The relationship between DC Comics, one of the two largest comics publishers in the country, and Diamond Comic Distributors, the only large distributor in the industry could grow closer as early as April. According to a 1995 DC memo that was leaked to the Journal, the terms of DC's contract with Diamond give the publisher the option of acquiring a minority interest in the distributor after the contract's seventh year. That seventh year ends on April 24.

Even more significantly, the contract gives DC the right to purchase Diamond outright as early as 2005. If it decides to purchase Diamond, the publisher is guaranteed a price estimated to equal approximately three times Diamond's annual earnings before interest and tax. In the memo, DC Publisher Paul Levitz described the purchase terms as "highly favorable" to DC.

Because Diamond is a crucial part of the business operations of virtually all American comics publishers, the prospect of the distributor falling under the control of a competing publisher has been a source of some concern in the industry. To date, both Diamond and DC have avoided any suggestion that such a buy-out is in the offing.

If DC has targeted Diamond for acquisition, one might expect the publisher to begin building equity at its earliest convenience. Following this logic, whether or not DC chooses to exercise its option in April to acquire a minority holding in Diamond could be a strong indicator of its future intentions regarding the distributor.

Diamond Marketing Vice President Roger Fletcher told the Journal, "I can't get into it because of confidentiality, but nothing kicks in this year. I can tell you that DC has expressed no interest in buying Diamond." This suggests that adjustments may have been made to the original contract, which have altered at least the timetable, if not more substantial elements. The aim of this article is to look at what clues of DC's intentions emerge from the history of the DC/Diamond deal and to speculate about why the buy-out option might have been to DC's advantage even if the publisher never intended to exercise its rights.

At the time that DC negotiated its contract with Diamond in 1995, the comics industry was a very volatile environment. Comics sales in general had begun to plummet from an all-time high and Marvel had just acquired its own distributor, announcing that Heroes World would thereafter be the only source of Marvel products. Marvel's move to self-distribute was the pressure that motivated DC's negotiations with Diamond. In fact, Levitz, in his memo, said, "[The Diamond deal] was only possible in the wake of Marvel's acquisition of Heroes World." He added that "it leaves us in a far superior position to theirs."

This last statement proved to be true. Marvel ran into difficulties ranging from angry retailers to inefficient shipping and returned to Diamond by April of 1997. No one knew how Marvel's experiment would turn out at the time it acquired Heroes World, however. Levitz's memo indicates a worry at DC that self-distribution would give Marvel an "increased marketing push with retailers." DC immediately sought to balance that by negotiating a favored status with Diamond. Marvel's withdrawal from Diamond followed by DC's exclusivity contract with the distributor threw the industry into turmoil, with the remaining publishers jockeying for position as best they could.

Even without the buy-out clause, DC's 16-year exclusivity contract with Diamond did more than trade the publisher's exclusive business for a few privileges -- advantageous catalog placement, extra promotions, etc. The new arrangement constituted the first brokerage deal in the comics direct market. Under the contract, Diamond would not be buying DC product for resale in the direct market as it had done with all other publishers. It would provide sales rep, distribution and promotional services in exchange for fees, including brokerage fees based on a sliding scale ranging from 6.25 to 7 percent of retail. (This is in contrast to the 10 to 15 percent of cover price that nonbrokered publishers typically pay to Diamond) In effect, DC would be selling directly to comics shops, with Diamond shaving off a percentage in fees for its services. The publisher would then have unprecedented control over wholesale pricing of its products, as well as control over reorder and backlist transactions. In his memo, Levitz commented, "[DC will] have the opportunity to ride what we anticipate will be a gradual escalation of net price (amount received by publisher) to retail price over the next few years without sharing with Diamond."

In addition to the publisher's increased share in profits, Levitz estimated that the comparatively low distribution fees, as negotiated, would save DC $2-3 million, and could give it leverage against the higher newsstand distribution fees charged by Warner Publisher Services. Ultimately, said Levitz, "DC is ensured [of] having the prime influence over Diamond regardless of our future competitive position."

At the same time, Diamond, in its announcement of the contract with DC, was assuring one and all that, "under this new sales representation agreement, Diamond will remain a 100 percent independently owned and operated company."

When informed that DC's contract would give DC not only a privileged status with Diamond, but an option to buy the distributor in a few years, Dark Horse's Lou Bank and Image Comics' Larry Marder told the Journal that arrangement would be a matter of concern to them. Despite their hesitations about becoming dependent upon a distributor that might one day be owned by a competitor, however, both Image and Dark Horse announced their own exclusivity/brokerage contracts with Diamond at the Comic-Con International in San Diego that July, leaving Capital City Distribution, the only other large comics distributor, unable to carry the products of the four largest publishers. As the industry condensed more tightly around a shrinking market, Diamond swallowed Capital, which had earlier swallowed the smaller Friendly Frank's Distribution, and the table had been set for DC with Diamond as a potential main course.

In his memo, Levitz had cited the advantages of securing the preferential services of the industry's largest distributor with a market share of 50 percent, but he must have known full well that the DC/Diamond coalition could precipitate changes that would hand its partner a market share closer to 100 percent. In any case, that is exactly what has come about.

In the 1990s, the corporate world had grown accustomed to companies absorbing one another in a fever of acquisitions and mergers that encompassed far more than the comics industry. And it was not uncommon for conglomerates to be so subdivided that they could be providing a service to a company, while at the same time competing against it. DC itself rested snugly in the belly of Time Warner, which was in turn swallowed by AOL. Mainstream comics publishers were, in fact, already dealing with Warner's newsstand distribution arm, Warner Publisher Services. In this environment, comics publishers apparently decided that they could live with the idea that they might one day find themselves exclusively distributed by a company owned by one of their largest competitors.

