Should Liberty Starz Trade at a Discount?

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.

Disclosure: none

Comments

[connorport]

If they were to dump their commons on the market to sell they would drive the price to nothing. They would be better suited leveraging the shares to strike "good deals" or to aquire SIRI all together.

2009 Nov 14 09:30 AM

[Pell]

Recent news suggest Libert will be consolidating their corporate structure. Or in the article's words "simplify". Their ownership in different companies has gotten so diluted with so many different arms to manage its makes sense.

I believe like Connorport Liberty is reorganizing itself for M&A. In fact wasn't t the Starz arm which recently hasthe opprotunity to a R/S and offcially took that off ht etable when they announced news of "simplifying" their ownerships?

There has aso been rumors Liberty and Malone my be marketing Direct TV for sale.

My belief is there is too much competition in TV and with the right managmenet and money supply SIRIXM is a better fit for Malone right now.

I think under Malone we will see SIRIXM expand and create the real Smart Phone. TV, Radio etc with the ability to get signals anywhere in the world.

2009 Nov 14 11:13 AM

[tafter12]

Should Malone go the route of taking over sirixm, that would result in SIRIxm shares going up, right? What about Mel's stake and his executives shares? would they sell, driving the price down, or would they stay on board as well? What about the number of overall available shares that sirixm offers? Would that number go down, un-delute the price under the current arrangement between Malone and siri?




On Nov 14 11:13 AM Pell wrote:

> Recent news suggest Libert will be consolidating their corporate
> structure. Or in the article's words "simplify". Their ownership
> in different companies has gotten so diluted with so many different
> arms to manage its makes sense.
>
> I believe like Connorport Liberty is reorganizing itself for M&A.
> In fact wasn't t the Starz arm which recently hasthe opprotunity
> to a R/S and offcially took that off ht etable when they announced
> news of "simplifying" their ownerships?
>
> There has aso been rumors Liberty and Malone my be marketing Direct
> TV for sale.
>
> My belief is there is too much competition in TV and with the right
> managmenet and money supply SIRIXM is a better fit for Malone right
> now.
>
> I think under Malone we will see SIRIXM expand and create the real
> Smart Phone. TV, Radio etc with the ability to get signals anywhere
> in the world.

2009 Nov 14 11:36 AM

[dealjunkie]

If Buffet and friends are correct that a wise place to invest is in a natural monopoly with very high barriers to entry, then TV is the wrong place to be - competition has been building for 50 years and entry is cheap - while SIRI is the monopoly for sat radio. The barriers to entry at the moment are huge and there are 100,000,000 cars on the road (?) which do not yet have sat radio.

Malone will move to take SIRI.


On Nov 14 11:13 AM Pell wrote:

> Recent news suggest Libert will be consolidating their corporate
> structure. Or in the article's words "simplify". Their ownership
> in different companies has gotten so diluted with so many different
> arms to manage its makes sense.
>
> I believe like Connorport Liberty is reorganizing itself for M&A.
> In fact wasn't t the Starz arm which recently hasthe opprotunity
> to a R/S and offcially took that off ht etable when they announced
> news of "simplifying" their ownerships?
>
> There has aso been rumors Liberty and Malone my be marketing Direct
> TV for sale.
>
> My belief is there is too much competition in TV and with the right
> managmenet and money supply SIRIXM is a better fit for Malone right
> now.
>
> I think under Malone we will see SIRIXM expand and create the real
> Smart Phone. TV, Radio etc with the ability to get signals anywhere
> in the world.

2009 Nov 14 11:37 AM

[R A F]

One thing is for sure: Sirius XM will be a building block in some deal, sometime, somewhere. It is an extremely attractive vehicle for merger with any one of the many major media entities. SIRI is not in play yet - but it certainly will be, sometime in the future.

2009 Nov 14 12:38 PM

[Pell]

Great comments in here. Accurate and inteligent. SIRIXM is on the block "for the right price".

Malone will make his move, the shares will be undeluted prior to purchase and management will be well taken care of due to poison pill.

I predict a premium per share for the purchase because it is a great buy. Dealjunkie great comment on entry into this industry.

The R/S by SiriXM is inevitable and so is the sale. They have no excess cash flow to take this GREAT PRODUCT to the next level, whereas Malone does. Another reason for the reverse split is stock manipulation and the fact that Malone himself is currently experiencing what happens when you allow your house to get messy.

By the way even management and Mel would be crazy to sell their shares too early. This is a blockbuster product that will eventually take over free radio just as cable took over free TV.

SIRILONG and lovin this play.

