Liberty recently completed the distribution of 2 class C non-voting shares (ticker symbol LMCK) for each LMCA or LMCB share. Now Liberty intends on completing its spinoff of Liberty Broadband (LBRDA/B/K). Each shareholder of LBRDA/B/K will be slated to receive rights (LBRKR) to purchase shares of LBRDK. Liberty Broadband’s S-1 was filed on July 25.
To summarize: I think that both the parent and the spinoff will be attractive stocks. I plan on owning both. It could make sense to be overweight Liberty Broadband.
Both parts will essentially consist of high quality businesses with high growth (Sirius XM and Charter). I don’t believe that this spinoff will result in a special situation where one piece will contain significantly better assets than the other piece. I think that it is a better idea to own both rather than just Liberty Broadband. Because there will be a lot of leverage underlying the companies, it is probably a good idea to diversify.
Which assets are “better” than the others?
I will define “good” as having one or both of the following characteristics:
- High, sustainable earnings growth.
- Currently undervalued by the stock market.
A good asset is essentially one with hidden value that isn’t currently being appreciated by the stock market. Sometimes Malone will stuff a spinoff with good assets so the spinoff may be far more attractive than the parent. The original Liberty-TCI split was an extreme example of this.
Pre-spinoff, Liberty Media consists mainly of the following assets:
- Charter shares and warrants.
- Sirius XM shares.
- Live Nation shares.
- Barnes and Noble shares.
- TruePosition and Skyhook.
- Time Warner Cable shares.
- Potential legal upside from Liberty’s 765M euro verdict against Vivendi, currently under appeal.
- Atlanta Braves.
- Miscellaneous assets- derivatives, a TV station, etc.
In my opinion, most of Liberty’s assets are good. Malone has largely kept good assets within Liberty Media and spun off lower-quality assets via share distributions of Liberty Interactive, Ascent, DTV, Starz, and Discovery Holdings (*Discovery is arguably very high quality). Let’s take a look at the assets that are arguably bad:
- Live Nation: This company will almost certainly have lower earnings growth than Sirius and Charter. The shares are arguably slightly overvalued.
- Barnes and Noble: It is likely that the Nook will fail and therefore BKS shares are currently overvalued. Not surprisingly, Liberty has sold most of its stake. Its current position is largely immaterial.
- TruePosition: There is a good chance that TruePosition’s biggest customer (AT&T) will not renew its contract given that AT&T has been publicly attacking TruePosition’s technology. The business is bad. It is unclear what valuation the stock market will ascribe to TruePosition’s legal upside.
- Time Warner Cable shares: Charter arguably has a better CEO (Tom Rutledge) than Time Warner Cable’s future CEO (Brian Roberts). However, Brian Roberts is no slouch and has a pretty good track record as Comcast’s CEO. I would argue that the TWC shares are a good asset, though not as good as Charter.
Overall, TruePosition and Live Nation are the “bad” assets that matter. The Live Nation stake will be roughly a ninth the size of the Sirius XM stake so it won’t matter much.
- Liberty owns around 5.3745M shares of LYV with a market value of around $1,290M.
- Liberty owns around 3.162M shares of Sirius XM (SC 13D/A) with a market value of around $10,878M.
TruePosition will likely be worth a tenth of Charter’s value (give or take a few hundred million dollars of TruePosition’s valuation). Based on earnings growth, Live Nation is a far better asset than TruePosition. However, TruePosition could potentially be a good asset if the stock market ascribes too little value to it once Broadband starts trading. It is also possible that the opposite will happen. It is not clear to me whether TruePosition is a “good” or “bad” asset.
Which piece does Malone like more?
Malone probably likes Liberty Broadband more than the parent (Media).
Of course, the relative attractiveness between the two pieces will depend on the price the shares trade at. Because Liberty Broadband shares currently aren’t trading, it’s a little premature to say that Broadband will be more attractive. However, the rights offering will force John Malone to increase the number of Liberty Broadband shares that he will own. He has some incentive to put the “bad” assets into the parent and the “good” assets into the spinoff with the rights offering. This is because the rights offering would increase his ownership of the spinoff after the rights offering closes.
