Back in the Game and a Quick Update

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?

http://www.bloomberg.com/news/2014-11-28/vodafone-said-to-eye-takeover-of-malone-s-liberty-global.html

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

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!

15 Comments

    1. The author is kind enough to share his thoughts with us and you are not paying anything. Maybe you should’ve read the disclaimer more carefully.

      Reply

    2. Thanks for the comment. Please keep in mind that this is a blog and not an “investment operation”. Sorry to potentially sound like a dick but this blog is for us (Me and Steven) and not for you. Some posts are merely quick thoughts, others may be more in-depth. But before you assume anything about our mindset or work ethic keep in mind that you don’t have the slightest clue in the amount of due diligence we do before we initiate a position. As always, it is only intelligent that you conduct your own DD before you initiate any position in the securities mentioned above. That said, I will make it clear in future posts whether I and/or others I advise hold a material investment in the issuer’s securities.

      Reply

  1. I’m not sure I would want to short Cablevision. Suppose that it’s like a utility. If it throws off safe, low-risk profits then it will be difficult to make money shorting it. Of course in practice, some cable companies do go bankrupt. But there are much easier ways to make money shorting (e.g. hundreds of frauds and scams out there).

    Reply

    1. Hi Glenn,

      Thanks for the comment. I think I pretty much laid out the quick thesis for you when we had dinner but I’ll lay it out here in a bit more detail. I think that’s definitely the market perception that Cablevision like many other cable companies offer a safe as a utility-like investment (Revenues are largely recurring with 2 year contracts, churn is relatively low and stable, competition is limited). Most cable companies are perceived that way because they’re essentially monopolies or duopolies on one or more product (broadband for eg.). However, my initial thesis is that the upside should be quite limited, and I still need to do a bit more DD before anything:

      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 is a bullshit 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 busy focussed 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 needed 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.

      On a more personal note I very rarely short sell if at all, and I agree with you that shorting frauds is more often than not a better strategy. But I do follow the cable industry quite closely and think this is a potentially interesting opportunity for those of you that are interested. It might even be one of those situations where time is on your side as the business fundamentals deteriorate and they bleed a slow death. It’s an idea not for the faint of heart and I think the short interest is already quite substantial. I will update with a full write-up eventually.

      Enjoy the rest of your weekend.

      Disclosure: No position

      Reply

      1. Geez, I feel like you just wrote a writeup. 😀

        Personally, I focus on shorting the worst of the worst. Companies bleeding horrible amounts of cash, frauds, insiders illegally selling stock, paid stock promotion, etc. etc. (There are lots of such stocks out there.) I would never consider shorting Cablevision given what else is out there.

  2. Haha, I will definitely convert that post into a full write-up sometime.

    But yes I would love to short sell those types of companies as well, if you have a hard catalyst that can tank the stock in 1-3 years. The issue with those types of shorts is the timing of when the fraud will blow up and basically go to 0. With business fundamentals deteriorating the market will already be pricing in most of the issues most of the time. So you have the risk of holding on the painful losses if the management pumps up the stock or if theres a giant short squeeze etc. Basically if there’s a strong catalyst blowing up the stock in 1-2 years that would be a great IRR for a short sell but who will be the whistle blower? I don’t think Einhorning it is a very fun process after reading his book.

    With Cablevision the thesis is that they will start bleeding a lot of cash if the thesis plays out and they may have to recapitalize the balance sheet. Given that the market is already pricing in M&A in the stock and hasn’t taken into account the severity of future subscriber losses I think this idea provides an attractive risk/reward. Upside is limited IMO, and is a good partial hedge if you have a lot of cable exposure in your portfolio.

    Reply

    1. Were you the one who mentioned to me that ActivistShorts did a study and found that fraud shorts work better than valuation shorts? (Unfortunately they don’t take into account the borrow and buy-ins.)

