Liberty Entertainment Group (LMDIA) Q2 2008 Earnings Call August 11, 2008 11:00 AM ET
Greg Maffei - President and Chief Executive Officer
Chris Shean - Controller
Mike George - Chief Executive Officer of QVC
Bob Clasen - Chief Executive Officer of Starz
Dan O’Connell - Chief Financial Officer of QVC
Bill Meyers - President and Chief Operating Officer of Starz
Glenn Curtis - Executive Vice president and Chief Financial Officer
John Malone - Chairman
Kit Spring - Stifel Nicolaus
Andy Baker - Jefferies & Company
Doug Anmuth - Lehman Brothers
Jason Bazinet - Citi
Benjamin Swinburne - Morgan Stanley
Alan Gould - Natexis
Doug Mitchelson - Deutsche Bank
April Horace - Janco Partners
Scott Devitt - Stifel Nicolaus
Please standby. Good day and welcome to the Liberty Media Corporation Quarterly Earnings Conference Call. Today's call is being recorded.
This presentation includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about financial guidance, business strategies, market potential, future financial performance, new service and product launches, and other matters that are not historical facts.
These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements, including without limitation, possible changes in market acceptance of new products or services, competitive issues, regulatory issues, and continued access to capital on terms acceptable to Liberty Media.
These forward-looking statements speak only as of the date of this presentation, and Liberty Media expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in Liberty Media’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
Please refer to the publicly filed documents of Liberty Media, including the most recent forms 10-Q and 10-K for additional information about Liberty Media and about the risks and uncertainties related to Liberty Media’s business, which may affect the statements made in this presentation.
On today’s call, we will discuss certain non-GAAP financial measures. The required reconciliations, preliminary note and schedules 1 through 3 can be found at the end of this presentation.
At this time, for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr. Greg Maffei. Please go ahead, sir.
Greg Maffei - President and Chief Executive Officer
Good morning and thank you, and thank you all for joining us today and for your continued interest in Liberty. We were pleased with this quarter's continued progress on our operational and structural goals. And today, we'll review the quarter by each tracker. We will discuss operating performance at are controlled subsidiaries. We will cover some of the transactions we are interrupt during the quarter and other key developments.
And Liberty's Controller, Chris Shean is going to start after my remarks by discussing the attributed businesses financial results and liquidity picture for each of the trackers. QVC CEO, Mike George, will join us to discuss developments at QVC, Starz CEO; Bob Clasen will review recent events at Starz. Also on the call I have with us today QVC’s CFO, Dan O’Connell, Starz’s, President and COO Bill Meyers, and EVP and CFO Glenn Curtis and several Senior Liberty Executives including our Chairman John Malone. All will be available to answer questions after our prepared remarks.
Before we discuss the specific results of the quarter, I want to review quarterly highlights and tie them a little bit indoor we are arching strategy direction at Liberty. First, Financial Management, we strongly believe that share repurchases under the right conditions are a very efficient way to return value to shareholders. And we executed on this during the quarter in two ways.
First in LCAPA, we repurchased 18.1 million share through the end of July reducing our outstanding shares by about 14% and DIRECTV continued its buyback. Earlier, as you may recall, we had executed a extensive agreement to hold our boarding ownership to 47.9%, which enabled DIRECTV to be active in buying back their stock. They have done so, and we are now about 49.5 economic interest, 1.5 percentage economic interest and as they continue their repurchase program which has been previously announced obviously, our economic ownership will increase.
We remain disappointed by the trading discount that LMDIA has to the spare some other parts valuation and we are still considering at options to create value for shareholders and address that.
Let me end the operations overall, first at Liberty Interactive. QVC had solid results given a very challenging economic environment with international growth led by strong performance in Japan. We had excellent results at Liberty Interactive in the e-commerce affiliates. Even excluding the effective acquisitions, and looking on a pro forma basis as if acquired at the beginning of '07 those businesses truly all performed quite well.
We made two commerce acquisitions, e-commerce acquisitions during the quarter small ones Red Envelope which we purchased out of bankruptcy and Celebrate Express, which is by season's largest online competitor.
The old GAAP model, which is the one deal at a time model that has been so successfully employed by Backcountry.com with and many site including Whiskey Militia, Steep and Cheap et cetera is now being looked at and processing is being deployed not only at new sites at Backcountry.com, but also across other companies in the Liberty portfolio. So excited to see successful synergy at work there.
And LMDIA, Liberty Entertainment, we had strong operating performance at DIRECTV and when they reported their numbers last Thursday specially impressed was the results in Latin America, a business that we think probably doesn’t get the full valuation in the marketplace in the DIRECTV stock that it deserves.
Starz Entertainment had continuing success executing on its strategy of audience aggregation providing end-to-end media services with good revenue growth and excellent adjusted OIBDA growth. And at LCAPA, continued focus on original contents Starz Media with successful and we have plan for numerous new releases in the third quarter. Overture Films, its still in its early stages, but we are pleased with the positive results shown to date.
At lastly looking at structural optimization as I mentioned earlier we continue to evaluate ways to try and reduce the discount from our stocks and the underlying values that they have on some of the parts basis and that may lead us to drive further structural efficiencies.
With that, let me turn it over to Chris Shean to talk about latest financial results.
Chris Shean - Controller
Thanks Greg. I guess, before I get into, I want to highlight the fact that we have a change in nomenclature with respect to our operating metrics. We now use the term adjusted operating income before depreciation and amortization, which I will refer to as adjusted OIBDA on the call instead of operating cash flow, which is what we have historically call that and we are going to use this terminology in all of our public filings and press releases on a perspective basis. So it’s the same term its just a different way of describing it.
The table that you are looking at for LINTA that shows second quarter revenue and adjusted OIBDA performance, it shows Liberty's Interactive attributed business has continued their steady revenue and adjusted OIBDA growth. The business is achieved 9% revenue growth while adjusted OIBDA grew 4%.
