BUSINESS WEEK ONLINE
May 22, 1998


DID RADIO DISNEY STEAL CANDY FROM A STARTUP?


As a kid, Christopher Dahl tuned into the melodramas of children's radio serials, swooning to the high-strung Western tales of Sky King and the Lone Ranger. He went on to create an action series of his own -- the Seventies silicone hit Six Million Dollar Man. Now, the 54-year-old Dahl, who is CEO of Children's Broadcasting Corp. (CBC), is starring in a real-life cliffhanger.

For 18 months, he has been battling Walt Disney Co.'s ABC Radio Networks and its newly formed kids' network, Radio Disney. In a suit before a federal court in Minneapolis, CBC alleges that ABC Radio breached a joint sales and marketing contract, stole trade secrets, and used the information to launch the competing Radio Disney -- all of which allegedly drove CBC's national kids' radio network off the air and sent the company's stock down nearly 60% since July, 1996. The cash-starved company laid out more than $2.8 million in legal fees in 1997, and, as it abandons the radio business, has recently sold all 13 of its stations for $61.7 million.

"These guys started out right from the beginning to deceive us," fumes Dahl, a tall Midwestener who is a near dead-ringer for Seattle Supersonics basketball coach George Karl. For proof, he claims to have "rooms full of smoking guns" -- internal memos he says he collected from ABC Radio executives.

An ABC Radio spokeswoman refused to comment on any aspect of the case. But in a preliminary court hearing last December, company lawyers maintained that ABC and corporate-parent Disney lived up to the contract and never misused Children's trade information -- much of which, they claim, was already public. Disney also maintains that Children's claims "are literally contradicted by the contract." For instance, the contract didn't prevent ABC from competing with Children's.

A judge is likely to set a summer trial date in the case -- though there's some indication the two sides might settle. The two have negotiated, and a source familiar with the talks says they are "very close" to an agreement in the "tens of millions." It isn't certain that there will be a deal, however. Disney is a tough legal skirmisher, according to John van Maanen, an MIT management professor who writes extensively on the company. "That's their operating style," he says.

How did these two companies -- a 108,000-employee global media conglomerate and a 200-person Minnesota radio broadcaster -- get locked in a duel?

The saga starts in May, 1990, when Dahl, who had already built and sold off a collection of entertainment startups, hatched CBC and Radio AAHS (pronounced Oz) -- the name of a 24-hour network that broadcast a diet of saccharine pop music, kiddie classics, and squeaky-clean call-in shows. The company planned to blanket the nation via low-power AM affiliates, and eventually accumulated 13 stations in big-market towns, including Los Angeles, New York, and Chicago. At its height, Radio AAHS covered 40% of the U.S. market through 32 company-owned and independent affiliates.

AAHS, as Dahl describes it, "wasn't a revolutionary concept, but everybody looked at it as revolutionary." Kids' programming had, of course, been a part of radio since the 1920s, but TV quickly killed many radio offerings. It took the success of cable TV's Nickelodeon to persuade some broadcasters -- including Dahl -- that kids'-only radio might be a hit, too.

Based on Nickelodeon's success, Dahl thought he could build a strong brand by exploiting the under-12 niche. "The formation of this thing was like USA Today or CNN, or any of these things that take a long time to build a network," he says. But CBC could not create that network with the same ease that a media giant could spin out a brand extension. AAHS would have had to start from scratch, persuading both radio executives and national advertisers that kids -- and their cash-wielding parents -- would want 24 hours of quizzes and carpool sing-alongs.

In fact, radio AAHS's Minneapolis flagship, WWTC-AM, became a favorite of parents, who preferred the station's gentle fare to gritty talk radio. "AAHS has become something close to a religion -- or at least faith strong enough to keep Tinkerbell alive,..." gushed a Minneapolis business newspaper in 1994.

Advertisers were a harder sell, however. From Day One, AAHS attracted interest from the likes of Target Stores, Domino's Pizza, and grocery chain SuperValu. But it struggled to impress national ad buyers, who represent a huge chunk of the estimated $220 billion in purchases made and influenced by children.

