Many people in the investment community – sell-side analysts in particular – seem to believe that Liberty Starz (LSTAV) should trade at a discount to its intrinsic value. Sell-side estimates of the magnitude of this discount range from 15% to 30%, significant numbers by any standard. The intellectual underpinnings for these discounts are weak. All of these analysts attribute their discounts to the fact that Liberty Starz will be a tracking stock as opposed to a traditional common stock. They appear to rely exclusively on the fact that Liberty Media Corporation’s other tracking stocks have historically traded at discounts to their estimates of intrinsic value. Few, if any, of the sell-side analysts covering Liberty Media’s Entertainment Group (LMDIA) seem to ask themselves why Liberty Media’s tracking stocks have historically traded at some discount to intrinsic value and whether those factors that drove the historical discounts will apply to Liberty Starz. If one peels back the onion a little bit further than they have, it becomes clear that Liberty Starz should trade at little to no discount to intrinsic value because of fundamental differences between Liberty Starz and Liberty Media Corporation’s other tracking stocks.
The discounts at which Liberty Media’s tracking stocks have from time-to-time traded can be divided into two parts, one related to their tracking stock structures and another related to their holding company structures.
A tracking stock structure may give rise to a valuation discount if the “guarantee” of the parent company’s liabilities that are not attributed to the tracking stock has some value. Tracking stocks are not issued by legal entities distinct from the parent corporation. As a result, any liabilities of the parent corporation –whether attributed to a given tracking stock or not – have recourse to the assets attributed to that tracking stock. In other words, from the perspective of a creditor, the tracking stock structure is irrelevant. Economically, this is very similar to a guarantee of all of the parent’s liabilities.
In the recent past, Liberty Media’s Entertainment Group and Capital Group (LCAPA) tracking stocks have undoubtedly reflected some value for this “guarantee.” QVC, which is attributed to Liberty’s Interactive Group (LINTA), had a tenuous liquidity position until very recently when QVC was able to issue $1.0 billion of senior secured notes, extend the maturity of a significant portion of its bank credit facilities, and borrow $250 MM from each of the Entertainment Group and the Capital Group on what appear to be market terms.
With QVC’s liquidity profile substantially improved, none of Liberty’s tracking stocks should be reflecting much value for their “guarantees” at the present time, and as a result, they should all trade at lower discounts to NAV than they have historically. The Entertainment Group, Capital Group and Interactive Group have equity values of $17.5 billion, $2.3 billion, and $6.7 billion, respectively, based on recent market prices. These equity values indicate that substantial cushions exist ahead of each tracking stock’s “guarantees” of the liabilities of the others. To look at the historical discounts that Liberty’s tracking stocks have exhibited and simply apply that discount to Liberty Starz ignores the fact that the “guarantees” that were once a significant issue no longer represent a material liability.
The second portion of the discounts that Liberty’s tracking stocks have historically exhibited relates to their holding company structures. Academics and practitioners attribute holding company discounts to a variety of factors. The most relevant factor in the case of Liberty Media’s tracking stocks has probably been an over-estimation of net asset value due to the lack of marketability of the holding company’s assets.
For example, Liberty’s Capital Group owns 40% of SIRIUS XM Radio (through convertible preferred stock), a publicly-traded company. In valuing the Capital Group’s stake in SIRIUS XM Radio, most analysts simply multiply the number of SIRIUS XM Radio shares that Liberty owns by the most recent trading price of SIRIUS XM Radio’s publicly-traded equity. Such an approach likely over-estimates the value of Liberty’s stake in SIRIUS XM Radio, and correspondingly over-estimates the discount at which the tracking stock trades. The most recent market price of SIRIUS XM Radio almost certainly reflects a transaction involving only a very small portion of SIRIUS XM Radio’s outstanding shares. If Liberty were to try to sell its stake in SIRIUS XM Radio, which represents a very large portion of the shares outstanding, it is quite possible that Liberty would realize a lower average price for its large stake than the price realized for a much smaller stake.
Another factor related to the holding company structures of Liberty’s historical tracking stocks that has likely contributed to the discounts they have exhibited is the limited information on all but the largest assets attributed to those tracking stocks. Consider the Entertainment Group for example. Prior to certain making certain filings with the SEC related to the planned split-off transaction and merger with DIRECTV, Liberty provided almost no information with which an investor could value Liberty’s interests in the Game Show Network and the Regional Sports Networks with a high degree of confidence. Clearly, the limited information that Liberty has historically provided regarding many of the assets attributed to its tracking stocks has almost certainly contributed to the discounts that those tracking stocks have exhibited.
Liberty Starz, with a 100% interest in Starz Entertainment, LLC as its only significant operating asset, should largely avoid any holding company discount. As a result of Liberty’s 100% ownership interest in Starz Entertainment, it has access to Starz Entertainment’s cash and does not necessarily need to sell Starz Entertainment to realize its value, so a discount for lack of marketability should not apply. Furthermore, Liberty provides a good deal of information about Starz Entertainment in its public filings, because Starz Entertainment is one of Liberty’s most significant sources of value. Correspondingly, Liberty Starz should not experience any holding company discount as a result of limited publicly-available information about its assets.
Liberty Starz should also trade at little to no discount to intrinsic value for another very simple reason: Liberty management has clearly shown that it is willing to take corporate actions to address any discount at which its tracking stocks may trade. Liberty has already authorized a $500 million share repurchase program for Liberty Starz, and would likely consider borrowing money to extend its repurchases of Liberty Starz shares to the extent the stock trades at a discount to intrinsic value. Liberty would also almost certainly consider distributing Starz Entertainment as an “asset-backed” security (i.e. a traditional common stock) or taking some other type of corporate action if Liberty Starz as a tracking stock persistently trades at a discount to intrinsic value.
In summary, there are three primary reasons why Liberty Starz is different than Liberty Media’s historical tracking stocks and should trade at little to no discount to intrinsic value. First, while the “tracking stock guarantee” had weighed on the value of Liberty’s tracking stocks in the recent past, the liquidity issues at QVC have been largely resolved and significant equity cushions exist at each tracking stock. Second, a significant portion of the discounts that Liberty’s tracking stocks have historically exhibited have almost certainly been due to holding company discounts. With a 100% interest in Starz Entertainment as its only operating asset, Liberty Starz should not be subject to a holding company discount. Finally, if for no other reason, Liberty Starz should trade at little to no discount to intrinsic value because Liberty management is clearly willing to take aggressive action to address any discount at which the shares may trade.
The equity of Liberty Starz is currently trading on a when-issued basis under the ticker LSTAV. At $47 per share, the market’s current valuation of Liberty Starz implies that Starz Entertainment is worth only 4.4x FY09 Adjusted OIBDA and 5.2x FY09 operating income. If you believe that Liberty Starz should trade at a hefty discount to intrinsic value for some reason, you may consider Liberty Starz’s current valuation appropriate. Otherwise, you’ll likely find Liberty Starz presents a pretty compelling bargain.