B4LLS
The following segment was excerpted from this fund letter.
Lining up with the Cable Cowboy: Liberty Broadband (NASDAQ:LBRDA)[1]
81-year-old John Malone is a storied American operator and investor in the broad media and telecommunications arena. Malone is, of course, the player who frightened the bejesus out of Rupert Murdoch by acquiring 19% of News Corp (NWS) voting stock in 2004-2006, before agreeing an asset swap in December 2006 to allow Rupert to sleep at night.
The early part of Malone’s career is laid out in the 2002 book “Cable Cowboy”[2] which documents the growth of TCI (Telecommunications Inc) from its origination in 1958 controlled by its original founder, Bob Magness. Malone joined up as 32-year-old CEO in late 1972 in a period where most of the nascent cable businesses had saddled themselves with outlandish amounts of debt; TCI’s debt at the time was equivalent to 17x revenues.
The story of the growth of TCI, where the stock multiplied over 900-fold between 1972 and 1998 prior to its sale to AT&T in 1999, is documented in William Thorndike’s “The Outsiders” (Chapter 4)[3] together with a focus on three of Malone’s “recipes” to accelerate shareholder returns, usually to his own (as well as shareholder) benefit, namely:
- Liberal use of debt in an appropriate manner against long term cash flows, at low interest rates and with lengthy maturity;
- Use of tri-partite capital structures with A, B and C class shares having respectively 1, 10 and nil votes per share – Malone invariably retains control through ownership of the B shares, as is the case with LBRDA;
- Use of spin-outs and “tracker stocks”[4] to make transparent the valuation of individual components of the company. This is best seen in “Liberty Media” where the entirety of the company’s assets are attributed to three tracker stocks: Formula One (FWONA), Atlanta Braves (BATR) and Liberty SiriusXM (LSXMA). You can’t buy stock in “Liberty Media”.
Malone has historically been a marvellous seller of assets to – and buyer of them at distressed prices from – large media/telco conglomerates. This reached an early culmination with the sale of TCI to AT&T in June 1998 for $55 billion, settled in March 1999.
Malone had established Liberty[5] in 1991 as a means of separating the more speculative assets (cable programming regional sports) plus a small amount of TCI subscribers from TCI through a complex exchange offer where shareholders in TCI were able to exchange shares in that company in exchange for rights to subscribe to Liberty. Less than one third of the shares were taken up, which gave Malone – on borrowed money – 20% of the “B” class Liberty super voting stock (of which more below), and 40% voting control.
Once the AT&T transaction had settled, Liberty gained additional cash, but left Malone free to explore options in the telco/cable/TV markets.
Liberty Broadband is one of seven structures, encompassing nine securities including tracker stocks within the “Liberty” empire:
- Liberty Media, noted above which consists of the three tracker stocks FWON, BATR and LSXM;
- Liberty Global plc (LBTYA), providing broadband and mobile in Europe;
- Liberty Latin America (LILA), a replica of LBTY across selected countries in South and Central America;
- Qurate Retail (QRTEA) a home-shopping entity encompassing HSN and QVC amongst other assets;
- Liberty TripAdvisor (LTRPA) which holds a 21% economic stake, but 57% voting position in TripAdvisor (TRIP);
- LMF Acquisition Opportunities (LMACA), a special purpose acquisition corporation (SPAC); and
- Liberty Broadband.
At 31 March 2022, LBRDA equity is comprised of the three classes noted above; 22.56m single vote “A” class, 2.54m 10-vote “B” class and 139.9m non-voting “C”; John Malone controls LBRDA via his ownership of 92% (2.148m) super voting “B” shares, despite holding only a 2.1% economic interest.
LBRDA has two assets:
- GCI Holdings – a specialist communication and entertainment provider to Alaska, acquired in December 2020 for an effective equity value (via stock swap and cancellation of LBRDA shares owned by GCI) of $3.06 billion; attaching debt of $2.2 billion and other liabilities were offset by an investment in Charter (below); and
- 26% interest in Charter Communications (CHTR, Charter) an $81 billion equity capitalised (enterprise value ~$174 billion) cable network with over 30 million residential customers and 2.16 million small and medium business relationships[6]; at the share price on 30 June 2022, the CHTR stake is priced at $24.15 billion.
Hence, it is clear that the value within LBRDA is virtually exclusively driven by Charter, its share price and an intriguing buy-back mechanism (below) which even more inexorably links the two companies.
