JEROME H. KERN - ON COMMAND - (ONCO)
CEO Interview - published 07/31/00

DOCUMENT # KAM625

JEROME H. KERN is Chairman and CEO of On Command Corporation. An acknowledged mega-deal maker in complicated, multi-party transactions, Mr. Kern served as Vice Chairman and a member of the Board of Directors of Tele-communications, Inc. (TCI). He was the architect of the AT&T/TCI merger and TCI’s representative in a number of other high-profile mergers and acquisitions, including the Time Warner/Turner Broadcasting merger. Prior to TCI, Mr. Kern was a senior partner of Baker & Botts, L.L.P., where he was the senior corporate lawyer in the New York office. For over twenty years, he was the principal outside legal counsel to TCI and Liberty Media, and is currently serving on Liberty Media’s Board of Directors. Mr. Kern graduated from the New York University School of Law (L.L., 1960, Cum Laude) where he was a Root Tilden Scholar and Managing Editor of the New York University Law Review (1959 to 1960); he was named to the Order of the Coif. He also holds a Bachelor’s degree from Columbia University (A.B. 1957). Mr. Kern is a member of the Board of Trustees of the New York University Law Center Foundation and serves as a Director on the Boards of Volunteers of America (Colorado Chapter), City Meals-on-Wheels in New York, the Colorado Symphony Foundation, and the Institute for Children’s Mental Disorders.

Sector: Entertainment - Services

TWST: Could we start with a quick history and a brief overview of On Command?

Mr. Kern: For about 10 years, On Command has been the leading hotel in-room provider of video on demand, principally feature movies and adult movies. More recently it’s taken on the responsibility for delivering the full-video platform and also introduced two new products, which we call @Hotel TV, and @Hotel PC. @Hotel TV is an Internet service delivered through the television set, so it’s actually full Internet access utilizing a wireless keyboard, while comfortably sitting in your hotel bed. And @Hotel PC is high-speed connectivity through a separate port. We also have, as part of the entire system, the Sony Playstation for those hotels that want to have games available for their guests. The company was a subsidiary of COMSAT, going public through the acquisition of SpectraVision, another company in the video-to-hotel field, approximately four or five years ago. It was then spun out and acquired by Ascent Entertainment, a subsidiary of COMSAT, which owned the basketball team Denver Nuggets and the hockey team Colorado Avalanche. After the Spectra Vision transaction, Ascent wound up owning roughly 50% of On Command. Ascent Entertainment was then acquired by Liberty Media two-and-a-half months ago. And through that, Liberty Media became the controlling shareholder of On Command. I’ve had a long working relationship with both Liberty Media and TCI, and at that same time I was appointed the CEO of On Command.

TWST: When you look at the marketplace, who are you competing with?

Mr. Kern: Everybody. But we’re better.

TWST: Who else is in the hotel business?

Mr. Kern: We’re the largest provider, having close to one million rooms on the video platform. LodgeNet has about 750,000 rooms and is just coming up to speed, where they offer the full menu of products that we offer. But we are currently far ahead of everyone in the field in Internet connectivity. Between @Hotel PC and @Hotel TV, we have in excess of 90,000 rooms that are fully connected and operating. LodgeNet’s on the video side. There are other players that do elements of the video platform, like World Cinema and Hotelevision. And on the Internet high-speed connectivity platform in the public arena, there’s CAIS, STSN, Wayport, and several even smaller companies that provide high-speed connectivity to the hotels. Again, nobody offers, other than LodgeNet, the full menu of services. And currently, in the hotel community, we have more connections than anybody else in the field. By that I mean both Internet and video connections.

TWST: What is your market share?

Mr. Kern: It depends on how you measure the market. On the video side, we have one million rooms, LodgeNet has about 750,000 and the rest of the players have relatively small numbers, if any. We see as additional competition that cable companies are trying to get into this space by combining equipment that can deliver video on demand, thus competing with us in very small test areas. There’s currently competition from AT&T Broadband in Chicago and from Cox in San Diego.

