Description

Lars recommended Liberty Media as a long in early January of this year.  Since then, the near-term catalysts underlying Lars's recommendation have been superseded by events.  However, these superseding events (and a stock price 10% less than the price at which Lars recommended the stock), make LMCA a more attractive long.

Company.  LMCA is a holding company owning controlling and non-controlling interests in media, communications, and entertainment companies, including subsidiaries Sirius XM Holdings (53%), the Atlanta Braves baseball club (100%), and TruePosition (100%); equity affiliates Charter Communications (25%) and Live Nation Entertainment (26%); and minority positions in Time Warner, Time Warner Cable, Viacom, and others.

Recent Events.

• In February, Comcast and Time Warner Cable agreed to merge, trumping CHTR's bid for TWC. 
• In March, LMCA withdrew its proposal to acquire the balance of SIRI shares it did not already own. 
• In April, CHTR agreed to (1) acquire approximately 1.4 million TWC subscribers from CMCSA subsequent to (and contingent upon) the closing of the CMCSA/TWC merger, (2) a subscriber swap with CMCSA, whereby CHTR would receive 1.6 million TWC subscribers and CMCSA would receive 1.6 million CHTR subscribers (again, subsequent to and contingent upon the closing of the CMCSA/TWC merger), and (3) contribute equity (in the form of its own stock) to acquire an interest in, and provide management services to, a newly created spin-off from CMCSA serving 2.5 million CMCSA subscribers (the spin-off would occur subsequent to and be contingent upon the closing of the CMCSA/TWC merger; CHTR would own 33% of Comcast SpinCo and would be paid a fee equal to 4.25% of revenues to provide management services to Comcast SpinCo). 
• In May, Liberty announced a stock dividend whereby holders of Liberty's Series A and Series B common stock will receive a dividend of two shares of Series C common stock for each share of Series A or Series B common stock.  The dividend is payable July 10, 2014. 
• Also in May, Liberty’s board authorized management to pursue the spin-off to Liberty's shareholders of the common stock of a newly formed company to be called Liberty Broadband.  Liberty Broadband would be comprised of Liberty’s interests in CHTR and TWC and Liberty's wholly-owned subsidiary TruePosition.  In the spin-off, Liberty's shareholders would receive (1) one-fourth of a share of Liberty Broadband common stock for each share of Liberty common stock held by them, and (2) a subscription right to acquire one share of Series C Liberty Broadband common stock for every five shares of Liberty Broadband common stock they receive in the spin-off (irrespective of the series of common stock received).  The subscription price will be equal to a 20% discount to the 20 day average trading price of the Series C Liberty Broadband common stock following the spin-off. 

Valuation.  LMCA currently trades at a 17% discount to NAV.  Below are:  (1) LMCA's current NAV per share, pre and post the pending Class C share dividend; and (2) an analysis of the estimated NAV per share of legacy Liberty and Liberty Broadband subsequent to the spin-off.

Three comments concerning valuation:  (1)  NAV is pre-tax.  By whatever means Liberty assumes full control of SIRI (or distributes SIRI to its shareholders), it is nearly certain to be done on a tax-free basis.  Likewise, it is unlikely that Liberty's CHTR stake will be rationalized in a taxable transaction, and I believe that the same will be true with respect to its LYV stake.  That leaves potential tax consequences with respect to a small amount of assets at an indeterminable future date.  (2) NAV does not include the judgment entered in favor of Liberty against Vivendi Universal by the United States District Court for the Southern District of New York. Liberty's judgment, entered in 2013, is for approximately €945 million (over $1.2 billion), and is currently on appeal before the United States Court of Appeals for the Second Circuit.  The full amount of the judgment would, if paid, add approximately $11 (pre-tax) to current per share NAV ($3.70 post Class C dividend), and would, I believe, stay with legacy Liberty.  (3) NAV is without regard to LMCA's proposed LYV share purchases.

Although the pending spin-off of Liberty Broadband is a near-term catalyst, I don’t expect, based on Liberty's past history, that the spin-off will work to immediately close the discount to NAV.  Rather, the spin-off will better enable Liberty to, over time, extract value from and add value to its stakes in SIRI and CHTR.  To the extent discounts to NAV persist after the spin-off, that will work to the benefit of Liberty's shareholders, as Liberty will have the opportunity to make accretive share repurchases.

Legacy Liberty.  The investment performance of legacy Liberty will depend mostly on (1) the business and financial performance of SIRI and (2) the incremental value added by Liberty, both from monetizing its stake in SIRI, and from other corporate actions.

As noted above, LMCA withdrew its proposal to acquire the balance of SIRI shares it did not already own.  Although it is always dangerous to predict Liberty's future actions (as events so far this year have shown), Liberty will likely stand pat for the foreseeable future, passively increasing its ownership stake in SIRI by virtue of SIRI's ongoing share repurchases.  Using consensus EBITDA and cap-ex figures, assuming SIRI maintains leverage at 4x EBITDA at a blended rate of 5.5%, and assuming SIRI's share price increases 10% per year, Liberty's stake will be over 80% in four to five years.  An interest greater than 80% will give Liberty access to SIRI's cash flows with no tax leakage, and also significantly reduces the cost if Liberty still desires to acquire 100% of SIRI.

