Here’s how I see it.
Some people are superstars at operating a cable company while the majority of people are bad at it. One way to figure out who the superstars are is to figure out how much money is made per home passed. Liberty’s investor day presentation uses adjusted EBITDA per home passed, which is a rough proxy for this. (I would prefer to subtract maintenance capex from adjusted EBITDA.) Each home passed represents a potential customer. Good operators will turn a high percentage of its homes passed into customers and sell them as many services as possible (television, premium channels, Internet, voice, video-on-demand, etc.).
Liberty’s investor day presentation (PDF) compares various cable companies:
Historically, Charter had been very poorly managed while Cablevision has been well managed. Tom Rutledge attributes Cablevision’s performance on this metric to his performance as Cablevision’s chief operating officer (*not the CEO). Now that he is Charter’s CEO, he will try to get Charter up to Cablevision’s (old) performance level.
What the adj. EBITDA/home passed metric doesn’t take into account is that there are differences in each home passing. Charter has a mostly rural footprint. It will not face as much competition from competing non-satellite technologies (phone lines, fibre) because rural areas cost more to build out than urban areas.
One downside of this metric is that it does not measure return on invested capital. This metric could be gamed by overinvesting in capex at poor rates of return.
Other important metrics of an operator’s skill are the penetration rates of video, Internet, and voice services.
The idea is to buy into poorly managed cable networks and have a superstar manager take over. There is a reason why Malone is obsessed with controlling the companies he owns. He knows that management makes a huge difference in shareholder return. (He learned this lesson the hard way when he sold Liberty to AT&T, which overpaid for assets and took on too much debt.) This is the template for Liberty Global’s roll-up strategy. Global could make an accretive deal taking over Virgin Media because Virgin was poorly operated (e.g. very low rates of video, Internet, and phone penetration per home passed on the cable side).
As far as Charter goes, Charter was lucky enough to have Tom Rutledge become its new CEO. Malone recognized the opportunity and bought a large stake in Charter, recognizing the turnaround that was about to happen.
I suspect that Malone doesn’t explain this game because he doesn’t want other people playing it. He doesn’t want shareholders of publicly-traded cable companies to install better management teams. He wants his competitors to operate their assets poorly so that he can swoop in, buy them at low valuations, and turn them around for very healthy profits. As cable companies tend to be heavily leveraged, small improvements in operations can translate into big profits. He values controlling his companies as it allows him to protect his capital from bad management.
When shares are expensive, Malone uses them as currency for acquisitions. Otherwise, he pays for acquisitions in cash/debt.
If you were to consider John Malone a fund manager, it is clear that his track record is incredible (especially after tax) compared to well-regarded fund managers. In a way, he is secretly one of the greatest value investors of all time. And unlike many well-regarded fund managers, he invests in companies within his circle of competence. He is the former CEO of a cable industry so he understands the media industry very well and generally sticks to media-related stocks. Unlike many well-regarded fund managers, he does not invest in industries that are very difficult to understand or very difficult to perform due diligence on (mining, oil & gas, pharma, investment banks, etc.).
Unusual buyback strategy
Malone understands that he can make arbitrage profits if his company’s shares are constantly significantly overvalued or undervalued. I think Malone has an incredibly unusual style in that he tries to keep his shares undervalued. Suppose he had done the opposite and kept his shares overvalued. He would use the overvalued shares to constantly roll up other cable assets. Integrating other cable companies would eat up a lot of management’s time. As well, the resulting company would become quite massive and eventually size would be an anchor on performance. The opposite is a little more attractive. By keeping his shares undervalued, he is able to shrink the amount of capital he is managing so that size isn’t an anchor on performance.
The financial statements of Malone’s companies are highly unusual in that they use some fairly obscure and arcane accounting. His use of tracking stocks is highly unconventional and makes his stocks harder to understand. I believe that these are weapons that Malone uses against his investors (institutional and retail) to trick them into selling shares at too low a price.
Historically, Malone’s companies have often been able to buy back huge amounts of shares over very long periods of time. It is rare for his companies to be overvalued.
Economies of scale
When a cable company accounts for a very large percent of a programmer’s revenue, suddenly the cable giant has an unusual amount of leverage over the programmer. If they fight over pricing, the programmer will be hurt a lot more than the cable giant. Negotiations become a little unfair. However, government regulators would likely step in and prevent companies from having this type of power.
I think that economies of scale somewhat distract investors from the overall game that Malone is playing. Scale is a legitimate explanation for Malone’s wheeling and dealing but I don’t think that it is the real reason behind most of his deals. If scale was extremely important, he would not be constantly buying back shares rather than growing his cable empire’s scale. As well, Cablevision has performed quite well (when Rutledge was the COO) versus its much larger competitors Time Warner and Comcast. Scale is not as important as good management.
In my opinion, the reason Malone talks a lot about scale is because his merger deals require shareholder approval of the company being taken over. Malone needs to convince the shareholders of the acquired company that his deal is “good” for them. Typical reasons in favour of a merger would be synergies and economies of scale. If shareholders were smarter, perhaps they would stop trading directly against Malone (and his #1 salesman George Maffei) and find better managers for their cable assets. I would not want to trade against a self-made billionaire.
Malone hires really good tax lawyers who find legal ways of reducing taxes. His tax reduction strategies generally take advantage of:
- Tax deferral strategies. By deferring taxes as much as possible, Malone essentially acquires interest-free loans from the IRS. Often these strategies are confusingly described as “tax-free” (e.g. a tax-free spinoff should really be called a tax-deferred spinoff).
- Tax breaks that politicians introduce. Because politicians intentionally introduced these tax breaks, tax strategies surrounding them usually aren’t questionable or risky. However, tax breaks are often ruthlessly exploited after they are introduced. The IRS often implements new rules to counteract all of the borderline fraud that tries to exploit tax breaks. So, there is still some risk to particular tax strategies. There are areas that are grey. I believe that Liberty Ventures is taking advantage of tax equity related to tax subsidies for green energy.
The big picture
I think that the most important part of Malone’s strategy is recognizing the important of good management. A huge amount of value is created by installing good management teams into poorly-managed companies. This is intertwined with his obsession with control and understanding what he is investing in.
The second most important part of his strategy is buying low and selling high.
The other aspects of his strategy (tax, buybacks, economies of scale, etc.) are just icing on the cake.
*Disclosure: Long LMCA and no position in LBTYA. I may initiate a position in LBTYA in the future.