QVC the primary global performance among the Liberty Interactive attributed businesses continues to operate in a challenging retail environment. Nonetheless, the business managed 4% consolidated revenue growth and 1% adjusted OIBDA gains.
Liberty Interactive's other e-commerce businesses, which include Provide Commerce, Backcountry.com, Bodybuilding.com and BUYSEASONS again posts strong financial results and continue to grow at a rapid pace. In the aggregate the e-commerce businesses experienced revenue and adjusted OIBDA growth of 97% and 108% respectively, due in part to the acquisitions of Backcountry in June of 2007 and Bodybuilding in December 2007.
Now if you look at this on a pro forma basis revenue and adjusted OIBDA growth of these e-commerce businesses was 41% and 75% respectively. So, on an organic basis they had quite impressive growth.
On the next slide, we will go into further detail on QVC's quarterly results. QVC experienced consolidated revenue growth of 4% to $1.76 billion during the quarter while adjusted OIBDA grew 1% to $387 million. Revenue growth, while slow by QVC's historical standards was achieved without incremental promotional efforts. Consolidated adjusted OIBDA margin dipped by 60 basis point during the quarter resulting in adjusted OIBDA growth lagging revenue growth. Adjusted OIBDA margin declines were primarily the result of lower gross margins experienced across most product categories.
Domestic revenue decreased slightly in the second quarter to $1.18 billion and the mix of products sold shifted to accessories areas, away from home and jewelry. The average selling price increased 6%, while total units shipped declined 4%.
Domestic adjusted OIBDA decreased 2% in the second quarter to 286 million while the adjusted OIBDA margin decreased 50 basis points to 24.2% primarily due to product mix and freight and warehousing cost. QVC.com sales continued to grow as a percentage of overall domestic sales, rising from 23% in second quarter of '07 to 25% this quarter.
International revenue increased 14% to 580 million for the quarter, while adjusted OIBDA grew 11% to 101 million. Revenue growth was due to favorable foreign currency exchange rates, and subscriber growth in both the UK and Japan.
Adjusted OIBDA growth lagged that of revenue as adjusted OIBDA margins declined 50 basis points primarily due to higher commission cost as a percentage of net revenue, due to new fixed rate affiliation agreements in the UK and Japan. Excluding the effect of exchange rates, International revenue increased 3% for the quarter, while adjusted OIBDA increased 1%.
QVC UK local currency revenue increased 3% on a 4% growth in units. In Japan, QVC experienced 10% local currency revenue growth, the first double-digit quarter sales increase since the fourth quarter of 2006. QVC Japan has continued to successfully show gains in home, jewelry and fashion and shift away from the health and beauty products due to the height in regulatory focus on those products that began at March 2007.
In Germany, our business experienced softness in jewelry and apparel resulting in a 3% decline in net revenue on a local currency basis. Management remains focused on completing the turnaround of this business.
Now, I hand the call over to Mike George for additional comments and color on QVC.
Mike George - President and Chief Executive Officer of QVC
Thanks Chris. I will provide a little more background on Q2 results and then talk to you about some of key initiatives we have underway for the back half of the year.
In the US as Chris mentioned we continue to see flat sales results driven in part by the ongoing contraction and consumer spending. We were obviously, not satisfied with these results. We expect to drive stronger growth with our brand and our business model. So we remained very much focused on finding new ways to engage our customers and earn a greater share of wallet to overcome the softness in overall consumer spending.
We did see double-digit growth in a number of business in the US, including cookware, consumer electronics, health and wellness, garden, beauty, precious gems and handbags, however, these gains were offset by softness in a number of other home, jewelry and apparel categories. So this reconfirms for us that our customers are willing to treat themselves when we provide compelling products and presentations. And we need to deliver on that promise more consistently.
Our priorities going forward remain the same. First, we are focused on adding exciting brands and products that will command our customers' attention. In the last few months we launched Cesar Milan, better known as The Dog Whisperer, if you followed this show, celebrity stylist Gretta Monahan and Clinton Kelly, as well as the London Fog and Apparel, and Vincent Longo and Beauty.
Upcoming launches in the next 2 to 3 months include Anne Klein, Izzard, Calvin Klein, Soma Intimates and Mark.
We'll also be entering the wine business through a partnership with MyWinesDirect and launching a new wellness product line with Dr. Andrew Weil. Second, we are continuing to enhance our multichannel platform to drive incremental revenue growth. For example we recently launched a concept called 'private reserve' which features high-end limited quantity products available exclusively on qvc.com and we had strong early results with the collection of pearl jewelry from Honora, one of our top brands.
We will also be launching in the next month or two a mobile website and text messaging features and several other Internet and other new media pilots. And we are delighted to announce that both Verizon and AT&T along with several smaller affiliates, plan to distribute QVC and high definition later this year in addition to our regular broadcast, which will provide us essentially with the second channel position on these affiliates and we believe new viewers to QVC. This is the start. We expect our HD distribution expand significantly next year.
Now third, we are focused on creating exciting must-see programming and have several major events planned for the back half of the year to build consumer excitement and interest in our programming. We will be talking a lot more about following holiday campaign in the next few weeks.
We also continue to be disciplined regarding our promotion practices. As Chris mentioned, while gross margins are down slightly in the quarter, this is primarily due to product mix and higher freight expenses, which we will largely anniversary in August. We are also continuing to keep a tight lid on operating expenses.
Turning to the UK, we saw business slowdown somewhat in Q2 following a strong Q1, largely due to softness in our TRPs and then our crafts and collectibles businesses. The rest of the base business was solid with particular strength in jewelry and beauty. Our OIBDA margins in the UK continue to be challenged due to the cost of our new long term DTT contract. However, if you exclude those costs, OIBDA margins were actually up over 100 basis point from last year and will be the cost of the new distribution in October.