      The thing about scams, frauds, and scams attached to real businesses is that they have less real business going on than a real business. Because of this, their intrinsic value is generally lower. Because of the scam aspect of the short, insiders may be siphoning money from the company. There also isn’t much in the way of a real business that makes money. So you have a “negative carry”. Real business are trying hard to make money for shareholders; the scam guys aren’t. With the scams, time is on your side as long as you aren’t shorting Ponzi scheme-type stocks.

      The Ponzi scheme stocks are the ones that continually issue stock repeatedly. Those are no fun. Those who invest in a Ponzi scheme early enough will actually make money. And vice versa for a shorts. So I don’t like those shorts as much. But I short ’em too.

      2- With the scams you don’t really need a GSAT-style bear raid or catalyst. With a lot of them, insiders will be dumping huge amounts of shares onto the market.

      3- In practice, look at how some valuation shorts work poorly:
      BBRY. Eventually the shorts were kind of right. But look at how long it took for the stock to fall and how awful the squeeze was.
      CRM. Painful.
      LULU. Painful.
      TSLA. Painful.

      CMG. Einhorn’s thesis was hilarious (Cantina Bell was going to hurt Chipotle). Painful.

      The short squeezes are just as bad if not worse. Unfortunately, time isn’t on your side if these companies make money after you short them.

      Reply

      1. No that wasn’t me but I agree with that 100% as long as there’s absolute certainty that the fraud will go to 0 with near-term catalyst(s). I don’t focus too much time on finding frauds and I’m really not aware to too many that are traded in North America unless they are some sketchy reverse merger Chinese company which I think the market has caught on to that trend already. You mentioned that there are a lot of scams out there so if you know where to find them I’m all ears.

        As a value investor I care most about free cash flow and my IRR. Quickly going back to my Cablevision thesis it’s really difficult for me to see them generating any positive levered free cash flow within the next 1-2 years unless its under VERY aggressive assumptions including substantial programming synergies. If the business is going to generate negative free cash flow from now onwards then the equity will take a huge hit. This is quite different from the 3 growth stories you mentioned above where they can still grow into their valuation if your bull thesis is correct. In general I’m not a fan of shorting or valuation shorts but my research so far supports the bear case. I’m not saying CVC will go to zero but if you factor in the operating and financial leverage in this business the downside can be substantial. Timing is still an issue for me here, I’m watching it like a hawk but might not ever initiate a position. I’m a long biased investor.

      2. On my blog I’ve written a lot of posts on how to find frauds. 90%+ of the stocks on the TSX Venture are scams attached to real businesses (see the post on the TSX Venture explained). I explain stock promotion and “investor relations”. I explain sketchy accounting in mining and oil and gas. I explain how reserves can be inflated. To find frauds you just have to put in the work. That being said, I feel like some people will never “get it”.

        2- Regarding Cablevision: subscriber loss takes time. For example, satellite television had a great product relative to cable, over the air, etc. and it still took a very, very long time for it to get market share. Sirius XM is taking a long time to get market share even though it has the best product (best content).

  3. You have a fair point regarding the time element but also keep in mind that CVC has less room for error because every subscriber loss to them has a larger incremental impact to the bottom line than say Comcast or DirecTV who have multiples of CVC’s subscriber base. CVC also has the highest ARPU in the industry. Best way to quantify this is to look at past case studies where local cable monopolies faced FiOS competition and put a conservative assumption of subscriber losses for CVC. Also, if you’re a cablevision subscriber and switch over to FiOS, you’re not just going to cut one of your services if you’re currently on a bundle as that doesn’t make sense – you’re probably going to cut your entire bundle. I concede that its typically annoying for most people to switch their services, but FiOS will be marketed and promoted aggressively.

    Yes I agree the TSX venture is full of scams. Frankly I don’t waste my time looking at mining companies because I can’t forecast the commodity cycle. There are local gems but I don’t pay that much attention at all to Canadian companies sadly.

    Reply

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