Liberty Global: If Vodafone And Sunrise Deals Go Through, Shareholders Get Virgin Media Business For Free

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About: Liberty Global Plc (LBTYK), LBTYA, LBTYB
by: Vladimir Dimitrov, CFA
Summary

The market is assuming a relatively low probability that the Vodafone deal would go through.

Significant upside in potential, should both Vodafone and Sunrise deals get approval.

Cash received would allow Liberty Global to strengthen its position in its core markets.

The Business

Source: libertyglobal.com

Liberty Global is in its final stages of transforming its business model. The company used to have a significant presence across Europe and in few Latin American markets.

Image result for liberty global

Source: libertyglobal.com

For the past few years however, Liberty Global has been executing on its strategy to focus on its core markets by:

  • completing a split-off from Liberty Latin America in 2018;
  • selling its UPC business in Austria to T-Mobile again in 2018;
  • got EU Commission approval for its acquisition of Ziggo;
  • Liberty Global's subsidiary Telenet completed acquisition of Base telecom;

Still in the works are the two most sizable steps to:

  • sell businesses in Germany, Czech Republic, Hungary and Romania to Vodafone;
  • sell Swiss network to Sunrise;

As regards the Vodafone deal, both Vodafone and Liberty Global managements have expressed their confidence that the deal will go through. The German newspaper Frankfurter Allgemeine Zeitung has also recently reported that the EU Commission seems to be mainly concerned with German cable market and Vodafone's increased bargaining power with German broadcasters given its dominant market share and own content.

Vodafone also struck a deal with Telefonica Deutschland to offer wholesale access to its cable network in Germany. This has likely to clear most of the commission's concerns around the broadband market. On May 24th, however the EU Commission announced that it will delay its decision by 2 weeks to July 23rd.

Although Vodafone and Sunrise deals are not completed yet, in my base case valuation I look at Liberty Global value per share, should both deals get approval.

Sum of the Parts Valuation

Source: libertyglobal.com

So let's review each of the different businesses on the assumption that both Vodafone and Sunrise deals go through.

Liberty Global has a total number of shares outstanding as of Q1 2019 of around 738m.

Source: Liberty Global 2019 Q1 10-Q Filing

Vodafone Disposal Group

Vodafone deal is worth EUR 18.4bn, comprised of EUR 10.8bn in cash and EUR 7.6bn worth of Liberty Global debt. Using the current EUR/USD exchange rate of 1.1186, we arrive at the following numbers:

Source: author's calculations based on data from ig.com

The cash received under the deal is therefore equivalent to $16.4 per share. Comparing that with Liberty Global (LBTYK) current share price of $24.79, this makes the rest of the Liberty Global businesses worth $8.4 a share.

Sunrise Deal

There is more uncertainty around the Liberty Global Swiss business deal with Sunrise as Freenet (Sunrise Communications’ top shareholder) has recently blocked the company's right to issue additional capital.

Source: Liberty Global Q4 2018 Investor Call Presentation

However, should the $6.3bn deal go through, Liberty Global would receive $2.6bn in cash. Assuming the rest is debt and other liabilities this equates to $3.5 per share.

Adding both Vodafone and Sunrise deals together, Liberty Global would receive a total cash payment of $19.9 per share. This leaves $4.9 per share value for the rest of Liberty Global Businesses.

Telenet stake

Liberty Global has a 60% in the publicly traded Belgian telecom operator Telenet. According to Telenet annual report the company has 114m shares outstanding and each share trades at EUR 47.94. Applying the EUR/USD exchange rate used above we arrive at $6,115m market cap of Telenet. Multiplying that by 60% (Liberty Global stake) and dividing it by Liberty Global total number of shares outstanding, we calculate that the Telenet investment equates to $5.0 per share.

Source: author's calculations based on data from Yahoo!Finance, Liberty Global 10-Q Filings, Telenet Annual Report;

Fair Value Investments

As of Q1 2019, Liberty Global's fair value investments were valued as follows:

Source: Liberty Global 2019 Q1 10-Q Filing

Since the end of March 2019, most of these have declined in value therefore the following adjustments must be made for the publicly traded investments:

Source: author's calculations based on data from Yahoo!Finance and Liberty Global 2019 Q1 10-Q Filing

Again, using all of Liberty Global shares outstanding we can calculate that the value of these fair value investments is $1.5 per share.

Source: author's calculations based on data from Yahoo!Finance and Liberty Global 2019 Q1 10-Q Filing

Ziggo JV

Using the equity method, Ziggo JV with Vodafone is worth $3,624m (see above). On a per share basis this equals to $4.91, however the Joint Venture has been losing money for some time now.

Source: Liberty Global 2018 10-k Filing

And although the loss narrowed in FY 2018, the Q1 2019 was worse than the comparable period a year ago.

Source: Liberty Global 2019 Q1 10-Q Filing

Looking at comparable companies in Netherlands, Belgium, Sweden and Italy, Telecom Italia trades at the lowest P/S and P/B multiples as it's the only peer that was loss-making in 2018.

Source: author's calculations based on data from Yahoo!Finance and Liberty Global 2019 Q1 10-Q Filing

To remain conservative, I will use the lowest market value per share of Liberty Global which is $1.46 per share based on P/S multiple.