Germany slipped back to negative sales growth after a stronger Q1 showing. We are continuing to make progress shifting the business to more everyday pricing produced in the use of promotional tools, diversifying the product and programming mix including introducing 60 new shows in the quarter and maintaining a disciplined stance on cost reduction. At the same time, we continue to be challenged by uneven sales results and higher obsolescence rates as we test new products and reduce the use of promotions. So we remain very focused on driving this turnaround.
We recently announced in Germany the hiring of two outstanding executives who will lead our merchandising, planning, broadcast and internet operations in Germany. The Senior Merchandising Executive at Target for 20 years and was also Chief Merchandising Officer of QVC US a few years ago and has rejoined us in Germany. Also, [Matia Spork] who has deep retailing experience in Europe including leadership roles at [Auto Verson], Harrods and most recently as Chief Merchandising Officer at HSE will be joining us in April of next year. We believe the addition of these two seasoned retail and home shopping executives will provide a significant boost to our business in Germany.
And finally in Japan, I will repeat with the continued acceleration in sales, which have done a good job growing our fashion and jewelry categories to offset the erosion and health of beauty and some home businesses driven by the changed regulatory environment.
And like in the UK, the cost of expanded distribution in Japan, in their case, CS Digital is depressing OIBDA margin. Excluding the impact of these costs, which we will anniversary in December, our margin rate was up over 100 basis points in the quarter, reflecting our strong focus on expense management.
And finally in the current environment, in addition to managing expenses and gross margins in a diligent manner in all of our markets, we also think it's prudent to be cautious in our capital expenditures. We now expect our CapEx for 2008 to be around 150 to 160 million, down from our prior forecast of 190 million, and well below our annual expense of the – our annual CapEx of the prior two years, which was about 250 to 275 million.
And with that I will turn it back to Chris.
Chris Shean - Controller
Thanks Mike. Let's take a quick look at Liberty Interactive's liquidity picture. We continue to maintain a strong capital structure and good liquidity at the businesses attributed to Liberty Interactive. The Group has attributed cash and public investments of 3.7 billion, and has 7.7 billion in attributed debt. Excluding the value of the positions in Expedia and IEC, which could provide incremental liquidity, Liberty Interactive's quarter ending attributed net debt of just under 7 billion, equates to a leverage multiple of just over 4 times adjusted OIBDA , which we consider very comfortable for these businesses. We are likely to maintain this level of leverage until we see stronger capital markets and ready access to capital.
Now moving onto Liberty Entertainment, attributed revenue grew 32% in the second quarter, while adjusted OIBDA was up 13%. Revenue in adjusted OIBDA growth resulted from growth at Starz Entertainment coupled with inclusion of Liberty Sports Group.
Now taking a closer look at Liberty Entertainment's principal consolidated subsidiary Starz Entertainment, it’s revenue increased 8 -- this was driven by an increase in the effective rate for Starz services into a lesser extent subscriber growth mitigated by Starz fixed rate affiliation agreements. Starz subscribers increased 6% while Encore's grew 11%.
Starz adjusted OIBDA grew 24% as operating expenses increased 4% due to increased SG&A expenses associated with new Straz new branding campaign. Programming expenses decreased 4% as lower bonus payment amortization was offset partially by higher effective rate for the movie titles exhibited in 2008.
Now let's take a look at Liberty Entertainment's liquidity picture. The Liberty entertainment businesses are in a position of financial strength. At quarter end LMDIA was attributed with approximately 14.1 billion of public investment. In addition to its public holdings, Liberty Entertainment had attributed cash and liquid investments of just over 1 billion at quarter end. Total cash in public holding approximated 15.1 billion well in excess of the 2.6 billion based amount of attribute debt.
Before, we turn to Liberty Capital, I will next hand it over to Bob Clasen, who would like to say a few words about a number of exciting events at Starz Entertainment and Starz Media.
Bob Clasen - Chief Executive Officer of Starz
Thanks Chris. Starz had another strong quarter of growth and our customers continue to tune in. The Starz flagship channel finished first in total day ratings among premium networks for ten of the first 26 weeks this year. Prior to this year Starz had never finished first in a weekly premium network ratings.
We continue to execute on our year long branding campaign, which will be centered-around our first original dramatic series crash, which will premiere on Starz October 17th. Our affiliates responded enthusiastically to our original strategy and we plan to use a variety of platforms to promote the series, including central episodes via promotional channels on demand and the internet. And we have a concentrated multimedia advertising campaign set to the end of September.
Our affiliates have also embraced our continually expanding offering of HD channels. In the past few months we have launched Starz HD on DIRECTV, DISH Network, Time Warner, Charter Communications and others. Earlier this month we launched Encore HD our 5th distinct hi-def channel. DISH network has already added it to the line up and other distributors including Comcast, will follow shortly.
The core business at Starz Entertainment has always been to sell our services wholesale to affiliates, who in turn market them to the consumer often in a package which provides much more compelling consumer value. This quarter we announced our first affiliation agreement with Starz Play with Verizon Communications, which is offering the service to 8.5 million Verizon High Speed data customers.
Starz Play is a subscription based video download service for delivering movies and other video content over the internet that can be bundled with the subscription to the Starz Channels and/or a subscription to high speed internet services.
On the Starz Media side, revenue for the quarter declined by 13% versus a year ago, while operating income was flat. We continue to expect that the company will generate negative operating results for the coming 2 to 3 years as we continue to invest in producing and marketing programming.
Overture Films the visitor is proven to be the surprise indie hit of the summer. It opened on April 11, and is still in theaters today finishing on the top 10 to 15 films for many of the weeks since it opened. It will be a strong seller on the video market where we will begin it in October and on Starz Channels.
Mad Money the first Overture Film which opened in theaters in last January hit home entertainment in June to our Anchor Bay Home Video Company. The film was the biggest selling pneumatic release that we get debut and has generated about 25 million in gross revenue since then. That money will be on the Starz Channels and Starz Play later this year blazing trails for other Overture Films as we pursue our strategy of aggregating audiences across multiple distribution platforms.
