Liberty Global: Unclear Path To Shareholder Returns

About: Liberty Global Plc (LBTYA), LBTYK
by: Michael Wiggins De Oliveira

Unclear narrative leaves investors on the sidelines.

Liberty Global is hopefully getting closer to divesting its 2 main assets, bringing in around $15 billion of cash.

Ultimately, I believe that Liberty Global is undervalued.

Investment Thesis

Liberty Global (LBTYA) (LBTYK) is an interesting investment.

As a reminder, Liberty is looking to sell its Germany, Hungary, Romania and the Czech Republic operations to the Vodafone Group (VOD) for $12.7 billion of cash proceeds. Separately, its UPC Switzerland operations for roughly $2.6 billion ($6.3 billion enterprise value). Together these assets sales reach around $15 billion of cash.

At the moment, the market thinks these deals won't go through, and there is always the chance the market is right and these deals do not go through.

Consequently, if these deals do not go through, investors will punish the stock. On the other hand, assuming the deals do go through, there is some upside potential.

Background To Liberty Global

The above slide does a great job in highlighting Liberty Global's operations if the assets sales do go through.

Early Retiree does a great job in summarising the background to Libert Global.

Many Moving Parts

The aspect which attracts me to Liberty Global is divestitures of a John Malone company. That speaks for itself. Liberty Global is hoping to divest of 2 meaningful assets, Vodafone (in Summer) and UPC Switzerland (back end of Q4 2019). If it goes through it will bring in approximately $15 billion of cash and equivalents.

Free Cash Flow Improvement?

Liberty discusses adjusted OCF (this is largely similar to adjusted OIBDA. It's not quite the same as EBITDA because one is based on operations and one based on earnings. But if it helps, you may think of them as the same).

Liberty's guidance for 2019 OCF is for it being flat to down. With free cash flow benefitting from a 20% reduction in capex. Altogether, Liberty is guiding continuing operations to generate $550 million to $600 million.

Now, the cautious investor in me immediately raises a yellow flag at this juncture. Free cash flow is benefiting in 2019 from an aggressive 20% reduction in capex.

It would be unreasonable for anyone to think that this reduction is sustainable. Consequently, on the one hand, there are bigger moving parts to the story here. But on the other hand, we are discussing what will be left after all the divestitures are done and dusted. And that is a very mediocre operation.

Financial Position - Punchy Debt Levels

Liberty carries a lot of debt. That is to be expected from a John Malone company. They typically do carry a lot of debt, given their strong recurring free cash flows.

However, to be fair, Liberty Global nevertheless carries more than a fair amount. Presently, it finished Q1 2019 with 5.3x net debt. If the $15 billion of assets are not divested of, Liberty will need to turn its focus towards bringing down its net leverage to a more manageable range of less than 5x, and realistically closer to 4.5x. Because as discussed above, Liberty is not really growing all that fast to comfortably support that amount of debt.

Share Repurchases?

Yet another question mark surrounds what Liberty will do with the cash proceeds? This is the core part of the story. Yet Liberty has made no attempt to discuss a reasonable plan. One would hope that Liberty will be wise and repurchase their own shares. But investing in hope rarely pays off.

Liberty highlights to investors its unconsolidated 50% joint venture with VodafoneZiggo, has some value which presently appears to be unaccounted for by investors.

For reference, the publicly traded Telenet (OTCPK:TLGHY), which does not generate as strong an OCF as VodafoneZiggo is given a value of $4 per share by Liberty's management (close to $3 billion). This means that VodafoneZiggo should minimally be worth around $3 billion (as Liberty only holds 50% of the joint venture).

Then, you are still left with the investment Liberty Global has made, which management assigns a value of $2 billion.

Thus, not considered by investors we are looking at $2 billion for investments, at least $3 billion for VodafoneZiggo, and then the $15 billion for the divestitures - altogether $18 billion. Then, what's left on the side is Virgin Media (and smaller assets) which are expecting to generate at least $550 million coming for free.

Valuation - Margin Of Safety

It is not the case that if the divestitures ultimately go through, that Liberty Global is trading so cheaply that its share price will soar. Right off the bat, remember that Liberty Media is a very capital-intensive operation. Any meaningful increases to capital expenditures will meaningfully reduce free cash flow.

Next, the truth of the matter is that the ongoing operations are not particularly strong. They are very much middle of the road in terms of performance. Thus, although the assets being sold were divested at premium prices of 10x to OCF, what is left in Liberty Global is likely to be priced at a conservative industry average of 8x.

The Bottom Line

Liberty Global has a lot of moving parts. No doubts. And I'm not intending to brag here, but I have a reasonably satisfactory understanding of financial markets. And if I struggled to get my head around all this, there is little chance the market will.

Assuming that Liberty does succeed in divesting of its assets, it will need to come out with a much clearer narrative than it has so far embarked on thus far. If for whatever reason Liberty Global does not succeed in divesting of its assets, the market will be merciless in punishing the company's valuation, because all the market will focus on will be a highly capital intensive and highly leverage company with lackluster growth.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LBTYK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.