TWST: As you look at this business over the next couple of years, what do you expect to go on? What changes, if any, do you see taking place?

Mr. Kern: Our view of the marketplace is kind of totally different than the view of almost any other player in this space. We see our command as a broadband delivery system of the complete menu of video and Internet product. So we’re reevaluating our product and will be making an announcement shortly about the video lineup. There’s no reason that our delivery system shouldn’t deliver more than just feature movies. At this point in time, it can do short features, it can do all sorts of video products, it can do specialized video products and tiered video products. What we’re doing right now is focusing our attention on what a hotel guest really wants, particularly the business traveler who occupies most of our rooms. Let me give you an example. If you’re Jerry Kern, you’d love to watch the NY Knicks play basketball, wherever you were in the world. I’d pay the $10 – the price you pay for a movie - much more easily to watch the Knicks. I might even pay to watch the Yankees. On Command is aware that there are a lot of complicating factors before we show these games in our hotel rooms There are league issues. We know the games are in the air, on satellites; they’re being distributed. Right now we can deliver the actual games, but we have to obtain the rights to deliver from either the teams or the leagues, or both. We’re working in all those areas. There are all sorts of specialized movie product and television product. If you’re traveling, maybe you’re not time-sensitive to the HBO series, “The Sopranos,” but you’d watch three episodes of “The Sopranos” for a price in your hotel room. Or some vintage movies might appeal to you if they were packaged and priced properly. So those are all the things with which we’re working on the video platform. Now on the Internet side, there’s going to be a universe of very specialized Internet content, services that the hotel guest wants — like a concierge service, like a travel service, so that you can change or order your tickets if you’re on a trip with multiple stops. We believe we need to partner strategically in that space, and we’re actively pursuing tactical partnerships to provide the content on the Internet side. Keep in mind, what we want to deliver to the hotel chain is a complete package of video, Internet entertainment, as well as video and Internet guest services.

TWST: You say you’re in one million rooms. One million out of how many potential rooms?

Mr. Kern: That depends on a variety of factors. Right now the services of all the providers in this space are basically being delivered to high-end, larger hotels. We introduced a product that makes economic sense for us to go into smaller hotels but still with relatively high-price points. What we’re expecting to develop, and we’re actually working on, is a new product that can go into smaller hotels with lower average daily rates because there’s essentially next to no service in the $50- to $55-per-night hotels and motels. That’s a big potential market, probably another million rooms. The whole international market is large and fragmented. So there’s plenty of room to expand. Right now the hotel population is growing because the economy’s so good, and people are traveling on business. As the number of hotel rooms grows, obviously that presents new opportunity.

TWST: What is it that prevents the cable operators from going in and challenging you?

Mr. Kern: From a technological standpoint? What prevents them? Nothing. From a contractual standpoint, quite a bit since we’ve locked up the video rights to these rooms generally for long periods of time. So they can’t simply come in and replace us. It’s not like a cable franchise that expires on a given day. It’s more like the case of an overbuild, and you still can’t get into the room unless the hotel invites you into the room. So actually, our product works better than something the cable guys or the satellite deliverers could put together with the equipment that’s currently out there. We spent a lot of time developing the product. But technology will change, and there’s nothing that prevents people from putting together a video-on-demand product to go with the regular cable and broadcast bricks-and-mortar. As you may know, I worked with John Malone for 20-plus years. Five years ago he told us we were going to have 500 channels in our house, totally interactive, quite imminently.

TWST: I haven’t seen it yet.

Mr. Kern: Neither have I.

TWST: You keep waiting.

Mr. Kern: Yes. It’s getting closer, actually. But I only use that as an example of how long it takes — even if you know if you can do it — to get something out there, deploy it, and make it work.

TWST: So it’ll happen, but not quickly, and you’re protected.

Mr. Kern: We’re moving ahead to be ahead of everyone else. We’re developing new platforms to be totally digitally interactive in the hotel room, and we’ll have the most workable and cost-effective solutions. It’s really a question of keeping the customer and the hotel provider happy.