Overture shifts into high gear in the coming weeks and [recool] is here this year starring Luke Wilson opens August 15, that’s Friday, Traitor starring Don Cheadle and Guy Pearce opens August 27, and Righteous Kill starring Robert De Niro and Al Pacino premieres September 12. Anchor Bay Entertainment will handle the home video release of these films and continue its strategy of acquiring and producing low budget films for limited theatrical and then home video release.
The next one Surfer Dude starring Matthew McConaughey, with Willie Nelson and Woody Harrelson premieres roughly in September. The Film Roman Production is underway on Season 20 of the Simpsons and Season 13 of King of the Hill, also two marvel series are started in production along with the Good Family to premiere this fall on ABC. Film Roman is also producing a prequel movie Dead Space to coincide with Electronic Arts, highly anticipated game coming out this fall and our Toronto Studio has three CGI animated features that are in production for other studios.
Finally we are encouraged that Space Chimps, our animated feature film co-produced with Vanguard Films and distributed by Fox, is performing well at the box office, generating over 25 million in revenue through this weekend. These developments in the second quarter and projects on top are all designed to help us become an even more fully integrated media company capable of producing all types of programming for distribution on all platforms.
And now I will hand it back to Chris.
Chris Shean - Controller
Thanks Bob. These next slides address the Liberty Capital track of stock group. During the quarter Liberty Capital revenue increased 33%, to $174 million, while LCAPA was adjusted OIBDA loss increased 40 million. LCAPA's revenue growth was due to the inclusion of the Atlanta Braves, the adjusted OIBDA loss was primarily due to marketing and advertising costs associated with several Overture Films and Starz Media.
Now let's take a look at the Liberty Capital liquidity picture. Liberty Capital Group has attributed cash and public investments of 6.8 billion, and attributed debt of 4.9 billion. During the second quarter and through July 31st, Liberty repurchased 18.1 million shares of that Series A Liberty Capital common stock at an average price of $14.79, the total cash consideration of 267 million. These repurchases represent 14% of the shares outstanding.
With that said, I will now turn the call back to Greg for a quick recap of the quarter.
Greg Maffei - President and Chief Executive Officer
Thanks Chris and thank you to Mike and Bob for you updates on your respective businesses. These are obviously challenging times externally, but they are exciting times at Liberty. We continue to focus on maximizing shareholder value through driving strong operating results with our management team, managing our portfolio of assets among and within each of the tracking stocks and executing on innovative financial transactions.
I wold say overall we produced solid results this quarter, we will continue to strive to create better and best option to support, streamline our operations, identify additional strategic transactions, and further refine and simplify our structure. As always stay tuned. Thank you for listening today and thank you for your continued interest in Liberty.
I would now like to open the call for questions. Operator?
Thank you. (Operator Instructions). Our first question comes from Kit Spring from Stifel Nicolaus.
Hi. Can you comment on what you think the proper leverage ratio is for DIRECTV and then your take on DIRECTV, DISH Merger if that's remotely possible either now or in the future? Thanks.
I will comment briefly and I will ask John if he has got any incremental thoughts. But our leverage of DTV, I think it's clearly under-lever. The right number frankly today is not a function of what would be optimal in some textbook or some theoretical condition is optimal given market conditions of how much you need to if you want to chase debt you don’t need to execute on today in a very ugly environment. DIRECTV execute on some debt transactions, which look very clever and well timed given when they get them. At the time, they might look expensive, but today if you look however a lot less expensive than if you were ask to do them today. So they have a ton of liquidity relative to their needs. They are on a measured and appropriate buyback. We are enthusiastic about, talking about the long term theoretical leverage is probably not so relevant while we are sitting in a market where you don’t need to chase the debt.
As far as addition DTV, I am not sure exactly why that got such a round of enthusiastic media/investor attention over the last two, three weeks. There really hasn't been anything that's occurred or changed the market conditions other than potentially some people projecting on the impact of the -- or the foretelling of a Sirius XM merger and what might need, I don’t know what's changed or whether than could be done, obviously there are ton of synergies out there that deal had challenges once, the other could be done today in a different environment about. I don’t know enough about.
My view would be two and a half to three times leverage for the US entity because if you look at the tax ability of its current financial statement. However, debt availability and debt cost right now is prohibitive and -- but on a theoretical basis that would be a pretty stable long term client and of course one would want to also put leverage into the Latin American businesses both South America and Mexico in order to get higher equity returns there, neither of those are currently levered and they both produce a lot of free cash flow at this point. So there is quite an opportunity for enhanced shareholder returns through the use of leverage over time once the capital markets return to normal type situation and I agree with Greg. I don’t understand why the journalists all of a sudden discovered the potential of a merger of Echo with Direct. We have talked about it frequently in the past, it would be very synergistic if it were doable. However, we don’t see that the regulatory environment has changed since the last time we made comments on the subject and we think it will be problematic to try and merge the two companies at the current regulatory environment.
Thank you, Kit. Next question please.
Our next question comes from Andy Baker with Jefferies & Company.
Hi, thank you. Can you talk about with I guess Interactive could -- one issue starts tomorrow and I guess it starts regularly next week. Can you talk about the different pieces there, which you think are interesting? Obviously buried in this question is what you think about HSN going forward and are there any restrictions to your ability to make an offer today any shareholder protection et cetera? And, I mean, do you think having seven I guess publicly traded companies now as held by Liberty Interactive as opposed to just three, isn't that sort of bad for the transparency of that tracker?
I think we commented before we’re enthusiastic about the spend. We believe that they will provide probably increased options and choices both for the shareholders of those companies including ourselves. We will see how those respected companies trade, whether value is created, whether something are ultimately sold and whether we become a potential buyer of them or it really be a function of whether they are trading at and what is going out of time. Obviously, the one that’s been the most discussed for 10 to 15 years its potential combination with HSN. We’ve previously expressed our interest at the right price. We don’t know enough about where we’ll trade. We probably don’t even know enough about its operation details, it does appear that to their credit HSN is doing better, we’ll see where that -- how long that trend continues and we will see where it trades and we will take a look at the appropriate time.
