More Knots in Paul Allen's Cable Tangle

The chairman of troubled Charter Communications may be sued by his board of directors over his stock holdings

By Ronald Grover

He owns a cruise-liner-size yacht equipped with its own helicopter and mini-submarine. When he's not sailing to Alaska or the Mediterranean, he's flying his private jet to catch a game played by one of the sports teams he owns, the Portland Trail Blazers or the Seattle Seahawks. Clearly, billionaire Paul Allen enjoys his toys, but even the Microsoft (MSFT ) co-founder knows money doesn't always buy happiness -- especially when it comes to the cable-television business.

To call his $8 billion investment to create Charter Communications (CHTR ) six years ago a disaster is an understatement. That stake is now worth $423 million. Charter has been besieged by $19 billion in debt, a slew of subscriber defections to satellite, huge turnover of its senior executive ranks, and the taint of having to settle accounting issues with the Securities & Exchange Commission last summer. The 52-year-old Allen's original vision of a wired world, where couch potatoes would buy movies, shop, and pay bills with a click of their remotes, seems to be losing out to fast-moving Internet technologies.


  But behind the scenes, Allen faces even further indignity. The Charter chairman, who owns 57% of the company's common shares and controls 93% of its votes, could end up getting sued in Delaware Chancery Court by his own board of directors. That's almost unheard of in Corporate America. "It would be like a child suing parents for an auto accident," says Charles Elson, a governance expert and management professor at the University of Delaware.

Allen and a three-member special committee of the board are clashing over whether Allen should be required to swap preferred shares, for which he paid nearly $700 million in 2003, for the equivalent of Charter common shares, worth roughly $28 million. An attempt at nonbinding arbitration fizzled last summer, failing to resolve the differences, reports the company in its financial filings.

The two sides have since decided to settle their fight in a Delaware court mediation, the filing adds. But if the stalemate continues, "the special committee intends to seek resolution of this dispute through judicial proceedings," according to the filing. A spokesman for Allen declined to comment. The three committee members, Larry Wangberg, David Merritt, and John Tory, didn't return phone calls.


  The special committee contends that as part of a 2002 agreement, Allen agreed to swap the preferred shares for Charter "membership units" that were convertible into 24.3 million shares of common stock. That was part of a "put" arrangement in which Allen had helped insure a $3.1 billion acquisition of cable systems in 1999 by guaranteeing he would buy back the stock that was part of the purchase price.

But the "automatic-exchange" language was inadvertently dropped from the contract and wasn't included in the final version delivered to Allen and the sellers. In 2002, Allen paid $630 million to cable giant Comcast, which by then owned the shares, plus an estimated 4.5% annual interest fee.

Now, the board may be worried that shareholders could sue it for approving the deal in the first place, says Phillip Davis, partner in the Los Angeles office of Sheppard, Mullin, Richter & Hampton and an expert on special committees. "This is a board that's running scared," he says.


  Still, the special committee's determination that Allen has to give back the preferred shares places him "between a rock and hard place," Davis says. Special committees made up of independent board members carry significant weight with Delaware courts, he adds. "The likelihood of Paul Allen winning this is pretty remote."

The preferred shares could become an issue down the road for Charter if it needs to refinance some of its huge debt load in 2007. Some investors and analysts worry that a huge Allen position in preferred shares, which give him priority over other lenders, could make it hard to line up new financing. Says UBS Securities (UBS ) analyst Aryeh Bourkoff: "If I'm a bank, I would worry about the company's majority shareholder having a priority position to me."

The standoff between Allen and the special committee couldn't come at a worse time for Charter. The fourth-largest U.S. cable operator, with nearly 6 million subscribers, it's spending heavily on marketing to stem an exodus of customers. Despite recent success signing on new digital subscribers and launching a telephone service, Charter's losses increased to $352 million in its most recent quarter, on revenues of $1.27 billion. The cable operator's losses were a smaller sum of $293 million a year earlier. The company, which dipped into its remaining $1.2 billion in bank lines in the quarter, has enough money to get it into 2006, but will need to refinance in 2007.


  Robert May, the HealthSouth chairman who was appointed Charter's interim CEO in January, is trying to stay upbeat. May has visited Charter's far-flung operations to rally the workforce as the company works to sell off mostly rural systems with an estimated 300,000 subscribers to improve efficiencies in lucrative markets such as Los Angeles and St. Louis.

"At its heart, this is still a consumer business where you get your best results when your customers are happy with you," May says. But for Charter's board and its biggest investor, these are anything but happy days.

Senior Writer Tom Lowry also contributed to this report

Grover is Los Angeles bureau chief for BusinessWeek

Edited by Dan Beucke

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