TWST: If you look at the existing business, what kind of growth should investors expect over the next two or three years?

Mr. Kern: If you just take the existing business, we’re hoping to be able to generate close to double-digit growth and EBITDA. If you consider that currently we don’t receive any revenue for advertising on the video platform, instituting a revenue stream from that is very easy for us to do, and we’re going to get to that very quickly. Then if you look at all the new revenue streams possible from different content offerings, it geometrically increases. Not just the subscription offerings, but from advertising, e-commerce, etc. on both the Internet and the video platforms; we haven’t even projected numbers for those things in our presentations for the investment banking community and to the banks.

TWST: When are they likely to begin to show on the revenue line?

Mr. Kern: I would hope by year-end.

TWST: That soon?

Mr. Kern: Yes.

TWST: Is this all being developed internally, or are you going to do some of it through acquisition?

Mr. Kern: Yes and yes. It’s not necessarily acquisitions, although there will be some acquisitions, undoubtedly, or perhaps the acquisition of interest in other companies with which we can ally, where they’re further ahead in the space in developing the products.

TWST: So there’s some guys who are doing a good job out there.

Mr. Kern: There are at least one or two that we’ve seen. There are a lot that aren’t doing a good job.

TWST: That provides you with some opportunity.

Mr. Kern: Yes. I think we have a huge opportunity. On Command’s stock is extremely cheap at these prices.

TWST: What impact will the Internet have on your business, if any?

Mr. Kern: Huge because we’re relying on it to deliver an entire platform in the hotel rooms. And it also gives us the facility to go with the traveler outside of the hotel room.

TWST: When you say “go with the traveler outside the hotel room,” what do you mean by that?

Mr. Kern: The traveler’s connected to the Internet in a whole lot of different ways. He’s connected through his laptop, or he can get connected through dialing up on our TV-centric Internet equipment. He can now get connected through his Palm Pilot, a cell phone, and he’s got a computer back at his office. Think about this: if we can develop a portal that follows him wherever he goes, he could, in effect, be sitting in his office, making his hotel reservations and perhaps even choosing his movies or the services that he’s going to want when he checks in. This is our vision. Perhaps he works for Ford or IBM, and they only have certain hotels that they specify, and certain provisions with respect to what he’s allowed to charge back to the company. We can even conceivably bill it straight back to the company so that the guest doesn’t have to deal with paying the bill and submitting an expense report and all the rest of it. Now that’s the world of complete interactivity and portability that everybody in the telecom business has been talking about for the last 10 years. It’s a lot closer technologically, both from a technical and a hardware and software standpoint.

TWST: But we’re not there yet.

Mr. Kern: But we’re not there yet. But we’re going to be very close pretty quickly in my view. I think you’re going to see it all move much faster than it’s moved before.

TWST: And that just reflects the technology in broadband.

Mr. Kern: Yes.

TWST: You mentioned international. Will you do that on your own or through acquisitions or joint ventures?

Mr. Kern: That’s the one place I haven’t had enough time in the two-and-a- half-months that I’ve been here to make a firm decision. It’s a space that’s very fragmented. We’ve got rooms all over the world, but not high density in any single area, except for Canada. And there are multiple players in every area, and not just the same players. We have to look at an acquisition strategy — in some areas at a go-it-alone strategy; in other areas we tend to have local partners, even if they’re minority partners, that run our operations in some parts of the world. And that’s just the historical thing.

TWST: So that part of the equation is still to be determined.

Mr. Kern: Yes.

TWST: Do you have the management team in place that you need now?