In terms of there – I am not that familiar with their sort of structure going forward. Are their restrictions to your ability to pursue a controller, that’s control path there?
We have some restrictions that the shareholder including I think, roughly 30% of the votes and economics in the force fund companies. We have a restriction not to increase our percentage above 35 ultimately whether a friendly deal that’s up to our own in the marketplace, ultimately whether a friendly deal could be negotiated with their Board of Directors or shareholders of those companies remains to be same.
Yeah, we basically have agreed to know aggressive acts for a period of two years. Now public there are, its nothing of that nature. But we have no – there is no limitation on private discussions between the Liberty and the Board the Directors of these buying companies. We also have certain limitation as Greg said on increasing our ownership basically cap at a 5% incremental ownership, without making some kind of a deal. And on the downside we have certain limitation with respect to the sale of portions of our holdings in the various foreign companies. There is no change in our relationship with the core IAC or with the new IAC, that remains as it has in the past with two classes of stock and really no restrictions, no new restrictions relative to Liberty’s relationship there.
And your representation can be proportionate to your equity, your economic interest?
We have negotiated for at least 20% of the board in each case, and however, in order to maintain Sarbanes-Oxley requirements our designees need to be a mix of insider and independent directors.
Thank you very much.
Our next question comes from Doug Anmuth from Lehman Brothers.
Thanks for taking my questions. First one on QVC, and then a couple of structural things. First, in terms of the product mix at QVC clearly shifting in the tough environment reflects jewelry in home. Do you think you’re at the right mix now and how you continue to hold margins there if you shift further? And then a couple of question structurally what needs to be done to effectuate a hard spin of LMDIA in simplifying DIRECTV ownership, and also would you consider creating tracking stock for DIRECTV Latin America, given that you don’t believe its fairly reflected in DTV shares? Thanks.
I will comment if I could for one set on QVC and then let Mike only be far more illuminating. I think what you’re seeing happening in QVC is the function of what the consumer is choosing not necessarily what QVC is pushing or promoting, much the way that eBay seas cuts consumer growth drive, their categories, you’ve seen a shift in the marketplace where jewelry because of prices, gold increasing so dramatically, and home product is probably somewhat driven by lesser models in the way, you’ve seen an overall macro environment where both two categories are less attractive and innovation and consumer electronics has driven CE to be a larger share of the retial environment overall. QVC as a result reflect that. And I think they’ve done excellent job of, given that some of those categories are lower gross margin categories based on excellent job of controlling costs to offset the lower initial mark on that they are receiving. Mike you want to add to that?
To second that comment, I think it really is a function of what the consumer is excited about right now, as Greg pointed out, both the challenge that's been ongoing in the jewelry market, and then as you all know the apparel industry is in very tough shape in general and our core business has been not as bad as what we’ve seen at retail but certainly challenged and those tend to be a too higher gross margin categories. But I do believe over time those things have been flow and that we can over a long period of time maintain relatively stable margins. So as consumer electronics is hot right now, it comes at a much lower margin rate, but I see those as more short term in nature. The one other thing that’s affecting us in addition to the product mix that Greg described is that our today special value, which is our best deal of the day and is typically about 15% of our business has been for a long period of time. That business over the last several months has been growing faster than the rest of the business, which I do think again reflects in this environment that customer is really interest in the best possible values you can find and so, while the growth isn’t really disproportionate it is somewhat faster and that also suppresses your total margin, but all of those are things that I think will let them flow and again over the longer run I think we can maintain relatively stable margins.
Thanks Mike. On your second point about LMDIA expend potential, I think we’ve been probably suggesting that there are certain time limitations in our deal with News Corp that would prohibit us from doing that for a period. That’s not overwhelmingly long period given the timing of the February close. We’re certainly not committed to any course of action but we look at them all and when that – our contractual restrictions are terminated, we will have more freedom to make decisions. As far as DTV Latin America expend, I think we will look to the DTV management team to drive that, but I think we’re in of like mind that that business is not fully reflected in the stock price. Whether a tracker or ultimately a spin makes sense, I think those are a function of the maturity of that business, its ability to operate on its own and for what purpose I think chase carry would say if it's just a corporate finance valuation thing and a short term and it's not as excited if it opens up new opportunities and I think it might and I think he and I agree with Mike, we will probably look for things to do down the road, but we will look for DTV management to drive that, but I think we are like minded.
Okay, thank you.
Our next question comes from Jason Bazinet from Citi.
I just have one question for Dr. Malone. Most investor seem to understand that LCAP is trading at a steep discount, but it seems like the strategic issue is you don’t have a cash generative assets of size to sort of take advantage of that. And in that context at least when we speak to LCAP holders all of them seem to prefer a cash generative asset even one that’s declining like AOL dial to a passive equity stake and [tweaks] plus cash. So my question is would you consider doing a transaction that may not necessarily a strategic merits for the rest of the Liberty Enterprise but makes financial sense in the context of LCAP? Thanks.
Yeah, I think as Greg mentioned, LCAP strategy is a work in process, and whether or not a cash regenerative series of investments will take the form of capital investments, debt investments perhaps which as you know we are doing some of or whether it would be an operating business, it's not entirely clear. I think it’s a function of value and price and opportunity. Clearly an exit from the Time Warner equity stake into a cash generating asset would be attractive, but at the current time none have been proposed that we could take action on, but we would certainly continue to try and maintain good relations with Jeff and the Time Warner folks in the event that such a transaction would present itself.
Thank you very much.