2009 Nov 14 01:43 PM

[R A F]

Much too early to be talking about a reverse split at this time. SIRI is trading from technical strength and probability favors further appreciation into 2010. It would be much better to wait until the stock has appreciated to its indicated objectives well above 1.00 - and demonstrating the solid underpinnings of this company to grow on its own - before enacting a premature reverse split that would be interpreted as only a maneuver to adjust the share price above 1.00 to avoid a delisting notice (also totally out of the question at this time). Sirius XM is now firing on all cylinders and the stock is responding with increasing upside momentum; It would certainly be wise to wait for further gains into the first half of 2010 before contemplating a reverse-split to realign the capital structure. Any move to do so now would be seriously undercutting this upside potential, prematurely. Keep in mind, the resulting share price after a reverse split will be a function of the level of the share price preceding this action, and it is always advisable to wait for the highest possible price before such a decision is enacted. The technical strength of SIRI is now projecting potential toward 1.25 to 1.50 by mid 2010 and any reverse split from that type level would be infinitely better than acting when the stock is well below 1.00.

2009 Nov 14 02:32 PM

[Pell]

Agreed RAF. But I just believe the buy from Malone is coming sooner therefore, during negotiations Mel wants to do get the best price and doesn't want any loose strings to be held over his head.

The stock holders will be rewarded by a premium paid per share for this coveted company. Their won't be any time to think if the R/S was from strength or weakness.

The worst thing that could happen is institutional investors become Longers.


On Nov 14 02:32 PM R A F wrote:

> Much too early to be talking about a reverse split at this time.
> SIRI is trading from technical strength and probability favors further
> appreciation into 2010. It would be much better to wait until the
> stock has appreciated to its indicated objectives well above 1.00
> - and demonstrating the solid underpinnings of this company to grow
> on its own - before enacting a premature reverse split that would
> be interpreted as only a maneuver to adjust the share price above
> 1.00 to avoid a delisting notice (also totally out of the question
> at this time). Sirius XM is now firing on all cylinders and the stock
> is responding with increasing upside momentum; It would certainly
> be wise to wait for further gains into the first half of 2010 before
> contemplating a reverse-split to realign the capital structure. Any
> move to do so now would be seriously undercutting this upside potential,
> prematurely. Keep in mind, the resulting share price after a reverse
> split will be a function of the level of the share price preceding
> this action, and it is always advisable to wait for the highest possible
> price before such a decision is enacted. The technical strength of
> SIRI is now projecting potential toward 1.25 to 1.50 by mid 2010
> and any reverse split from that type level would be infinitely better
> than acting when the stock is well below 1.00.

2009 Nov 15 07:30 AM

[R A F]

If the interest from Malone is coming sooner, the share price (current, or on a reverse-split basis) is immaterial; The offer and the deal would be predicated and structured on the price to be agreed upon (current, or adjusted on a reverse-split basis).

There is no tactical value to enact a reverse-split in anticipation of a possible deal, as this could all be built into the negotiations at that time, if needed.


On Nov 15 07:30 AM Pell wrote:

> Agreed RAF. But I just believe the buy from Malone is coming sooner
> therefore, during negotiations Mel wants to do get the best price
> and doesn't want any loose strings to be held over his head.
>
> The stock holders will be rewarded by a premium paid per share for
> this coveted company. Their won't be any time to think if the R/S
> was from strength or weakness.
>
> The worst thing that could happen is institutional investors become
> Longers.

2009 Nov 15 08:36 AM

[Pell]

After R/S SiriXM has no perceived weakness in negotiations. Negotiate from strength and never let the other guy see any minor weakness that can be exploited.

I also see institutional money being invested in SIRIXM once the $2 threshhold is broken, pushing the price further up.

2009 Nov 15 01:25 PM

[SevenCostanza]

DVD -

By what method did you determine the following?

"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."

I arrive at similar numbers, but only as an EV/OIBDIA and EV/OI basis. Are you backing out cash and current assets as well?

Take care

Eric

2009 Nov 17 10:36 PM

[Deep Value Diver]

I don't really understand your question. Because OIBDA and Operating Income are operating/unleveraged metrics, they can ONLY be related to enterprise value not equity value.

I use the following assumptions in calculating the implied enterprise value of Starz Entertainment: i) 53.1 MM shares, ii) $608 MM cash, iii) $250 MM loan to LINTA, iv) $111 MM non-operating liability related to PSARs, and v) $43 MM - $54.9 MM of value for interest in WildBlue and PicksPal.


On Nov 17 10:36 PM SevenCostanza wrote:

> DVD -
>
> By what method did you determine the following?
>
> "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."
>
> I arrive at similar numbers, but only as an EV/OIBDIA and EV/OI basis.
> Are you backing out cash and current assets as well?
>
> Take care
>
> Eric

2009 Nov 19 09:14 AM