Charter, which operates as “Spectrum” in 41 US states dates back to 1980, but the formative transactions took place from 1998 onwards, with Paul Allen, the co-founder of Microsoft, as Chair. The company expanded rapidly by debt funded acquisition and concluded 2008 with $21.8 billion of debt, against just over $6.5 billion in revenues! CHTR filed for Chapter 11 bankruptcy protection in February 2009 but re-emerged with $8 billion less debt in November the same year.
The seminal transactions for the company occurred in March and May 2015 when the company announced the acquisition of Brighthouse Networks and Time Warner Cable respectively, aided by a $5 billion equity injection from Liberty Broadband.
The cable business is ostensibly about preventing “churn” – customers coming but staying for short periods of time, thereby rendering their lifetime value to the company lower than the cost of attracting them. The TV side of the business is not especially profitable; neither yet is the wireless business. However, the core cable business, supplying broadband continues to grow – in line with consumption of streaming services – and is a high margin (sunk cost) business. The threat to broadband comes from new technologies such as 5G wireless and fibre to the home which provides potential for “overbuild” of existing cable networks.
Charter has a significant cost competitive advantage which it is able to utilise to price its services under the mainstream competition and provides significant protection. This, together with the sunk capital cost aspect, provides credence to CHTR as an inflation hedge.
CHTR has an equity market value of $81.2 billion (173.6 million shares at $468); the shares have fallen from highs of $825 in September 2021. CHTR spend around $7 to $7.5 billion on capex per annum, against an operating cash flow (post tax and interest) in 2021 of $16.2 billion. This provides the shares with a free cash flow yield on equity of 10.6% if maintained; pre-tax and interest, the equivalent FCF yield on enterprise value ($174bn) is around 7%.
Given the likelihood that long bond rates in USA may even have peaked in the short term at 3.5%, these yields, even for a slow growing cable company are very attractive. However, looking out 23 years they are accentuated by strong equity buy-back program, which has averaged over $3.5 billion a quarter in the past two years which at prevailing prices would theoretically retire close to 30 million shares per annum (17% of issued capital).
One aspect that prevents such an aggressive share repurchase, but accentuates our view of holding LBRDA as a play on CHTR is the unique arrangement between the two companies. As part of LBRDA and Charter’s shareholder agreement, LBRDA cannot hold greater than a 26% interest in Charter and so sells CHTR shares to Charter as part of that company’s buyback program.
This is done on a monthly basis, based on CHTR’s buybacks in the prior month. In turn, this enables LBRDA to repurchase its own shares (if appropriate) from the cash proceeds of the CHTR sales. So LBRDA effectively represents a slightly geared (and discounted) entry to CHTR’s autosarcophagy whilst also engaging in the same self-cannibalistic practice.
LBRDA gains significant cash flow to retire its own shares by the forced resale of CHTR securities to maintain the shareholding at 26% in light of CHTR’s aggressive buybacks; in essence two connected spinning cogs.
LBRDA has retired a stunning 16.3% (31.6 million) of its own “A” and “C” class shares in the fifteen months since end calendar 2020, at an average price of $162/share against the prevailing level at end June 2022 of $115.64. This suggests future buybacks will be as aggressive as responsibly possible.
From an asset value standpoint, we estimate LBRDA at $115.64 to trade at an 18% discount to the value of its two assets, after the recent US$170m sale of the Skyhooks business, as follows:
|
US$ million |
||
|
51.554m CHTR shares @$468 |
24,155 |
|
|
GCI Holdings (assessed value) |
2,400 |
(cost $3 billion so 20% discount) |
|
Est. net debt in preference equity |
(3,228) |
|
|
EQUITY VALUE |
23,296 |
164.9m total “A, “B” & “C” class |
|
NAV/share |
$141 |
(18% discount at $115.64) |
Footnotes
[1] All values in US$
[2] “Cable Cowboy” Mark Robichaux (John Wiley & Sons) 2002
[3] “The Outsiders” William Thorndyke Jr. (Harvard Business School Publishing) 2012
[4] Tracker stocks are specialty equity securities designed to “track” the performance of an individual business within a larger company and have similar reporting characteristics to any listed corporation. However, the parent company legally retains ownership of the underlying assets/business constituting the tracker stock. Tracker stocks eliminate the need for a total spin-off of the business, but tracker securities can be spun off from the parent entity as has been the case with many components of the “Liberty” group
[5] http://csinvesting.org/wp-content/uploads/2012/09/rights-offering-and-over-subscriptions_final.pdf
[6] As at 31 March 2022
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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