I would add we are pleased to see TWX is up, up of some bottoms and we are happy for Jeff and for our shareholders, his shareholders and our shareholders both. And it might be just to finish on John's point, it might be worth reiterating our view about capital, which is to the fact that close trading in a large discount to its pretax number. A smaller discount to its liquidated hard aftertax number. Where we have that excess liquidity, we will try and ship away at the shares, at its below both pretax and aftertax liquidation value. Where we see value to do swaps, as John pointed out, we certainly will, but in general we see a benefit to delaying recognition of the tax liabilities and to keeping the thing alive because of the shield's generated off the exchange books. So we are working for ways to find cash generating assets or attractive financial assets and continue to do tax efficient transactions and ship away the equity as appropriate.
As you know LCAP's tax posture has been extremely complex and to some degree uncertain. Some of that complexity and uncertainty is slowly being resolved with the passage of time and various settlements with the IRS as they close out prior years. And so to some degree our inability to execute a clear strategy is a function of that uncertainty and complexity. So to some degree as I say it's the residue company and it is fairly complex in its tax and capital posture. To me that makes it interesting, but it also creates challenges in terms of a straightforward strategy for its future.
Great, thanks Jason. Next question please.
Our next question comes from Benjamin Swinburne from Morgan Stanley.
Hey, good morning guys. If I could ask a couple to Greg and John, one to take the comments you just made about our LCAP and apply them to the Entertainment Group, would you have I think some cash generation, a lot of cash on hand and the buyback plan, are you restricted from buying back that stock given some of the comments you made about the News Corp agreement and the LMDIA Tracker? And then second probably more interesting is if you look long term at the DIRECTV, balance sheet, cash flow generation and relationship to Liberty, you got a lot of financial value powers, pretty clear from their quarter that they are starting to see real operating leverage from the HD investments they have made. Where would you like to see that money go outside of equity shrink, given the network TV our decision recently there suddenly some fears out there that the advertising environment -- or the advertising business on TV is going to get tougher even taking the cyclical aspect out of it? Does that change your view of where DIRECTV should be say five years from now in terms of vertical integration or do you see this is as a pure play subscription business that should just stick to its meaning?
On the LMDIA buyback, yes, we do have couple of cash flow generating assets there, the Liberty Sports Group, obviously Starz is the biggest, some out of GSM, but we do have also 550 million of exchangeable debt attributed plus 1.9 billion we took on in the swap transaction to increase our stake. So while we have cash generation, we also have a reasonably high amount of debt and no clear path in a short term to pay all that off. So I think before we were aggressive in pursuing an LMDIA buyback, we want to know what the repayment short of share liquidation what the repayment methodology is. So that's been consistent. The difference in LCAP is that we have -- we believe it's excess liquidity against long term debt rather than 1.9 billion of bank debt.
On the DTV growth, I think you're increasingly going to see where DIRECTV as a very successful business in the US that will slow over time inevitably and will generate a lot more free cash flow. Some of that will undoubtedly be devoted to share repurchase, and again this is probably Liberty's, we are a major shareholder but we not the determinant, but I think the board is like mind. Some of that will be devoted to share purchase. Whether there are vertical integration assets are worth pursuing, I think the marketplace is somewhat dubious of those kind of transaction then it will take some convincing all the way around to make that happen, but it's something that we will look in every case when they are out there and we have different situation in the Latin American business, which will grow to be a larger and larger percentage of the business. Growth environment non-consolidated cash flow in some cases get cash flows that are sometimes difficult to perpetrate or sporadically give a patriot with less consistency and we will be pursuing probably more the growth strategy and I would encourage to think about other markets for growth that maybe different and maybe subscriptions businesses outside the US and outside of Latin America, I think those are all potentially there at DTV Lat-Am because it make more sense than a DTV US.
I think the reality right now is that DTV is trading at a forward multiple of 4 times. It's pretty hard for them not to think primarily about shrinking their equity. When they are paying that type of price, and despite the credit situations around the world, some of their assets, if you want to go buy them seems to be asking prices north of 10 multiple. But that’s just too large a discrepancy and valuation expectation for DIRECTV to do much other than shrink its equity and go organically, which are grey opportunities especially in Latin America. So, acquisitions whether horizontal or vertical look to me to be problematic because of valuations right now. Meanwhile DIRECTV a) is not sensitive to advertising revenue, like the rest of the media business is. And b) has focused heavily on sports live, realtime, high definition sports, which seemed to be the least vulnerable to issues of PVRs and other competitive incursion. So right now, you have to say that their strategy is dead on, which is equity shrink continue to look over their shoulder and Greg and I am trying to figure out what the ultimate rationalization between their public shares and Liberty Media, Liberty Entertainment are, which is clearly somewhere like minds are going to come together and there has to be some rationalization of the businesses.
I think to jeopardize John's point, of all one of the things that’s attractive in this environment about Liberty Media as a whole, compared to pretty much every of the major media company we are the least ad related, least ad sensitive media group out there of the traditional media companies. So subscriptions and transactions are well, we are making our money and that’s a good place to be today.
Thank you very much.
Our next question comes from Alan Gould with Natexis.
Thank you. A question for Mike George. Mike, I am Looking at your results versus the HSN results, and I recognize it's a difficult environment and you are three times the size of them but for the first time it seems that their metrics are growing better than yours, is it just, is your comps or are they doing something different than you?