Mr. Kern: We have a great management team, actually. I got here and was surprised to discover that the leaders in some of the areas — for example, Richard Fenwick, in R&D and engineering, and David Simpson, who manages our regional operation and field services — are really first-rate executives. Ron Lessack runs our operations, and he’s been doing it for a long time and knows the product very well. I brought in Nancy Gallion, who was formerly CEO of Your Choice TV, to head up programming and marketing because that was an area that hadn’t gotten enough attention. I’m looking at beefing up the whole sales operation. And we should be in a position to make some announcements in that area soon. Formally, I don’t call it the office of the CEO, but I added two really good people without line responsibilities — an SVP of strategic development and a VP of corporate development, both of whom sort of act as my arms and legs in looking at all these various areas. But the whole area is going through a huge amount of change, and to characterize it as having a lot on our plate, that’s true. But the nice part about that is this huge amount of opportunity that nobody’s captured.

TWST: Are there any areas that still have to be shored up?

Mr. Kern: From a management standpoint? I don’t really believe so. I mean, we obviously are going to need people — we’re moving to Denver — for at least the corporate headquarters for Denver, and there will probably be transitional changes, but not at the top ranks.

TWST: Why the move of corporate headquarters?

Mr. Kern: San Jose is really the worst labor market in the country. It’s also the worst space market. It’s good if you’re a high-tech business, and we’re leaving R&D and engineering there and manufacturing, for the time being. But in regards to the corporate staff, we can do much better every place else in the company here in the Denver market. We’re basically a domestic company with 350 people in the field throughout the United States. And being on either end of the country isn’t the best place to be. You’re much better served being located closer to the middle.

TWST: So Denver was a good compromise.

Mr. Kern: Denver’s the hotbed of this business, of the telecom business. A lot of programmers here, there are a lot of technology providers here. Our parent, Liberty Media, is here.

TWST: As the CEO, where are you spending your time? What’s your focus?

Mr. Kern: My priorities are to define the platforms and the offerings, to drive my people to really define the menu on the video side, to make the alliances on the Internet side, to develop the technology to distribute way down into the hotel universe. Those are really my priorities. When I get done with all of that on a domestic level, then my priority will be to take a look at what’s happening internationally with the same goals in mind. My priorities over the last two and a half months included getting the right people in place, and I think I’m there.

TWST: How would you describe the culture that you found at the company, and does it have to change?

Mr. Kern: It has change. I don’t know how much you know about the history of this company. The last CEO was Bob Kavner, who came out of AT&T, and he quit at the end of 1998. The COO, who actually was a CFO who became the COO, Brian Steel, left when Kavner left in June of 1999. They were essentially without a full time CEO from then until April of 2000, when I came in. So at that point in time, they’d been floating around without leadership direction, and without a willingness on the part of the Ascent ownership to really make any decisions or deploy any capital. So I came and found a group that was dying for direction and anxious to get on with it. By infusing it with the enthusiasm of all the new people, there’s kind of a new sense of adventure and enthusiasm and opportunity in the company. And I believe there’s a huge opportunity. I didn’t do this to play around for a few months. I think there’s an opportunity here to build a very large company.

TWST: What should investors worry about? Where’s the risk in the story at this point?

Mr. Kern: I guess theoretically everybody could wake up one morning and say, “When our contracts with On Command end, we’re going to go do something else.” That’s a scenario I can’t really see. Even the big hotel chains that are our major customers are not monolithic because they don’t control all the rooms that they own. So if they signed a contract with someone else, they couldn’t necessarily deliver all the rooms. I’ve looked at the economics of what happens if somebody leaves. And there’s an adverse impact, but it’s not dramatic, particularly if we’re successful in building up both new hotel rooms and new revenue streams. So I’m not real worried about it.

TWST: Is there a technology risk here? Can somebody come up with a better way of delivering what you’re doing?

Mr. Kern: No. Because if there’s a better way, we’ll come up with it first, and we’re actively working on it. There are always better ways to be developed, to do what we’re doing. And the other thing, when you think about it, is that we represent a million rooms today. AT&T has perhaps 30 million subscribers? This is a fairly small universe for them to completely reshape a system to compete with us. They probably have priorities internally higher than that. For some little guy to come along and reinvent the wheel, boy, that’s a real tough row to hoe.

