Tracking John Malone (Part 3) – Liberty Media (LMCA)

Liberty Media is John Malone’s flagship.  Of all of Malone’s companies, I am interested in Media the most since:

  1. It is likely that Malone will continue to put his best ideas into it.  This is probably the company that will grow the fastest.
  2. Continued share repurchases suggest that it trades at a slight discount to the value of its assets.

Liberty Media is difficult to understand.  Historically, John Malone has used complexity as a weapon against institutional investors to mislead them into selling stock at too low a price.  Malone’s complex Liberty companies have always tended to trade at a discount to what its assets are worth.  This allows Malone to continually buy back shares at low prices (this is like free money).  A secondary effect of this is that size becomes less of an anchor on future performance.  Historically, you would have done the best if you had stuck to buying the most complex part of Malone’s empire that he owns the most of.  He keeps the best businesses hidden in his flapship and spins off the mature businesses (e.g. Global’s cable assets), the slow-growing ones, and the not-so-great businesses (e.g. production companies/Ascent).  So, I would expect that his flagship company (Liberty Media) will grow faster than the rest of his empire.

This is a great business at a good price.

What makes a good investment?

To understand Malone, I think it makes sense to first talk about what makes a good investment.

One type of good investment is a company that is better with scale.  Some companies in the media business fall in this category.  Bigger cable operators can negotiate substantially lower rates for programming.  Their cost per customer goes down as they get bigger.  (Unfortunately, if they get too big and profitable, regulators and politicians will act against them.)  I believe that Sirius XM will experience similar effects as more subscribers will drive down per-subscriber costs.  In the long run, these types of companies can have explosive growth.

Another type of good investment is a company run by a top notch CEO.  Some superstar CEOs are able to generate unusual returns in mediocre businesses.  Tom Rutledge at Charter Communications is probably one of those CEOs.  These superstar CEOs tend to sustain high returns over long periods of time.

Another type of investment is buying companies that are trading below the sum of their parts.  Barnes and Noble likely falls into this category.  It has a profitable book store business (which is in decline) and a money-losing e-reader business.  Microsoft’s investment in Nook implies a market value of almost $1.704B ($300M / 17.6%; however, there are conditions to Microsoft’s investment which makes the implied value less than $1.704B).  BKS has a market cap of $1.09B.

Turnarounds can also be good investments.  Charter has historically been a poorly-operated cable company with low market share.  I presume that Malone is betting on Rutledge to improve Charter until it hits similar metrics to his previous cable company (Cablevision).  The problem with turnarounds is that there won’t be unusual returns or earnings growth after the turnaround is complete.  You may need to constantly flip these turnaround companies.

The problem with constantly flipping companies is that you have to constantly pay taxes on the profits.  If you could instead invest in a single company and hold it forever, you would essentially enjoy an interest-free loan from the government.  The interest-free loan can add a lot to overall returns if you compound the proceeds over very long periods of time.  There are ways to minimize and reduce taxes from constantly flipping companies.  Liberty has often “sold” its stocks through derivatives so that it doesn’t have to trigger capital gains.  It has also swapped their businesses for better ones, which is another way Liberty has avoided triggering taxes.  But at the end of the day, it is sometimes better to buy and hold a great business than it is to constantly flip assets.  I believe that Sirius, Charter, and Live Nation may be great businesses that are able to invest capital at high rates of return and will grow their earnings significantly over time.  Liberty Media itself is also a great business as you have John Malone at the helm allocating its capital, making deals with other companies, and finding superstar CEOs to install into his companies.

Liberty Media – what is it worth?

The easy answer is this: if Liberty Media is buying back its shares, it is probably undervalued.  Liberty reports share repurchases in its 10-K and sometimes in its conference calls and presentations.  From December 1 – 31, 2012, it paid an average price per share of $104.92.  It has to have paid over $104.92 for some of its repurchased shares, so it likely to still be undervalued above $104.92.

Now here’s the long answer.  Here are the three main areas where Liberty’s accounting masks the true value of its assets.

