If you were to change your cable/broadband provider tomorrow, how many options do you have? can you save money by doing so? not many other options, right? and most other options have similar cost, is that right? the answers to these questions are the same almost regardless of where you are based. It suggests that the cable business probably enjoys one hell of a competitive advantage.
Some people might have thought the previous post was a nice piece of history of little relevance for today’s investing landscape. However, John Malone — active as he has ever been — concocts another interesting deal in his flagship, Liberty Media. Similarly to the 1991 deal, this deal is about transferring Malone’s North American cable assets into a newly created company that will pursue opportunities in the cable and broadband markets. The deal, is fairly convoluted and it involves creation of new class of shares for Liberty Media, spinning off the cable assets into a new entity called Liberty Broadband and issuing right to purchase Liberty Broadband’s share at a discounted price. Confused? that’s exactly the purpose. Before we jump into that, let’s first take a 30,000-foot view of the media business landscape.
I referred to Bruce Greenwald’s book in my post about competitive advantage and now its time to take a look at one chart from the book:
Remember: competitive advantage is all about barriers to entry. Take a minute to try and figure out this chart, it is not that complicated. Content refers to creative data production, packaging is the aggregation, marketing and distribution of the content. An example for a packaging business in the media-business context is a cable channel. Finally, retail refers to the delivery to the final customer and this is where cable systems fall. The competitive advantage increases as you move from left to right on the X axis. Then there is a distinction between various types under each vertical. Before we return to the Liberty Media deal and without getting into details, the way I see it, cable systems business falls under the “Retail” vertical and then under “Mixed”, means it has some national but also some local characteristics and as such, it enjoys a strong competitive advantage. This was the long answer to the question I presented in the opening paragraph.
So Liberty is about to spinoff it’s cable assets and then give the new owners an option (but not an obligation) to increase their stake at a discount. Should one participate?
Liberty Media is currently traded at a slight discount to its various holdings. This discount is typical for holding companies but it widened after Malone had tried to swallow SiriusXM (this deal eventually fell apart but the discount persisted). As such, given that one feels good about the underlying assets’ price (you should check this for yourself!), there is not much downside and not much optimism embedded in Liberty Media’s stock price. Liberty’s main asset is it’s holding of SiriusXM, the satellite radio company. John Malone wanted to buy the whole company for a price similar to what it is traded today and that implies that he believes that Sirius is undervalued. Liberty, under the command of Malone’s first lieutenant, Gregory Maffei, constantly buys back it’s own shares, which also gives an indication of what Malone, one of the best capital allocators of all times, thinks about Liberty’s current valuation.
While the upside in that spinoff is not that obvious, one thing that is obvious is that there are many opportunities in the North American cable business. Comcast buys Time Warner Cable and the combined company will have to shed some subscribers to avoid an anti-trust issue, Charter, in which Malone owns a stake, will get some of the new subscribers and will see an opportunity to increase its value. Also, as one of the least efficient cable operators and with a new CEO on board (Tom Rutledge, who was Cablevision’s COO), Charter can create significant value by closing the performance gap versus it’s publicly traded peers. The new CEO of Charter, is considered to be one of the best cable operators out there so it’s easy to see why John Malone is excited about Liberty Broadband’s future. To sum up the reasons why I think there is a high likelihood for value creation here:
- The downside risk seems to be protected as Liberty is currently traded below its net asset value
- The economics of the businesses involved here are good as they enjoy significant competitive advantage
- The people involved: Malone, with a 40-year value creation track record and Rutledge with a proved cable operating capabilities at Cablevision
- From my value investing experience, investing in companies that are ran by exceptionally capable managers (and not overpaying for that pleasure) has never failed to make me happy
Take a look at the smile on Malone’s face on this video (1h33m;40s) when he says the following:
“And someday we may be a major shareholder of Comcast. We are partners with Comcast on other businesses and eventually I think we will become equity in Comcast. It’s a better business domestically than anywhere else in the world…”
At the time I write this, the value of one share of Liberty Media (LMCA) is $130.88. We shall revisit this sometime next year (I’ve set myself a reminder for Sep 2015) after the deal is settled and the new company issues a few quarterly reports and check if Malone still got the magic, assuming that one participates in the rights offering and exercises the right to buy Liberty Broadband’s shares at a discount. Any guesses?
As a side note, Buffett’s two hired guns, Ted and Todd have established a position in Liberty Global in the last quarter. They also hold Liberty Media (although less than they used to) and they hold a significant position in DTV (another Malone spinoff), that is about to be bought out by AT&T. No doubt, I’m not the only John Malone fan out there.