Virgin Media

To value the Virgin Media business, alongside the other smaller businesses in Central Europe, I use Price to Sales and Price to Operating cash flow multiples so first we need to adjust the total sales and the cash flow statement.

Adjusting total sales is rather easy as Liberty Global provides a breakdown by geography in its 10-K and 10-Q filings.

For the cash flow from operations, firstly we need to exclude changes in fair value of investments as these are associated with equity investments valued separately.

We should also exclude dividends from affiliates and take into account the cash flow from Belgium and Switzerland. To adjust the cash flow from operations for these two markets I use their share of total OIBDA in percentage terms to reduce the adjusted operating cash flow.

Source: author's calculations based on data from Liberty Global 2019 Q1 10-Q and 2018 10-k Filings

After calculating adjusted operating cash flow of $1,183m we need to establish a comparable multiple. For the purpose, I am using the same set of comparable companies as above plus Specturm in the U.S. and Sky (now acquired by Comcast).

Using the adjusted cash flow from operations and Price to Operating cash flow multiples, I estimate the following prices for the Virgin Media Business:

Source: author's calculations based on data from Yahoo!Finance and Liberty Global 10-K and 10-Q filings

I decided to exclude Sky from my sample as the company had a significant media business which is driving the higher multiple, as well as Spectrum which although being a comparable company, operates solely in the U.S. where the broadband market is more favorable. Telecom Italia and Tele2 in Sweden are the outliers in the sample. Telecom Italia multiple provides way too conservative price for the high quality Virgin Media business.

Using the multiples of KPN, Telenet and Proximus we could conclude that the value of Virgin Media business should be at least $8.5 per share.

Sum of the Parts

Assuming both the Vodafone and Sunrise deals go through Liberty Global would be worth around $36.4 per share which represents 50% upside from current levels.

What this also means is that, on the assumption that both Vodafone and Sunrise deals are completed as they are currently, the whole Virgin Media business could be purchased for free at current price levels.

The $36.4 price is still a conservative estimate as it doesn't take into account the return on investment of the cash received under the two deals (assuming both get approved).

Debt reduction alongside with share buybacks would most likely be the priorities. With $3.2bn of debt outstanding in 2019 and another large chunk due in 2021, Liberty Global management would probably take care of these first:

Source: Liberty Global 2019 Q1 10-Q Filing

Although a considerable amount would probably be used for share buybacks and debt reduction, Liberty Global is likely to pursue deals in the mobile and media segments to lower churn rates. As Mike Fries said during the last conference call:

And then lastly we're well positioned on fixed-mobile convergence. Belgium and Holland are of course fully converged today and reaping the benefits of lower churn and higher NPS while the U.K. and Switzerland which I'll talk about in a second are MVNO-based and just really getting started.

A large acquisition of O2 or a relatively smaller one of Tesco Mobile seem like the only viable options in the U.K. market. A deal between Telefonica and CK Hutchison for the acquisition of O2 was blocked by the European Commission three years ago. The deal was valued at £10.3bn at the time.

Since then however, O2 UK has improved its profitability considerably:

Source: Telefonica annual reports

Having said that and the already high price tag of the deal back in 2016, it seems rather unlikely for Liberty Global to pursue a deal for O2.

Another possibility is Tesco Mobile, which currently holds 6% market share of the mobile market in the UK.

Acquisitions in the media space are much more likely given John Malone's stake in Liberty Global and the company's fair value investments in the media space as well. The recently acquired Sky by Comcast also had a major focus on the media space which resulted in much higher multiples.

Whatever the case, the Vodafone and Sunrise deals would allow Liberty Global to strengthen its position in its core markets, lower churn rates and improve return on capital.

What if Both Deals Are Rejected

This is where valuation gets tricky. Liberty Global will almost certainly continue to look to offload most of its European operations as it will find it increasingly hard to stay competitive. Also debt load would be another significant problem.

Firstly, we need to adjust the cash flow from operations to exclude separately valued joint ventures and equity investments.

We should add back Interest expense to calculate Free Cash Flow to the Firm and value the whole business.

Then according to the CFO in 2019 a 20% reduction in Capital Expenditure is expected as a result of higher spending over the past few years.

Source: author's calculations based on data from Liberty Global 10-K and 10-Q filings

Cost of Capital of 5.5% is then applied.

Source: author's calculations based on data from Yahoo!Finance, Liberty Global 10-K and 10-Q filings and Aswath Damodaran

Assuming constant perpetuity growth, I calculate the following scenarios:

Source: author's calculations based on data from Liberty Global 10-K and 10-Q filings

This underlines the risk for Liberty Global shareholders' should the management fail to offload its huge debt pile by selling continental Europe operations.

Conclusion

Liberty Global has become a very complex special situation stock. The huge upside in the stock is heavily dependent primarily on the Vodafone deal being completed. Successful sale of operations in Switzerland is also key.

Nevertheless, Liberty Global's management has experience in such deals while Vodafone is already taking the right steps to get green light from the European Commission.

Should both Vodafone and Sunrise deals complete on time, Liberty Global would be able to significantly improve its competitive advantages in its core markets. This will be key during the ongoing 5G roll out cycle as well as traditional telecom services and media convergence over the past few years.

However some risks remain if the Vodafone deal does not get a green light. The huge debt load would pose significant risk to shareholders.

Disclosure: I am/we are long LBTYA. 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.

Additional disclosure: Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.