Liberty Global: Trades At A 25% Free Cash Flow Yield. Now Let's Look At The Pros And Cons

Summary

• Few US large caps that are non-cyclical trade with a 25% FCF yield.
• The company boosts world-class management, an amazing valuation, and a catalyst with the creation of a joint venture with O2 in the UK.
• Yet the company suffers no to low growth in its areas of business, is capital intensive, highly leveraged, and endures strong regulatory risk.
• We review the pros and cons to assess this opportunity.

Introduction

Ultimately a stock price rises because either (1) the underlying company's earnings rise, and the multiple stays constant, (2) the share count decreases and all else is constant, (3) the multiple increases, or (4) a combination of the above.

Ideally you want to buy a business whose earnings are growing, its valuation is cheap, and the company generates large amounts of free cash flow (FCF) that it uses to buy its stock when the multiple is low. Liberty Global's (NASDAQ:LBTYA) (NASDAQ:LBTYK) merger with O2, made public a few days ago, could create a scenario for much needed growth through the opportunity of up-selling and cross-selling products via bundling leading mobile and broadband products, as well as cost synergies (the team has a strong record in actually executing what it publicly commits to regarding synergies). This is alongside its current cheap valuation and large share buyback program.

When a business shifts from very fast growth (>20%) to strong growth (10-20%), to a small premium to GDP growth (5-10%), to GDP growth (2-5%), to small to zero growth (0-2%), to declining (<0%), each phase shift often leads to a re-rating in the multiple. This is often messy and volatile, hence is a period where valuation overshoots can appear; this creates opportunity for stock investors. We think this has happened to Liberty Global, a business that at the moment admits top-line growth is mature, i.e. virtually non-existent without some sort of resource conversion such as a merger/acquisition. The creation of the O2 joint venture (JV) creates that opportunity.

Industry Dynamics and History

Liberty is in the telecom sector. I have to admit I am not a fan of this industry because it is capital intensive, heavily regulated, and needs lots of debt to generate any sort of satisfactory return on equity today. It is not a

Analyst’s 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.