EDIT (8/14/2014): I think I am wrong on this point. The rights offering doesn’t really change his ownership. It merely funnels ~$700M (somewhere in that ballpark) into Broadband. Then Broadband will send $300M to Media. While it’s unclear how much money the rights offering will raise, Media will get a guaranteed $300M and Broadband will get the rest. Media may buy back a small amount of shares, so it’s actually Malone’s ownership in Media that might increase.
What is Charter worth? How undervalued is it?
For some background, see my post on Malone’s cable strategy.
Seeing value in Charter takes imagination. According to Charter’s financial addendum and its definition of free cash flow (page 6 of the addendum), Charter generated $74M in free cash flow which is down from $118M a year ago. 74 X 4 = 296. Charter has a market cap of $17.57B. The price to free cash flow ratio is around 59. The company is currently in the process of converting to all-digital. This is causing free cash flow to be anemic as the transition brings short-term pain (it pisses off analog customers who see little benefit from or are harmed by the transition) without much short-term benefit.
Currently, adjusted EBITDA per video passing is around $239 ($747M X 4 / 12,816K). If Rutledge can increase this to $450 per video passing (Cablevision levels), then there is an additional $211 per passing or $2,704M in adjusted EBITDA. Suppose that the tax on that additional EBITDA is counteracted by lower interest payments on Charter’s debt, accretive transactions, lower programming costs due to scale, NOLs, higher penetration than Cablevision due to Charter’s less competitive rural footprint, etc. etc. (Maintenance capex will be roughly the same.) Charter would have $3B in free cash flow. The current market cap divided by $3B in FCF results in a P/FCF ratio of 5.86.
If you believe that Charter will eventually hit $3B in free cash flow (current FCF is around a tenth of that), then Charter will eventually be a double or a triple. Charter could potentially do even better than that in the long run if it buys lots of poorly-run cable companies and uses its new scale to lower programming costs. To be a fan of Liberty Broadband, you have to believe in Malone and Rutledge. I will point out that John Malone is a former cable CEO and a self-made billionaire, so he probably knows what he is doing. But yes… you have to believe.
Liberty Interactive and Ventures
The LINTA/LVNTA split and subsequent rights offering has a structure somewhat similar to the proposed Liberty Broadband spinoff. Liberty Interactive split Ventures off as a tracking stock (Broadband will be a spin-off, not a tracking stock as originally proposed). Ventures had a rights offering. The deal was structured so that Ventures was highly leveraged and had little equity. Interactive would be cash-rich and would be able to buy back shares.
In the LINTA/LVNTA situation, the highest-growth company pre-spinoff was TripAdvisor. The home shopping networks (QVC, HSN) and online retailers that remained at Interactive demonstrated dramatically lower growth. This was definitely a situation where there was a big difference in the quality of assets between the two pieces. Ventures would also go on to hold tax equity deals (green investments) that have reasonably attractive returns. Ventures would also hold convertible debt that was advertised to be tax advantaged- they can be thought of as a “good liability”. The tracking stocks had a tax sharing agreement that is favorable to Ventures. Ventures would receive cash for any tax losses it generated (e.g. on tax equity deals).
What happened afterwards was:
- The value of TripAdvisor shares skyrocketed. On top of organic earnings growth, the shares started trading at a higher P/E ratio.
- Ventures did not find that many tax equity deals to do.
- Ventures could not find many opportunities to invest cash. Things did not go according to plan.
- Ventures started reducing its tax advantaged debt. I believe doing so eliminated the tax advantages of the debt. It turned out that this “good liability” isn’t as good as it originally seemed.
Ventures’ share price skyrocketed alongside TripAdvisor because most of Ventures’ assets consisted of TripAdvisor shares. Ventures stock performed significantly better than Interactive stock. In hindsight, what mattered the most was the quality differences in the assets. Luck also made a difference because TRIP started trading at a significantly higher P/E.
Unfortunately for me, I did not buy shares of either company. At the time, I did not research TripAdvisor at all and did not pay much attention to the quality of the assets. My old writeup is on this blog. I was hoping to buy Ventures incredibly cheap (which is why I didn’t buy any) when I should have bought a wonderful business at a fair price.
Here’s how I see it.
Ultimately, a rights offering is a way for Malone to buy more of something he likes.
