Betting on Liberty's Malone and Maffei

Includes: LMCA, QVCA
by: Dutchtender

Despite all of the value creation going on beneath the surface at John Malone's Liberty Media, its two tracking stocks, Liberty Capital (LCAPA) and Liberty Interactive (LINTA), on a market cap basis, now actually trade about 10% below the highly depressed, pre-spin levels of May 2006.

An experienced "tape watcher" might notice that LINTA especially, was being unrepentantly liquidated over the last few weeks (it's down about 25% ytd), perhaps by Oakmark, Weitz, any number of other value managers or troubled hedge funds. Many value shops are seeing their highest rate of redemptions since the dark days of late 1999 and early 2000.

Hedge funds that go long and short have seen many of their pair trades blow up. These investors are now in the process of creating liquidity for their funds, and may sell a perfectly fine holding simply because it is more liquid than some of their other holdings. Or it could be that selling LINTA is the best of a bunch of terrible options for an investor in distress. All of this chaotic, forced selling, has caused the shares of many attractive companies, including LINTA, to careen lower further than and faster than S&P 500 index, for no fundamentally sound reason.

During this credit crunch and crisis in confidence, investors have been shunning just about anything consumer related, but especially cable and retail properties. This disdain hits Liberty Interactive doubly hard since its primary asset, the 100% owned QVC shopping channel, is the leading multimedia retailer with about $7.6b in annual revenue. However, a purchase of LINTA at current levels ($15) could prove extremely rewarding down the road, when market conditions normalize.

Liberty recently disclosed in a press release that since the formation of the tracking stock structure, the company has repurchased approximately 14% of the LINTA shares, some at prices as high as $24.95. Running some of the numbers reveals why Liberty has been aggressively repurchasing LINTA stock. Backing out stakes in various other assets at current market prices, and accounting for net debt, reveals an implied value for QVC of roughly $11b, or around 8.5 x TTM adjusted operating earnings (to exclude amortization charges). That seems too inexpensive for a unique, low capital intensity, prize media asset that's had a long record of consistent profitable growth, and high returns on invested capital.

In all probability, the opportunistic Liberty CEO, Greg Maffei, has his net out and is scooping up what is being tossed overboard without regard to intrinsic value. With a substantial share repurchase authorization already in place, evidence is overwhelming that Liberty is a huge buyer of the LINTA tracker at these price levels and higher.

The current market quote for LINTA must seem illogical to the folks at Liberty, given the highly attractive economics of QVC, and the intimate understanding of the price they have paid for shares of QVC in past transactions. For example, in June of 2007, Liberty tendered for about 3% of LINTA shares at prices almost 70% higher than the current quote.

Furthermore, at today's price, Mr. Market's implied value for QVC is approximately 20% lower than a much "harder" and more rational appraisal made almost five years ago by Chairman Malone, just before he bought Comcast's (NASDAQ:CMCSA) large QVC stake for Liberty at an implied valuation of $14b. Yet QVC has delivered exceptional business progress since that 2003 purchase. In the long term, market participants will put LINTA on the "scale" and realize QVC is much bigger, better and stronger in every way than it was four years ago when Malone seized his opportunity to own virtually all of QVC.

This incremental value creation over the last few years at QVC is validated by the higher price Liberty recently paid for a small minority investment in QVC. In 2006, Liberty bought the approximate 2% sliver of the retailer that was in the hands of other investors, at an equity valuation of $16.5b, or just under 14 x 2006 ebita (earnings before interest, taxes, and amortization of intangibles). When an analyst factors in the debt Liberty has utilized to further juice returns at QVC (and shelter income), the ebita multiple is actually higher. The key takeaway is that Liberty is a buyer of QVC, not a seller, at ebita multiples over 60% higher than those prevailing today.

QVC is just a part, albeit a major one, of the wrongheaded evaluation here. Liberty has a host of other assets assigned to the LINTA tracker that are also likely being undervalued by investors. Liberty recently bought 14m more Interactive Corp. (IACI) shares, which itself seems significantly undervalued, due to benign neglect from investors, fatigued by Barry Diller's impulsive conglomerate building. The added shares give Liberty a 30% economic interest in IACI, to go along with its 23% stake in Expedia, (NASDAQ:EXPE) where Maffei was once Chairman. With effective control, the coming splintering of IACI into five pieces also presents Malone and Co. with numerous value enhancing alternatives at Liberty.

The story is much the same at Expedia, where Diller has been searching for ways to boost shareholder value at the leading online travel agency. The company, which has counter cyclical characteristics that make it somewhat more recession resistant than most consumer discretionary businesses, is likely worth far more to interested private or strategic buyers than current market prices suggest. When credit markets reopen, Expedia will likely either attract a bid (perhaps from Liberty), or lever up and significantly shrink its equity, increasing the value of Liberty's stake.

The evidence uncovered by piecing together the capital allocation decisions at Liberty in recent years, suggests that Malone and Maffei are still extremely bullish on "all things" LINTA. Their behavior seems wholly justified, however. When you take the time to unravel some of the complex structure here and do the math entailed in a breakup analysis, it's easy to understand and identify with their optimism.

It is during challenging times like these when smart owner / operators, like John Malone, do their "magic" and create long term value for themselves, and their shareholders. Lasting wealth is built by stepping up in troubled times, and having the conviction to buy great assets, controlled by value creating managers with plenty of skin in the game. That's exactly what you get right now at both trackers, but especially so at Liberty Interactive.