TWST: So from that point of view, it shouldn’t be much of an issue then.

Mr. Kern: As I say, that’s not where our concerns are. Our concerns — priorities is a better word — are to develop the platform. If you have a broadband pipe, it’s no different than the cable operator. On Command has whatever capacity available — 150 channels, 500 interactive channels. How do I drive revenue? What can I put in that pipe that people are willing to pay for? It’s not out of the realm of credibility that we could deliver IP telephony over the television set. I just came back from the HITEC 2000 Dallas convention where in the hotels, telephone service for the first minute was $6.00 when you got on the telephone, and every minute after that was some outrageous amount of money. And what’s happened is the hotel telephones are out of business because everybody uses their cell phone, which is also not cheap.

TWST: No. But it’s cheaper.

Mr. Kern: But it’s cheaper. So if someday we can build in Internet telephony, maybe the hotel gets an access charge for the call, but it’s a cheap way of communicating. That becomes very attractive. Again, we want to be the complete provider. We’ve got the pipe, and we want to control the portal across whatever face the guest is looking at — whether it’s plug-and-play, or the television set, or if there’s a computer in the room. And that’s what we’re driving toward.

TWST: What can investors use as benchmarks or milestones to judge whether you’re making progress over the next year or two?

Mr. Kern: Look at the alliances we’ve formed. Look at the revenue streams that we have added. The first milestone may be this: if you look at our direct competitor, they’re fully leveraged, so no capital is available for any new initiatives. So they either have to sell their soul, or wait. We’re very close to announcing a bank refinancing deal, so I suggest you look for that. Because we’re seriously underleveraged, we have sufficient capital to realize these goals; they’re not pie in the sky. That would be the first benchmark to look for. And then look at what we announce, and look at the alliances we form.

TWST: Those will be the key to the future for you.

Mr. Kern: Yes. To some degree, we’re considered to be in the telecom or cable space, and you’ve seen the recent transactions — investors will value a cable company in some cases for as much as $4,000 a subscriber. If you look at a hotel room as a subscriber, currently we’re generating about $23 an equipped room per night. On our new OCX systems, which have the Internet capacity, we’re developing $33 — this is revenue per hotel room, per month. So if you look at that, now our margins are higher because we show at the hotels, etc. But if we can come close to getting a cable valuation on our rooms, suddenly the business is worth many times what its current market cap is.

TWST: You mentioned you’re underleveraged, so you have the financial capability to do what you need to do over the next couple of years.

Mr. Kern: That’s right.

TWST: So that’s not an issue. Ultimately, what kind of margin can this type of business generate?

Mr. Kern: It’s too early to tell. It’s generating margins in the 20s now. Probably there isn’t as much programming cost built into the Internet side of it. So you can probably see margins come up. Whether they can get up to the 40s where the cable companies are, I’m not sure. It’s too early at least for me to tell.

TWST: You mentioned earlier you felt the stock was undervalued. Why is that? What’s the market missing?

Mr. Kern: I think there are a variety of issues. I think there’s not much interest in the space because there are only essentially two companies in it from the market’s perspective. We’re not covered by very many analysts. It trades pretty thinly. At $15 per share — I’ve forgotten what the cash-flow multiple is, but it’s relatively low compared to other telecom deliverers.

TWST: Why haven’t you gotten the coverage? Is it just because of the history of the company?

Mr. Kern: I think it’s the historic lack of leadership within the company. It’s the fact that the company is still relatively small in terms of general coverage. I think all that’s going to change by the way. I bought a whole bunch of it for a lot more than it’s trading for.

TWST: If you were sitting down with some potential investors, what two or three reasons would you give them to go out and buy your stock today?

Mr. Kern: Everything I said in this interview.

TWST: Thank you.

Jerome H. Kern
 Chairman & CEO
 On Command Corporation
 96 Inverness Drive East
 Englewood, CO 80112
 (720) 873-3200 
 (720) 873-3288 – FAX

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