It's hard for me to speculate, exactly on what the competition is doing. As Greg said earlier you have to give them credit that they have had some nice growth in the last few quarters. Their sales per customer and per subscriber are obviously well below ours and they have had difficult sales for a few years. So the comparisons are a little bit different. And of course their profit margins are well below ours. So there is a much bigger gap in profit per customer than sales per customer even. So definitely that gives you some room to do good things. And I think they are doing some good things in terms of brining them some new brands and freshening up their programming. So we watch them and as we do all the competition and try to learn what you can, but this is a business that obviously in QVC, that’s driven strong sales and profit growth over a long periods of time. And so what we don't want to do is sort of knee jerk in this current environment and radically change our programming mix. For example, if we -- we have talked earlier about the fact that consumer electronics is a strong category and it tends to be very high ASP category. That’s a category we could grow at a much more rapid weight than we are growing it at and give us the short-term sales boost, but we think that all comes back to haunt you, when the categories slow down and when you start to lack diversity of the programming calendar, so those are the things that drive us and again (inaudible) across them, but we are trying to in this environment still maintain a fairly diverse programming mix, keep freshening the calendar, not go too quickly after the hot businesses. We learned in Germany a few years ago that when you do that it comes back to hurt you. And also again being careful not to get too aggressive on the promotional front and maintain a more steady state on the promotional fronts. So I think those are the things that tend to guide our business and we think over time that will continue to pay off in terms of strong results over the long term, but clearly we are frustrated and disappointed by the weaker results in the short term. It's always motivating for the team to have someone to compete against. So we are delighted to see that resurgence because it gives us another rallying cry.
I think it's fair to say that you have to compare HSM performance with history, it's really in a turnaround mode now. If you look back two or three years, they are still operating substantially below where they were two to three years ago. So they had a perhaps problem, which they are now fixing, and so it's hard to compare growth from a deteriorated situation with growth from a consistently strongly performing situation. I think that should be taken into account. I think they are doing the right things in trying to get back to where they were two to three years ago and beyond at HSM, but it still needs to be looked at in the context of a turnaround from a deteriorated situation as opposed to growth from a high. Fuel is operating today at a all time high. It's growth rate has slowed but it is operating at an all time high, whereas H is operating roughly at 50% of where it was at its high performance mark. So you have to look at it that way.
Okay, thank you.
Maybe 60%. I want to give the devil his due.
Our next question comes from Doug Mitchelson from Deutsche Bank.
Hi thanks very much. Couple of questions for Bob and a couple for Greg and John. Bob just clarification Encore subs dropped sequentially, which was the first time we have seen that in a long time. And can you give us some underpinning of the economics of the Starz play VOD deals? And then for Greg or John, John you just introduced the concept that Time Warner hasn't offered you anything yet that you found interesting for LCAP swap. Have they introduced in AOL narrow band swap? I guess is the question there and then Greg I'm not sure if you can confirm this or not but I am interested if you can confirm that you're working on a heart spin for Liberty Entertainment? Thanks.
I will take the Time Warner one because I have probably have more dialog than after John. We have good dialog with Jeff and with all of in the strategy group there. We went through a long difficult process, we know each other because of that, that was a hard transaction. And I think they would come talk to us given our ability to affect tax efficient transaction for both parties, they would certainly come talk to us when they were disclosing of anything if there was a rational and as I said we have good dialog with them. Obviously I can't comment on any LMDIA spin other than to tell you that today we have no intention to do that. We look at every opportunity that we can think of, to be clever and smart and efficient for our shareholders but obviously we make no announcement until we made some decisions. While I was giving that so that the Starz team could pull their numbers, and Bob, do you have…?
Encore units June '07 to June '08 were up 10%.
I was picking up sequentially Bob.
Sequentially, okay. And while we are looking at that, I just comment on the Verizon dealers Starz Play. The key to this deal is the general approach we are taking with Starz Play, that it is a value added product and it adds value to the current Starz video customers and/or to the current Verizon high speed customers, so it's designed to be packaged, it is not a standalone product, it’s a value added product and the particular economics are integrately involved with the whole Verizon deal, they are doing very well with our video product, they are selling in over 45%. So we are very pleased with that and we don't make comments specifically on it but Starz Play is a value add proposition, not a standalone proposition, meant to be packaged with either our current Starz customers with Verizon and/or with high speed. And the for the…
Again it was minor job.
Why don't we take that offline if we could. We'd again come back and answer if we during this call or we will take up one follow up with you Doug, okay?
I appreciate that. Thanks.
Thank you. Next question operator.
Our next question comes from April Horace with Janco Partners.
Hi. Couple of quick questions on Liberty Interactive. It looks like the e-commerce business is now starting to represent about 10% of the revenue. Is there a goal in mind as to what kind of ratio you want with respect to Liberty Interactive and how much e-commerce should represent of the total? And then could you also give the percentage of Internet purchases from the international perspective and whether that's growing or not?
I will handle the first and Mike if you cover the second. On the first part, I think it's a little bit like theoretical debt levels. There is no number we can point to. What we tell you is that if we can find more businesses like the ones that we have bought, we would buy. We just don't have that many alternatives to buy well positioned, protected, growing reasonably priced with strong management teams Internet e-commerce businesses, we don't see that many. We bought four that are overall performing very well, we bought them and I think are very reasonable multiples. If you look at the growth against the e-commerce universe, they stand out and are performing quite well and we purchased them at numbers which are well below the average multiple of which that e-commerce universe trades. So the combination feels very good. We look at anything from 50 million or less because if you look at things like Celebrate and Red Envelope, which are more kind of tuck-ins, we bought them through less, but sort of standalone we probably look at anything from 50 million to 5 billion. We can't find that many that we could buy at attractive prices. So I don't think we have a theoretical number. We have first given paucity of opportunities, we first look there and then when we don’t see that we are looking at international expansion opportunities for QVC or share repurchase. That's kind of our three places where free cash flow goes for Liberty Interactive. Mike, maybe you could comment on the growth of the Internet businesses internationally.
Yeah, let me kind of give you the numbers, our US Internet business as you know we have got 25% of our total sales, in the UK it was 19% percent, also about 19% in Japan and 12% in Germany. So that's dot.com a percent of our total sales. So it is smaller internationally, a little less mature but growing at healthy rates and I think it's fair to say, that -- I don't have the exact growth rate in front of me, but I think it's fair to say that in every market that penetration rate has continued to climb. So we do look globally at the expectation that our Internet business will increase as a percent of our total sales by 2 to 300 basis points per year, may be little bit faster in the international markets given that it start from a lower base and I think we continue to stay on that kind of trend line.