The problem was ratings. Arbitron, the company whose listener logs are the lingua franca of radio ad-buying, does not track listeners under 12. Without hard numbers, AAHS sales reps had to resort to anecdotes and indirect audience measures, which weren't always persuasive in an industry obsessed with familiar, quantifiable measurements. "It was a very touchy-feely kind of sell. It came from the heart," remembers one former ad rep who wishes to remain anonymous.

Gary Donovan, a station manager for a former AAHS affiliate in Anchorage, Alaska, agrees: "It was certainly more of an artistic success than a financial success," he says. "The audience loved it, but we didn't have advertisers beating down the door."

So in 1992, AAHS made plans to emerge from obscurity, first with a February public stock offering, then with an aggressive rollout to affiliates across the nation. By January, 1994, AAHS had lassoed 17 affiliates reaching 18% of the country. Most important, big names were also starting to take the AAHS concept seriously. In the summer of 1994, Time Warner agreed to launch a co-branded AAHS magazine and children's music CD. And Disney (which had not yet purchased ABC) signed on for a weekend radio show aired from both Disney World and Disneyland.

Such high-profile deals and expansion did not come cheap. CBC'S losses reached $3.2 million in 1993 and $4.5 million in 1994. Quarter after quarter, Dahl reminded investors that "losses will decrease" or, as in 1994, that it "continued to be a building year."

It was becoming increasingly clear, however, that AAHS did not have the affiliate reach necessary to entice national advertisers. And there was still the nagging lack of ratings. Eager to add more firepower, in early 1995 AAHS set out to secure a partnership with ABC Radio, the country's largest radio syndicator, owner of national flagship stations and an ad-sales machine.

The two opened talks via a dealmaker at investment bank Jefferies & Co. By April, 1995, they agreed to research a potential pact, with ABC possibly helping AAHS in advertising sales and affiliate relations.

Then in July, a bombshell hit. Disney bought ABC, which froze all of ABC's contract negotiations. When AAHS and Disney/ABC got back to the table in September, AAHS was still eager to ink a joint marketing plan, which would bring it national-network status. The Disney/ABC imprimatur was also a valuable endorsement for future stock offerings (two months later, it would help CBC net $20 million in new money). In a final agreement reached in November, 1995, AAHS agreed to pay ABC $25,000 a month plus ad-sales commissions, and issued stock warrants to ABC worth 20% of the company. For ABC Radio, the deal added a small but growing niche to its huge syndicated menu. And if it found Radio AAHS an attractive long-term prospect, it could exercise its stock warrants.

Much of the lawsuit hinges on the months following the Disney/ABC merger. As early as 1992, the two had considered -- but passed up -- the idea of creating a children's radio network. One key issue on which the suit turns is when they reconsidered. AAHS's lawyers argued in the pretrial hearing last December that "[ABC was] trying to duplicate [CBC's] programming, its existing business and future potential, to target the same accounts with the same pitch, stealing the overall business plan and approach of Radio AAHS." While that might have been questionable ethics, did it violate the contract? In arguing no, ABC points to a clause allowing it to sell advertising "in connection with any format developed by ABC...now and in the future."

For proof of its position, CBC cites the presence of Disney Director of Strategic Planning & Development Lynn Kesterson-Townes in meetings between it and ABC Radio. The suit says "she informed Children's that her job at Disney for the next six months was to learn all she could regarding Children's operations." CBC argues that she became especially familiar with its database of advertisers and its confidential market research.

More telling, Children's alleges that ABC neglected the strategic alliance. It sold only $23,000 in advertising during the nine months they were partners, and recruited no new affiliates. In the pretrial hearing, AAHS's lawyers detailed a deposition from eventual Radio Disney manager Scott McCarthy, who said in the document that he instructed his staff to meet only certain contractual minimums. ABC had no comment.

In the same December hearing, Disney countered that much -- if not all -- of the information it got on the AAHS operations was publicly available. As for ABC's failure to deliver new ads and affiliates, the shortcomings were a result "of an untested product that nobody's ever had any success in selling," ABC's lawyers contended.