He presumably saw value in TripAdvisor and in future tax equity deals. By having the rights offering happen at Ventures, he effectively had more of his money invested in TripAdvisor and tax equity deals. (The cash from the rights offering would go to Interactive, which was buying back shares. In the end, his investment in Interactive went up slightly while his investment in Ventures went up more.)
Note that the rights offering is a little tax inefficient, which is somewhat unusual for Malone. To raise the cash, Malone was presumably selling other shares and paying capital gains tax on those sales. As well, the rights offering diluted his voting control on the company. I do not believe that the Broadband rights offering will result in dilution of his voting power.
I think that Malone wanted the share price to be as low as possible so that he paid as little as possible when he exercised his rights.
At the time, there wasn’t a lot of transparency regarding Ventures. Management didn’t explain tax equity / the green investments, the tax characteristics of the convertible debt (which can now be found in Interactive’s investor presentation), etc. etc. The accounting was quite unusual and complex. The spinoff was also designed so that Venture’s book value would be deceptively low.
In my opinion, management’s arguments that these split-offs and spin-offs increase investor transparency is a little bogus. Malone isn’t very candid with shareholders except where legally required.
Ventures versus Broadband
I don’t think that there will be a big difference in quality between Liberty Media and Liberty Broadband. The fact that Broadband is issuing rights suggests that Malone thinks that Broadband has better assets (e.g. that Charter is better than Sirius XM).
Will Broadband be undervalued?
Malone has taken a few steps to make Liberty Broadband unattractive… presumably to increase the odds that he pays less to acquire shares of Broadband. The inclusion of TruePosition is weird and will confuse investors. I don’t see the connection between Charter and TruePosition. Media analysts will likely discount TruePosition because they do not understand it (especially if they value it based on cash flow or earnings). However, it seems that Broadband will be easy to value because almost all of its value is in publicly-traded shares (Charter and TWC). I doubt that it will trade at a significant discount. However, Liberty’s predecessor LMDIA did trade at a discount when most of its assets were in DTV shares. Anything can happen.
The parent company has many complexities (e.g. Vivendi judgement) and may continue to trade at a discount. In connection with the spinoff, Broadband is slated to distribute $300M to Liberty Media. Liberty Media may use this cash to repurchase shares (or retire debt):
As of December 31, 2013 Broadband had a cash balance of $9.3 million. In addition, Broadband had cash of $19.1 million invested with Liberty, under the terms of an intercompany note agreement. Additionally, in connection with the Spin-Off, Broadband intends to enter into a $320 million credit arrangement pursuant to which it is expected that Broadband will borrow $300 million prior to the completion of the Spin-Off and will have $20 million available to be drawn following the Spin-Off (see “Description of Our Indebtedness”). Pursuant to the internal restructuring, and prior to the Spin-Off, it is anticipated that Broadband will distribute $300 million in cash to Liberty. Liberty intends to use all of the distributed proceeds received from Broadband to repay indebtedness or to repurchase shares of Liberty common stock under its share repurchase program, pursuant to a special authorization by Liberty’s board of directors, within twelve months following the completion of the Spin-Off.
Reading the S-1
Intercompany note agreement
The S-1 filing does not state the terms. It is possible that there will be a hidden asset or liability here.
The S-1 filing provides some financial information on TruePosition. The biggest problem with TruePosition is that their main customer might leave.
TruePosition has one significant customer [AT&T], the loss of which would have a material adverse effect on the Company’s business. For the years ended December 31, 2013, 2012 and 2011, this customer accounted for 85%, 93% and 56%, respectively, of the Company’s total revenue.
In YE2013, TruePosition generated $77.363M in revenue and operating income of -$0.088M. The true profitability of this business is unclear because TruePosition is engaged in patent trolling lawsuits and a antitrust lawsuit. These expenses may result in a future windfall and obscure the current profitability of the company. If legal expenses are in the $10-20M range then TruePosition makes around $10-20M in pre-tax income. (Skyhook’s lack of profitability also muddies the picture.) I find it extremely difficult to model out the company’s future operating cash flow given that AT&T may fail to renew its contract. In the past this company was very profitable as it generated more than $640M in pre-tax income leading up to YE2011.
Both pieces are good. Depending on Broadband’s share price (who knows what it will be…), Broadband may be a little better.