Wanted to leave a quick note before the start of the weekend. I’ve recently come back from backpacking Europe and it was an amazing experience. Travelling the world can broaden your perspective on life.
Quick update on ideas:
1) Liberty Global: Can it really be a 2 for 2?
I love levered equity plays with an inherently superior business model attached; investing with Cable king Malone has indeed been very profitable for shareholders. I think the complicated holding structure of Liberty Global and the fact that they don’t pay a juicy dividend is keeping traditional yield hungry investors away, creating an opportunity to invest in a best in class run company at a reasonable levered FCF multiple. Shares have run up quite a bit since part one of my write-up, but there’s still quite a bit of upside left on my conservative estimates if you’ve been holding this. 1) The German broadband market remains under-penetrated with the majority of dwellings requiring tenants to pay for cable as part of their rent, 2) Ziggo was recently acquired, and synergies will be substantial in the Netherlands as they role out quad-play vs the incumbents and re-sellers, 3) Cable remains a strategic asset in Continental Europe, as wireless players starved for spectrum are now seeing the value of having a strong fixed broadband network. 4) Major OTC product offerings remain at an infant stage in Europe; Netflix has recently expanded into Germany, and I expect Liberty Global to up-sell their tiered broadband offerings. My apologies for the lack of numbers, but the real value of Liberty Global is actually 5 major European cable companies, and I’m too lazy to load up my spreadsheets that took forever to build. I’ll try to put up a reasonable intrinsic value range in the future. Thesis remains intact, this is almost the same playbook as Telecommunications.
2) DirecTV: Now a Risk-arb play
You’re getting an unlevered ~9% spread relatively uncorrelated with the broader markets which is pretty decent in this low interest rate environment. The deal is expected to close in 6-7 means which means the IRR should be around 18%. There’s definitely some risk involved with the deal, as the FFC has recently paused the clock. Quite frankly, I wouldn’t want to be a holder of AT&T stock, but if the deal were to fall through, owning DirecTV wouldn’t be the worse thing in the world. I still like the business, but the easy money has been made. You can also hedge out some of the risk by short selling AT&T. Maybe play this only when you have a too much cash sitting on the sidelines and don’t mind owning DirecTV for the longer-term.
3) Interactive Brokers: Hidden Value and an Owner-Operator
I love hidden value plays. Here you have a market making business that appears to be a mediocre business or at best average business, obscuring the true profitability of the holdco. The hidden gem is the brokerage business, which has been growing nicely. For those of you that have never used Interactive Brokers as your discount broker, I highly recommend giving it a try. It’s by far the best discount brokerage service, and has the lowest cost service in a relatively commoditized market. The float is relatively limited which is part of the undervaluation as the founder holds most of the shares. This will be a full write-up in the future.
4) EBAY: Activist Play and Spin-off
The management have been horrible. There have been no share buybacks for nearly the past 5 years except for offsetting stock options. I’ve never seen a CEO step down entirely and not take the same position in either the spinco or holdco. I think when Paypal and eBay split up, there will be a major multiple re-rating and the capital allocation discount will largely disappear.
5) Long Charter Communications/Liberty Broadband and Short Cablevision
1) The stock is currently priced with a large takeover premium. Historically Cablevision has traded at a premium compared to the other publicly traded Cable operators even though it has a smaller subscriber base of around 3mm because of the attractive demographics in the greater New York City region. Cablevision has the highest ARPU per subscriber in the industry at ~$155 and has a best in class video, broadband and telephony package along with lots of great upgrades. They also have the highest penetration rate across their footprint at ~55% I believe. Even though broadband in America is still a growth market (which the market also under-appreciates when it comes to cable names in general), I believe Cablevision has limited room to grow or up-sell its subscriber base. Essentially Tom Rutledge who many industry experts say is the best operator in the industry did a fantastic job growing the business before leaving for Charter. Going back to the takeover premium, Cablevision is now trading more in-line with comps on an EV/EBITDA basis, which I think in general is not a very useful valuation multiple for valuing cable companies anyway (the tooth fairy is not going to pay for large the CapEx spending). In short I don’t think there are any willing buyers at these prices. Comcast/Time Warner Cable are busy dealing with the FCC/DOJ and merging. Charter is focused on growing its business in rural America where it is very little FioS/U-verse overlap. I also don’t think Malone would use Charter/Liberty Broadband to pay even a small premium to the current multiple for Cablevision given that a large majority or 100% (still need to confirm) of Cablevision’s footprint faces FiOS competition. DTV/AT&T are also busy merging and it would be quite foolish for Verizon to acquire CVC after they just spent $23B on their FiOS to the home product as part of their NYC expansion plans. WRT getting acquired or getting taken private by the Dolans or a PE firm (which would offer no synergies if a private takeover were to occur), I believe it will only happen at much lower prices, and it’s only logical that the Dolans would like a lower price.