Dahl concedes that at the time, he considered such explanations "reasonable." But his attitude changed when ABC dropped out of the agreement after less than 10 months. Subsequently, the suit says, ABC contacted Abritron to discuss an under-12 ratings service -- using AAHS's own listener data without its knowledge. And even before it canceled the agreement, ABC had assembled a team of 55 MBAs to investigate the children's radio market -- including in cities where AAHS broadcasted. Says a bitter Dahl: "I don't enter into agreements thinking that people are going to [use them] to gain a competitive hold against me."

The contract finally fell apart in a meeting on June 21, 1996, when then-ABC President David Kantor told CBC that Disney would not exercise its warrants and that it was close to starting its own kids' network. On July 30, Disney announced that it was terminating the CBC agreement, and that it was entering the market with a four-city pilot called Radio Disney. Coincidentally, two of the pilot cities were in AAHS territory -- in Salt Lake City and in its home-base of Minneapolis. An "incredulous" Dahl watched CBC's stock drop 22% that day, as it suffered a double blow: Not only was the company losing the services of a master marketer in ABC Radio but it was now in competition with the preeminent children's brand name: Disney. And Radio AAHS was no longer allowed to broadcast from Disney amusement parks.

Dahl originally labeled Disney's entry an endorsement of the kids' radio concept, but that didn't mean AAHS could compete. In the months after the announcement, CBC scrambled to reassemble the sales and marketing force it had scrapped when it signed the ABC deal. But AAHS's advertising plummeted, and affiliates began to jump ship. "Disney went around and bad-mouthed us," recalls the former AAHS advertising rep. "Of course, we were going after the same dollars, there were two players in the game, and Disney is an aggressive company."

"Radio AAHS went out of business because Disney presented more of an attractive advertising package to sponsors," says Joel Denver, publisher of the radio-industry Web site allaccess.com. "Let's face it: Disney has got a lot of clout."

Radio AAHS supporters see an inconsistency here. "They sold one or two ads over a six- or eight-month period," says Eric Miller, a portfolio manager of Milwaukee's Heartland Value Fund, which holds Children's Broadcasting shares. "How credible is it to say they couldn't sell the product, and then three weeks later say they're getting into the business themselves?"

So far, Radio Disney executives won't disclose their ad sales. AAHS lawyers contend that in internal documents, Disney valued the children's radio market at $116 million to $274 million in annual advertising revenue. James Duncan, who publishes Duncan's Radio Market Guide, estimates that top-tier Radio Disney markets, such as Los Angeles or New York, could generate $3 million to $4 million in revenue each year. Stations outside the top 50 markets could bring in just a tenth of that, Duncan says.

How much is the suit potentially worth? Radio AAHS, which never turned a profit, would have a hard time establishing that it lost the entire market. And it would likely have limited recovery for breach of contract -- ABC Radio's supposed failure to drum up ad sales and new affiliates.

Awards could get much higher, however, if CBC could prove that ABC and Disney stole trade secrets and used the information to duplicate the Radio AAHS operation. Even Minneapolis Radio Disney station manager Brian Acker, who competed against AAHS, concedes that while he "knew we were offering a different product, [it was] perceived as the same." Indeed, the mix of music and on-air personalities does seem similar to that at the former Radio AAHS. But to win big, AAHS will have to show more than likenesses between two operations. It will have to prove fraud by Disney and ABC executives.

Meanwhile, Radio Disney pushes ahead, having just landed its 23rd affiliate since its May, 1997, national debut. And just as Disney built up its network, Radio AAHS began dismantling its own. It took less than seven months after the Disney rollout for Radio AAHS to announce its closing. "We were simply not in a position to take any other course," Dahl said as he flipped the off switch on Jan. 30.

The company is now trying to refashion itself as an advertising production house, using the $61.7 million from the sale of its radio stations. "You hear stories like this," Dahl muses, "that Big Business does this." He says he could accept getting beat on a "level playing field...But this wasn't a level playing field." And he vows, "we are going to show some damages."


By Dennis Berman, Staff Reporter, Business Week Online

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