In the summer of 1997, after Marvel had returned to Diamond, the United States Department of Justice launched an antitrust investigation into the comics industry. The investigation was dropped in November of 2000, with no action deemed necessary, but Justice Department officials told the Journal the case could be reopened if conditions changed or new evidence of monopoly conditions arose.

How likely is it that DC will take advantage of its option to acquire Diamond? Levitz was asked by the Journal, in a 1995 interview, if DC was planning to buy a distributor. DC had just signed its contract with Diamond, but Levitz did not know that the Journal knew some of the unpublicized terms of the transaction when he gave his answer: "I don't think we've excluded the possibility of DC buying a distributor or doing it ourselves at some point in the future or through another arm of Time Warner. But we don't have any plans to do these things or this would have been a very easy and appropriate time to do it. But the future is a long time."

The Journal then asked specifically whether DC planned to buy Diamond. Levitz responded, "We have no intention to do so."

After a series of speculative questions about how important it was to other publishers that Diamond maintain its independence, the Journal zeroed in on the precise question "Does DC have the option to buy Diamond at some point?"

Levitz replied, "As I've told you, there's a lot of sets of circumstances that may exist under this contract. We're not interested in having a discussion of every possibility that might arise." Pressed by the Journal for an answer, he said, "I gave you an answer, Chief. You can take it or leave it."

When the Journal revealed that it had already known the answer before it had asked the question, Levitz declined to confirm or deny the veracity of the DC memo and angrily concluded the interview.

Seven years later, he was no more open to invitations to discuss DC's potential acquisition plans. When the Journal approached DC spokesperson Patty Jeres to ask if DC intended to acquire a minority holding in Diamond when that option comes up in April, she said neither Levitz nor DC would have any comment on the matter.

Levitz was closely involved in the negotiation of the Diamond contract, and the memo is his report to his superior at Time Warner, Sandy Reisenbach. At the time, he held the held high positions of executive vice president and publisher at DC. With the upcoming departure of DC President Jenette Kahn, he will have become the most powerful officer at DC Comics. It is safe to say, therefore, that his opinion as to the desirability of acquiring Diamond will go far toward determining DC's course of action.

We know from the memo that Levitz regarded the buy-out option as a "key deal point." Specifically the option grants DC the right, but not -- as Levitz pointed out -- the obligation, to buy Diamond at any time between the contract's 10th year and its termination in its 16th year, or in the event of owner Steve Geppi's death, disability or departure from the company. The purchase price would be based "on a highly favorable formula ranging from 3 to 5 times EBIT [Earnings Before Interest and Tax], reduced proportionately for the portion of its sales derived from DC, which we anticipate will yield a final purchase price of 3 times EBIT or less if we decide to proceed." Interest, in this formula, refers to payments on long-term debt. Companies are frequently purchased for much higher multiples of EBIT, which may explain why Levitz considers the formula "highly favorable."

Beyond the immediate advantages accruing to DC's new brokerage deal, Levitz's memo makes reference to "far-reaching benefits for DC" and "long term bottom line benefits." These almost certainly refer to the opportunities posed by the acquisition options that would arise later in the contract. Exercise of those options could be seen as beneficial, he wrote, "if we feel their profitability makes [Diamond] a desirable acquisition, or if we feel ownership/control is required as our market evolves."

By speaking in terms of long-term benefits, Levitz gives the impression that he is already thinking favorably of Diamond's acquisition prospects. But in his most direct statement on the subject, he makes the desirability of acquisition contingent upon profitability and the direction of the market's evolution. By offering the test of whether "ownership/control" will be "required as our market evolves," he suggests that such no such requirement exists at the time and positions a deciding factor for acquisition in the future.

In discussing the advantages of the new brokerage deal Levitz notes that Diamond would bear the costs of maintaining, adjusting and improving distribution-related infrastructure -- in contrast to Marvel's situation at Heroes World, where the distributor's new owner was looking at considerable expansion costs. He also notes that, as broker, Diamond would assume all the risks associated with collecting payment from retailers. If DC were to acquire Diamond outright, these advantages would disappear, casting further doubt on whether acquisition would be a profitable move for the publisher. Why negotiate for an option if it is not already seen as desirable? Is there a sense in which an option can be beneficial even if it's never exercised? The great impetus for DC's negotiations with Diamond was the perceived need to counter the implications of Marvel's move into self-distribution. As Levitz observed, DC's brokerage deal with Diamond gave it almost all of the advantages that Marvel enjoyed with Heroes World, but none of the headaches. The one additional advantage that Marvel's ownership of Heroes World conferred was, precisely, control over ownership. DC achieved this same control by virtue of its acquisition option. Without the option, there was nothing to prevent Marvel/Heroes World from trying to swallow Diamond, in which case, DC would've been bound by an exclusive distribution contract to its worst enemy -- the very threat that other publishers, including Marvel, now face from DC. With the option, no one could buy Diamond out, without DC getting first shot at it according to fixed purchasing terms. From this point of view, it may be that the buy-out option holds its greatest value for DC only so long as it is not exercised -- as a kind of scarecrow against other predators.

Which is not to say that it is not also a very real hedge against what Levitz called an evolving market. Times change, and Diamond is more than it once was -- no longer just a guarantee of access to DC's share of the market, Diamond today essentially is the direct market.

1995 reporting by Eric Reynolds.

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