Assuming that revenue growth gradually tapers to 6% per year, that EBITDA margins plateau at 42%, capital intensity of 3.5% until 2016, then increasing to 4.5% to account for the satellite replacement cycle, cash taxes beginning in 2018, and share repurchases under the assumptions stated above, SIRI's EBITDA should double in seven years, with EBITDA per share increasing 4-1/2 times.

This financial performance should be reflected in SIRI's stock price and, therefore, legacy Liberty's stock price.  To the extent SIRI's stock price does not fully reflect its financial performance, Liberty benefits as SIRI's stock repurchases will more quickly increase Liberty's stake.  In addition, Liberty should add incremental value, whether though its own accretive share repurchases, actions with respect to its stake in LYV, or through other actions as yet unknown.  Regardless, holders of legacy Liberty shares will in all likelihood do better than holders of SIRI shares.

Liberty Broadband.  The Liberty Broadband spin-off gives investors the opportunity to participate in (1) the continuing turnaround of CHTR's operations, (2) the turnaround of the TWC operations being acquired by CHTR in the Comcast transactions, (3) the potential rationalization of Comcast SpinCo, and (4) potential further consolidation of the domestic cable industry by CHTR and Liberty, orchestrated by John Malone, one of the premier deal-makers in the business, with operations managed by Tom Rutledge, one of the best operators.

Even without regard to the Comcast transactions, Charter's business prospects are favorable.  Recent results are showing the fruits of the restructuring implemented by Tom Rutledge:  CHTR's systems should be all-digital by the end of the year, enabling CHTR to reclaim analog bandwidth and thereby improve its high speed data offering; video subscribers increased in the first quarter; and cap-ex should drop significantly next year after the digital conversion is complete, leading to significant free cash flow in 2015, increasing further in 2016 and beyond.  Further, CHTR's large NOLs and high tax basis (tax depreciation exceeds book depreciation) mean CHTR is not likely to pay cash taxes this decade.

The Comcast transactions add to CHTR's attractiveness: 

• CHTR is acquiring the systems at a reasonable multiple of 7.125x 2014 EBITDA (before negative synergies for increased programming costs, with the acquired systems being brought on to CHTR's higher rate card). 
• The transactions (including Comcast SpinCo) nearly double the number of CHTR's managed subscribers. 
• The transactions significantly improve the clustering of CHTR's systems, allowing for more efficient management and marketing. 
• The transactions have no negative affect on CHTR's miniscule (3%) FIOS overlap. 
• A 4.25% management fee will be paid to CHTR for services provided to Comcast SpinCo. 
• CHTR has the option to rationalize the ownership of Comcast SpinCo after two years.  CHTR and Liberty are prohibited from acquiring additional shares in Comcast SpinCo for two years after closing.  Thereafter, CHTR and Liberty will have the opportunity, if advantageous, to take control of Comcast SpinCo (although any such action, if undertaken by CHTR within four years after closing, requires the approval of either a majority of the independent SpinCo directors or a majority of SpinCo shareholders other than CHTR).  Further, although Comcast SpinCo will have its own management team, Tom Rutledge will serve as chairman of SpinCo.

Given (1) the favorable valuation at which the systems are being acquired, (2) the (likely) favorable debt financing used to finance the acquisition, (3) the opportunity for CHTR to improve operations at the legacy TWC systems, and (4) the management fee paid to CHTR by Comcast SpinCo, the Comcast transactions will be accretive to CHTR's already improving free cash flow per share.

The investment performance of Liberty Broadband will depend in large part on the business and financial performance of CHTR.  However, Liberty Broadband should add incremental value to the reflected CHTR results, whether through its own accretive share repurchases, or through direct participation in future cable consolidation.  In this regard, Liberty Broadband should raise between $500 million and $700 million in the rights offering being done in connection with the spin-off, giving Liberty Broadband a good foundation to take value-enhancing actions.  An initial purchase at a significant discount to NAV, combined with the incremental value likely to be added by Liberty management over time, will result in the holders of Liberty Broadband shares enjoying better returns that the holders of CHTR shares.

Risks.

SIRI's revenue and EBITDA growing at rates less than those implied by SIRI's current multiples.

Execution risks with respect to (1) CHTR's ongoing turnaround; (2) the integration (and, where needed, turnaround) of the acquired TWC systems; (3) the management of Comcast SpinCo; and (4) further consolidation.

Denial of regulatory approval of CMCSA's acquisition of TWC.  This would void CHTR's acquisition of TWC subscribers, CHTR's subscriber swap with CMCSA, and the creation of Comcast SpinCo.  On the other hand, denial may open other opportunities for CHTR and Liberty Broadband.

Rising interest rates.  The SIRI thesis depends in part on SIRI's ability to raise incremental financing at reasonable interest rates to maintain 4x leverage. Increased rates make that less feasible, resulting in smaller buybacks and a less rapid equity shrink.  Likewise with respect to CHTR, increased rates will make future leveraged acquisitions less attractive at current valuations, and to the extent valuations come down to reflect higher rates, CHTR's valuation would not be unscathed.

Catalyst

Near Term:  Spin-off of Liberty Broadband.

Longer Term:

Legacy Liberty:  SIRI stock repurchases, increasing LMCA's interest in SIRI ultimately to 80 - 100%.

Liberty Broadband:  Continued turnaround of CHTR's operations (including to-be-acquired TWC systems); potential consolidation of Comcast SpinCo after stand-still provisions expire; further consolidation of cable industry spearheaded by CHTR and Liberty.