#1- Not all of Liberty’s stocks are marked to market – Roughly $52.51 – $59.19/share

The Sirius XM and Live Nation stakes are publicly traded.  The 10-K lists the difference between fair market value and carrying value.  Remember that Liberty has to pay taxes on its capital gains.  Because this tax doesn’t have to be paid right away, there is essentially an interest-free loan from the government attached to it.  I don’t think that Sirius and Live Nation will be liquidated anytime soon as these are great businesses that should compound well over a long period of time.  So, I would heavily discount the tax liabilities on these capital gains (e.g. the future $1 in tax owed is worth maybe $0.2 to $0.5 today).

#2- Liberty has deferred tax liabilities.  Roughly $3.71 – $5.93/share.

According to GAAP accounting, Liberty has $903M in deferred tax liabilities.  This is excluding the additional tax liabilities discussed in #1.  Again, this $903M should be discounted to its present value.

EDIT:  To clarify, I am making the assumption that $1 in tax due in the future is worth $0.2 to $0.5 today for all of Liberty’s deferred tax liabilities.

#3- Spinoff trickery – Roughly $13.95/share

Liberty’s latest 10-Q/10-K filing is for the quarter ended Dec 31, 2012.  However, the Starz/Liberty spin happened after that date.  For whatever reason, the accounting rules allow for Liberty and Starz to shift assets around after the quarter has ended.  But, these deals aren’t reflected on Liberty’s balance sheets.  The balance sheets don’t record assets and liabilities for future deals that are going to happen.

So if you read the 10-K carefully…

At the time of Spin-Off, a cash distribution was made of approximately $1.2 billion from Starz to Liberty which will replace that operating cash flow for the near term.  […]

As of January 11, 2013 the Company no longer has any outstanding debt to service on a go forward basis as all outstanding debt obligations remained with Starz in the Spin-Off.

(I could be wrong here.)  The bottom line is that Liberty has about $1.7B that isn’t reflected on its balance sheets (the debt is a little over $500M).

There are other little areas where Liberty’s book value understates the value of its assets.  It has a collection of miscellaneous other assets (e.g Atlanta Braves) which are likely worth more than their carrying value.  I will ignore those items as they are at most worth only a few dollars per LMCA share.

By my estimations, Liberty Media has roughly $70.17 to $79.07/share in hidden value and $52.86/share in book value.  (I arbitrarily assume that the B shares will receive a 7% premium if the share classes were collapsed.)  Fair value for LMCA shares should be somewhere around $123.03 to $131.93.

*Disclosure:  No position.  You see… I wasn’t smart enough to buy shares during 2009-2013.  I may or may not buy shares or call options in the future.

EDIT:  I missed Liberty Media’s claim against Vivendi.  The latest 10-Q for the quarter ending March 31, 2013 states:

In connection with a commercial transaction that closed during 2002 among Liberty, Vivendi Universal S.A. (“Vivendi”) and the former USA Holdings, Inc., Liberty brought suit against Vivendi and Universal Studios, Inc. in the United States District Court for the Southern District of New York, alleging, among other things, breach of contract and fraud by Vivendi. On June 25, 2012, a jury awarded Liberty damages in the amount of €765 million, plus prejudgment interest, in connection with a finding of breach of contract and fraud by the defendants. On January 17, 2013, the court entered judgment in favor of Liberty in the amount of approximately €945 million, including prejudgment interest. Vivendi has filed notice of its appeal of the judgment to the United States Court of Appeals for the Second Circuit, and, in that court, Liberty intends to seek a higher rate of pre-judgment interest than what the district court awarded. The case is stayed pending the appeal and the appeal in this case has been consolidated with the expected appeal of a class action brought against Vivendi by other shareholders. The amount that Liberty may ultimately recover in connection with the final resolution of the action, if any, and the timing of the resolution of the action is uncertain. Any recovery by Liberty will not be reflected in our consolidated financial statements until such time as the final disposition of this matter has been reached.

Liberty should win roughly US$990M (this may be adjusted), which is roughly US$8.18/share.

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