Why Diller Is On Top Of The World

In the annals of american labor, show-business mogul Barry Diller has set a record for pay that's unlikely ever to be broken. By merely showing up for the first day's work as chief executive of the newly created Vivendi Universal Entertainment, Diller will collect a 1.5 percent piece of the action worth at least $275 million. Even if he were to quit--for good reason, of course--on the spot. But wait, it gets better. Unlike almost every other American working stiff, Diller will enjoy a second fortune in tax savings on his compensation. NEWSWEEK has learned that if Diller unloads his stake even on his first day of work, his $275 million won't be regular income, but capital gains. As such, he'll pay Uncle Sam almost $60 million less in income taxes than he'd pay if his $275 million were considered salary. "When you are bringing in talent like Barry Diller, you have to give him strong incentive," says Jean-Marie Messier, chief executive of Vivendi Universal, and Diller's putative boss.

And you also have to toss in a few billion crumbs to Diller's other employer, USA Networks. USA is getting $11.7 billion of value in return for assets that it bought for $4.1 billion in 1998. How much tax do you think USA is paying on its $7.6 billion gain? Try zero. Nada. Nothing. Ditto for Vivendi Universal, which is getting $7.7 billion of value for USA Networks stock valued at only $2.5 billion in that 1998 deal.

Diller, who previously ran the Paramount and Fox studios and helped found the Fox TV network, has reportedly been talking about shaking up the economics of the entertainment industry. His deal certainly shakes up the economics of charismatic media moguls running showbiz empires. It also shows that in addition to having glitz, dealmaking prowess and connections (including a seat on the board of The Washington Post Company, NEWSWEEK's owner), Diller hangs with star-quality tax mavens.

Most of the enormous coverage accorded this deal has focused on the huge ambitions of Diller, who has tried for years to get control of a major broadcast-TV network, and Messier, who's hard at work trying to transform a French water company into a multinational media colossus. The sweet tax deals have escaped public view because the players didn't mention them, for fairly obvious reasons. But some cognoscenti know about the tax angles, and you can find some details buried deep in filings at the Securities and Exchange Commission.

To follow this textured story line, you need a little history and also a simplified script showing how Vivendi Universal Entertainment, known as VUE, works. History first. In 1998, well before it was acquired by Vivendi last year, Seagram sold its cable networks and TV production to Diller's company for $1.6 billion of cash and stock valued at $2.5 billion. (That stock is valued at $7.7 billion in this deal, a nice return.)

Now, let's look at VUE. Despite what you've read, seen and heard in other media, Vivendi isn't actually buying the USA Network and other assets from the company that Diller runs. Rather, Vivendi, USA and Diller are starting a partnership and using it to swap assets around. Vivendi is putting the following into the partnership: Universal Studios; USA stock being valued at about $8.3 billion, some of which Vivendi is buying from Liberty Media, run by the famously taxophobic John Malone, and $1.6 billion of cash. USA is contributing its TV and cable businesses, as well as deal-blocking rights and stock-purchase warrants. Diller is contributing a noncompetition agreement and some other odds and ends. And, of course, he's contributing his biggest assets: aura and Wall Street creds.

Got all that? OK. At the end of the day, USA Networks takes from the partnership the USA stock that Vivendi put in, the $1.6 billion of cash, a 5.4 percent VUE interest that's valued at $1 billion and a $750 million "preferred interest" in VUE. Total: $11.7 billion. In return for its contributions, Vivendi gets a 93.1 percent interest in VUE and the USA stock-purchase warrants. Diller gets the 1.5 percent interest in VUE. He doesn't have to pay tax on the value of that interest, because it's not stock: it's the right to get 1.5 percent of whatever the partnership distributes to its partners. The right to get that money isn't taxable. And while Diller is working without a salary or contract, the cash generated by his VUE stake should keep him off the bread lines.

For reasons that verge on the incomprehensible, Diller for tax purposes is considered to have gotten his interest in VUE in 1995, when he first got involved with USA, then known as Home Shopping Network. So if Diller sells his interest for $275 million on day one, it's a long-term capital gain, not salary income. Thus he pays Uncle Sam the cap-gains maximum of 20 percent rather than the 41.05 percent bite that Uncle Sam takes on salary income from people in the top tax bracket. Which Diller's undoubtedly in. Apply the difference to $275 million, and Diller saves $59.1 million.

All this tax avoidance, by the way, is perfectly legal. It's the kind of perk moguls get, but is usually beyond the reach of peasants. As they say in Hollywood, that's showbiz.