upside is that the Kirch crisis could hasten a European Union campaign to remove the privileges of the Landesbanks, which have risky loan portfolios but high credit ratings because of their state guarantees. The affair also helps proponents of greater financial scrutiny and disclosure, especially after America's Enron Corp. disaster. "We don't actually know the full scale of the group's indebtedness and when the debts all fall due," concedes one official at a creditor bank. Pressure for disclosure could spread to listed companies such as Volkswagen that are stingy with information.
And what of Kirch? He is scrambling to stay liquid, selling assets such as his stake in publisher Springer or his 25% interest in Spanish broadcaster Telecinco. Industry observers expect him to try and keep control of his treasured rights library, the largest in Europe. In January, Kirch appointed Georg Kofler, former CEO of ProSieben, to try to rescue the pay-TV operation. If Kirch is forced to leave the scene, even old adversaries will feel a twinge of regret. "In terms of understanding Hollywood and the importance of content, he was 20 years ahead of everyone in Germany," says ex-Bertelsmann exec Dornemann. What Kirch didn't understand was Germany's need to change the way it does business.
By Jack Ewing with David Fairlamb in Frankfurt