In line with that, Mike, mike you could comment on the growth in mobile and particularly in Japan, which is obviously mixed in form of -- another form of form factor that's being utilized.
Yeah, Japan was the first of our markets with a mobile capability and they are running about 8% of their total sales on mobile. It was introduced a couple of years ago. So to go from 0 to 8 is obviously an encouraging development. We did launch a mobile platform in the UK in last fall. I am not saying that's still in the kind of 1% of sales range. That's at an early stage and will be launching the first phase of a mobile application in the US in the next month or two. Cleary I don't think we will see numbers like the Japan numbers because that market is obviously much more accustomed to doing a lot on the mobile phone. But I do think it suggest that there is potential to have this sort of QVC on-the-go kind of platform.
And I guess along with that, what you see is the US is the most developed PC traditional Internet market. Some of the other markets had mobile phones, another markets like UK, maybe you can comment briefly as well Mike on the Buy button on (inaudible) adapt well to new platforms whether it be Internet US, which is the most mature, mobile in Japan or example like the [B Sky B] in UK.
On the QVC in the UK, we call it QVC Active and as you may recall we have had for a number of years a platform where you could order on your remote control. We recently this year have launched a real expanded version of that service and starting in September you will now be able to potentially view four different TV channels by navigating on your remote control, the main channel that we are broadcasting live. You could also view the same channel but the programming that was on the previous hour. So if there is TV program on right now that you are not interested in, you could pull up the beauty program and watch that from the prior hour. That’s the first of the additional channels. The second additional channel is a 24-hour channel devoted solely to our beauty category. And the third additional channel is a channel that just focuses on our key promotions of the day. So we are very excited about that technology. Clearly that's a different video platform and market in the UK than in the US for example. But I think it speaks to how this industry is going to evolve over time where between mobile Internet and the convergence between Internet and TV, there are just going to be a lot of choices about how to get rich video content on demand. We are conducting a few more minor experiments in the US that we are not quite in a position to talk about. We are looking at various sorts of VOD and a Buy Button kinds of cash, but obviously a much more complex and diverse platform in the US, which makes it a little more challenging. But between the Japan mobile learning and UK learning, we think there is a lot to build on.
So I think -- thank you, Mike. I think we have the answer to Doug's question on sequential Encore?
First of all, Doug great tick up. We had 31 million customers and we were off from the first quarter by 150,000 Encore customers. These customers were from essentially three affiliates who either had declines in subscribers during that quarter or repackaged as one of them did. All three of them are from our so-called fixed rate affiliates who pay specific amounts on an annualized basis and so a decline doesn't affect our revenue and that will be the reason, but good pick up, it only took three of us 10 minutes to find that.
Great, thank you. Operator, I think one last question.
Our last question comes from Scott Devitt from Stifel Nicolaus.
Hi, thanks a lot. Two questions please on LINTA. First, could you just talk through the areas of CapEx reduction relative to last year? I think there was an international FC last year but it would be helpful to have some clarity there? And then separately I believe Amazon in their second quarter did about 4 billion in revenue at a 7% EBITDA margin and QVC did 1.8 billion at 22% OIBDA margin. Amazon has a presence in all QVC markets now, so given that the infrastructure the businesses are pretty similar, I am just interested in your thoughts on whether or not the increase in SKUs on the Internet and the lower margin and the guarantee-free shipping represents a risk to QVC or if you think your SKUs are protected long term and your demographic lessened risk? Thank you.
Mike, I assume you want to handle this.
Yeah, I will jump in. On CapEx, the primary differences from the last two years is that we have completed a round of significant infrastructure expansion. The distribution center is going up in Japan and in the US and significant expansions of our DCs in UK and Germany and that really drove a bubble in CapEx. We are looking over time, we don’t see another substantial wave of infrastructure requirements for a number of years other than building a call center in Germany that is underway and in fact we put in place a lot of strategies to try to mitigate the need for infrastructure. For example, we are launching in September the use of home agents to represent that call centers and we think changes in technology will enable us to meet our expanding customer service needs, for example agents rather than through build out of physical plant. Those are the kinds of things we are doing to -- well, part of it is the natural bubble that occurred in the evolution of our business and part of it strategies we are putting in place to be tighter and more productive in how we deploy capital.
On the question about margins and the risk from Internet competitors, certainly something we pay a lot of attention to, but at this point it is not something that causes us great deal of concern. Any more than any form of competition is always concerned. Part of what you see in our -- there are a number of things that drive our superior results versus an Amazon or those kinds of players, first is product mix. The mix of products we sell tend to be higher margin kinds of products. So everything we sell, we sell out of value. Everything we sell has to be sold at a price that is advantageous to the prevailing retail price and that advantage range is from 20 to 50% based on our store audits. So it's not that we are providing products that are already a great value, but we do have heavy mix towards categories like apparel, accessories, beauty, and jewelry that are much higher margin categories than say books and music. So that's part of the differences, the efficiency of the model. We don’t obviously have huge expenses that go towards advertising, which most Internet players do, search advertising and the like because of the power of our TV channel has brought -- bring traffic to the Internet. And yeah, for all of those reasons we don’t see ton of pressure on margins. It's a factor we pay attention to it. We try to increase our value all the time but don’t see that sort of SKU proliferation as a huge risk to us.
Thank you. If I could just thank everyone for joining us, I would make a couple of remarks. Liberty has been probably known for a long time for financial innovation. I think increasingly in this difficult environment, I am pleased to say we are seeing strength in our operations and the management team and innovations and things like ODAT that are showing another side that is -- another way to add value and hopefully we will be able to see that reflected in the share price to our shareholders going forward.
Thank you very much for joining us this morning and we look forward to speaking with you next quarter if not at our Investor Day in September.
This concludes today's Liberty Media Corporation's quarterly earnings conference call. Thank you for attending and have a good day.