2) I’m not convinced Cablevisions’ cash flows will be “stable” in the next several years. Simply google Verizon’s FiOS roll-out into the Greater New York City area and you will find articles saying that they haven’t even successfully made the product available for sale yet. A reason for this is probably because Verizon has to get permission from every landlord to connect their lines into the building. This has been taking a long time, but it’s reasonable to assume that they will successfully roll-out their product and have it available for SALE by sometime next year latest. According to their franchise agreement with New York City in 2008 they agreed to have it available to ALL of Greater NYC by June/July of this year already, but I don’t think that was completed. The current mayor is pushing them hard to get this done ASAP. FiOS is already currently being heavily promoted in limited areas, at prices lower than CVC’s optimum product even though FiOS is a superior product. So this is potentially a large part of my thesis, and if you look at historically case studies of what happened to parts of Comcast’s or TWC’s footprints after encountering FiOS or U-verse overbuilds, it’s not a pretty picture. Some regions had cumulative subscriber losses of up to 40% over a few short years. You can easily see large subscriber losses in CVC’s footprint even under conservative scenarios. A quick counter-argument may be that CVC has a more loyal and affluent subscriber base so they will experience less churn and I think the market already has this perception as CVC’s recent results have not shown any meaningful acceleration in subscriber losses since FiOS is not 100% for sale yet across their footprint, but even a 20% total reduction in their subscriber base will hurt them big time over the next several years. I have to confirm exactly what their total exposure is to FiOS is though, but I know for sure that it’s greater than 50% of their total footprint.
Couple this with programming costs increasing annually in the low double digits (10-12%) on a per subscriber basis and their cash flow will quickly start to evaporate as they will have less subscribers to spread their fixed costs across. The operating and financial leverage is HUGE in this one. In fact management know this and have been shedding assets (sale of Bresnan to Charter for eg.) over the past few years to pay down debt. They keep cutting costs and fat and soon they will be touching bone. Just read over the past several 10-Ks and you’ll see plenty of one-time restructuring/miscellaneous costs. The capital structure situation does need to be more closely monitored however, for this idea to work. For valuation I do have them at a negative levered FCF yield for 2015/2016 depending on how well they manage their costs and subscriber loss ranges. They might even have to cut the dividend which would tank the stock as catalyst.
3) Cablevision’s management team is not the best to be polite. Half of the board and senior executive management team are comprised of family and related family members. They’ve had many conflicts in the past, even tried taking Cablevision private twice before. Even Malone stepped down from their board in the past as he knew it was essentially the Dolan’s company. Think about it, you let a pioneer of the industry and the most successful person in the cable business step away from your board – I don’t think that’s very smart. Rutledge was very good and a pioneer of the triple play, but now he’s gone so who’s going to steer the ship? Even if there was another superstar brought in, I think the upside is still pretty limited given my previous points and the FiOS competition. In short, they’re in a sticky situation and have been dealt a tough hand by being concentrated in New York.
In short, Cablevision is getting squeezed from both sides and is a victim of its own success. On a side note, I regret not digging deeper in Charter initially when Malone bought out Oaktree and party’s stake in the company. It was clear what his intention was and in a way the business strategy was very sound. Expand slowly in rural America where there is less competition from the Telcos and slowly take back share from the DBS players – similar to the TCI days when he targeted rural areas first. Ironically the most attractive market in America gives CVC the best in class Cable economics on the revenue front, but also is a great market for FiOS deployment.
Have to run now, have a great weekend everyone!