Thoughts on the Charter / Time Warner merger

The CHTR / TWC merger is mostly about rolling up and turning around poorly-managed cable assets.  The bet is on Tom Rutledge (Charter’s current CEO) being able to turnaround poorly-run cable assets.  Ideally, he will get the productivity of the assets similar to or higher than Cablevision, his former employer.  For a deeper dive, see my post on “Malone’s cable strategy“.

charter-EBITDA-per-home-passed

I think that it is likely that Charter is much better off with the merger than without it.  Its shares trade at a premium valuation (relative to TWC), presumably because the market recognizes that Tom Rutledge can squeeze a lot of extra productivity out of cable assets.  Charter shareholders benefit if its shares are used to acquire companies with relatively less expensive shares.

As well, the turnaround game works best when the company consists mainly of poorly-run assets.  Post-turnaround, there is little room for value creation.  Constant takeovers are good for Charter because it dilutes Charter’s ownership of mature post-turnaround assets.

Deal complexity, voting control

The deal is structured in a way that Malone’s voting control (and board of directors representation) in Charter far exceeds his economic interest in Charter.

John Malone values control of a company highly.  The main reasons are:

  1. With control of a company, he can fire incompetent management teams and install better management.
  2. By having control of a company, Malone enables the CEO to invest for the long term.  Rutledge can convert his cable systems to all-digital, freeing up bandwidth for faster Internet and more channels of digital cable.  In the near term, the conversion is painful.  It causes short-term subscriber losses because some people prefer analog cable (e.g. they do not need to rent boxes from the cable company for every single TV in their house).  Analog customers get pissed off when they realize their bill is going up.  The conversion will cause a lot of customer service calls and expenses.  As well, the capex required reduces free cash flow in the short run.

Investment Company Act regulation

The second reason why the deal structure is complex is because Malone wishes to avoid regulation under the Investment Company Act.  If Liberty Broadband owns less than 25% of Charter, it can potentially become regulated under that set of laws.  If that happens, Malone’s supervoting shares in Liberty Broadband may no longer be allowed.

So, some aspects of the deal are there to avoid regulation.

Spinoff value leakage

The following diagram shows the evolution of Malone’s empire:

2014-11-04-updated-liberty-diagram-03

One of the problems with the spinoffs is that Liberty Ventures (LVNTA) ended up with excess cash and Liberty Media (LMCA+LBRDA) ended up with too little cash.

In the past, Malone owned a greater percentage of Liberty Media (LMCA+LBRDA) than Ventures.  So, his best investment ideas (e.g. Charter) went into Media instead of Ventures.  Ventures was sitting on so much excess cash that it started buying back some of its tax-advantaged debt.

As part of the CHTR/TWC deal, Ventures will invest in Liberty Broadband shares (press release).  So:

  1. Ventures deals with its excess cash problem.  It can pursue its original plan, which was to invest its capital at rates of return that exceed the costs of its tax-advantaged debt.
  2. Malone gets to maintain a high level of voting control over Charter.
  3. There will be conflicts of interest between Ventures and Broadband shareholders.  Malone owns more of Broadband than Ventures.  This can potentially be detrimental to Ventures shareholders.  In the past, Malone owned slightly more of Ventures than Interactive.  Ventures and Interactive swapped assets and stock in a deal that can be construed as unfair to Interactive shareholders.  Ventures shares were arguably a little overpriced and used to buy good assets from Interactive (cash, e-commerce businesses).
  4. #3 leads to minor value leakage because the spinoff structure creates unnecessary legal bills.

Liberty Broadband (LBRDA, LBRDK)

Liberty Broadband is a way to potentially buy Charter stock at a small discount.  See my old post “Liberty Broadband valuation spreadsheet”Unfortunately, I haven’t had the time to update it and to make sure that it is free of errors.

As part of the proposed Charter/TWC merger, various parties will buy shares of Liberty Broadband.  They are paying $56.23/share.  The press release states:

Liberty Interactive (along with third party investors, all of whom will invest on the same terms as Liberty Interactive) will purchase newly issued shares of Liberty Broadband Series C common stock (the “Series C Shares”) at a per share price of $56.23 (equal to Liberty Broadband’s net asset value on a sum-of-the parts basis).

The current market price of Liberty Broadband C shares is $53.03 while the A shares trade at $52.86.  So, it is implied that the C shares trade at a discount to their private market value / net asset value.

Share class arbitrage

My post “LMCA/LMCK share class arbitrage” explains the concepts behind share class arbitrage that apply to the class C (LBRDK) and class A (LBRDA) shares of Liberty Broadband.  The class A shares have more voting power than the non-voting C shares.  In theory, the A shares should be worth more than the C shares.  Historically, Malone has demanded a premium for supervoting shares.  The supervoting shares give him greater control of a company so he has greater influence over a company’s board of directors (e.g. he can vote on who gets hired and fired).  I think that it is likely that he will continue to nudge/bully the directors of his entities into paying a premium for supervoting shares whenever the share structures are collapsed.  He has done so in the past with Ascent (ASCMA family) and the LMDIA family in its deal with DTV.  I predict that he will do so again in the future.

I think that it is irrational that the A shares trade at a lower price than the non-voting C shares.

*Disclosure:  I own shares in Liberty Broadband.

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One thought on “Thoughts on the Charter / Time Warner merger

  1. Getting involved in the deal through Broadband or Ventures seems like a decent bet to me.

    I’m looking at (fcf + interest expense)/subscriber. There seems to be a pretty decent correlation with total subscriber amount of FCF/subscriber. I think this is pretty intuitive because not unlike Sirius XM I think the variable costs of the business are fairly small compared to the fixed costs. So if Charter can get up to a FCF/subscriber of around $500 before interest expense, which is what Comcast is currently pulling in. I would expect Charter to be able to make more than $5b in free cash flow (after the tremendous debt load). Which if you include another set of assumptions as to some sort of large buyback could get the stock up to more than $350/share and potentially greater.

    However I am no industry expert. And valuing the company assuming only stated synergies of $700m Charter would be fairly valued. So I think buying Charter through one of Malone’s vehicles is probably the way I’m going to play it.

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