What are we reading?

Sanjay Bakshi’s Opening Remarks at MDI (Link)

Liberty Global thesis on LiLAC (ValueWalk)

Ajay Piramal considers IPO for increase valuation (Mint)

Yes Bank’s Opportunism blamed for failed share sale (EconomicTimes)

New SEBI rules led to speculation; QIP deferred by two quarters (EconomicTimes)

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Buffett on Reinsurance

Just a post to keep some notes on reinsurance to self.

The Berkshire Shareholders meeting had little in terms on new content though it was good to see that both Charlie and Warren razor sharp as ever.

Probably one of the most interesting insights came in the initial parts of the Q&A. Reinsurance. Berkshire Hathaway had sold down its position in Munich Re and Swiss Re in 2015. When asked a pointed question about it, Buffett was very articulate and gave two key reasons for it: a. Low to negative yields in Europe b. Surplus capacity in reinsurance industry.

In a way, Buffett was alluding to the fact that with hedge funds like Greenlight Re and Thirdpoint Re entering the reinsurance business and being hungry for float, it is likely that too much competition will make (or has made) pricing softer in the market. Supply up, demand is the same. This should raise two questions: a. Buffett is reducing exposure to the reinsurance business by reducing his stake, Greenlight Re and Thirdpoint Re are going long at the same time. One must thoroughly consider the consequences of betting against the man who built the most profitable reinsurance business in the world and has constantly reminded us that the insurance industry is survived the longest by those who walk away when pricing is not adequate to the risks taken. b. If there is going to be softer pricing in the market, investors in companies like Greenlight Re and Third Point re, not only have to tide over the cost of float but also the rich fees that the hedge funds rake in.  The two net cost adders might make the economics very difficult for investors to make meaningful returns unless the reinsurance companies have many home runs on the investment side.

With the low to negative yields, float becomes less valuable as the capital structure of many of the reinsurance business like Swiss Re and Munich Re allows them to invest float in only certain types of securities. Buffett is essentially betting that it will be tough for reinsurance companies to invest float in positive returns instruments for quite sometime to come. Unless of course, you are Prem Watsa and assume that deflation is going to take over in which case the bonds become very useful. Time will tell. Time to increase watch on the insurance holdings.

Valeant Pharma Non-Gaap Definitions

It is one of those posts where I am just reproducing Valeant’s Non-Gaap definitions. I just cannot imagine all these expenses being excluded. Source is Q4 2015 results presentation. Link here

The reason I have reproduced this here is to remind myself when I see something like this in a management metric to run the other direction. All I can say is wow… just wow… and run… It is beyond me how to evaluate the operating performance for an acquisitive company with this disclosure…

Going by this disclosure; Bill Ackman can exclude his Valeant loss while reporting because it is a non-cash charge.

Adjusted EPS Management uses Adjusted EPS for strategic decision making, forecasting future results and evaluating current performance. In addition, cash bonuses for the Company’s executive officers are based, in part, on the achievement of certain Adjusted EPS targets. This non-GAAP measure excludes the impact of certain items (as further described below) that may obscure trends in the Company’s underlying performance. By disclosing this non-GAAP measure, management intends to provide investors with a meaningful, consistent comparison of the Company’s operating results and trends for the periods presented. Management believes this measure is also useful to investors as it allow investors to evaluate the Company’s performance using the same tools that management uses to evaluate past performance and prospects for future performance.

Adjusted EPS reflect adjustments based on the following items:

Inventory step-up and property, plant and equipment (PP&E) step-up/down: The Company has excluded the impact of fair value step-up/down adjustments to inventory and PP&E in connection with business combinations as such adjustments represent non-cash items, and the amount and frequency is not consistent and is significantly impacted by the timing and size of our acquisitions.

Stock-based compensation: The Company has excluded the impact of previously accelerated vesting of certain stock-based equity instruments as such impact is not reflective of the ongoing and planned pattern of recognition for such expense.

Acquisition-related contingent consideration: The Company has excluded the impact of acquisition-related contingent consideration non-cash adjustments due to the inherent uncertainty and volatility associated with such amounts based on changes in assumptions with respect to fair value estimates, and the amount and frequency of such adjustments is not consistent and is significantly impacted by the timing and size of our acquis itions, as well as the nature of the agreed-upon consideration.

In-Process research and development impairments and other charges: The Company has excluded expenses associated with acquired in-process research and development (including any impairment charges), as these amounts are inconsistent in amount and frequency and are significantly impacted by the timing, size and nature of acquisitions. Although expenses associated with acquired in-process research and development are generally not recurring with respect to past acquisitions, the Company may incur these expenses in connection with any future acquisitions.

Philidor Rx Services wind down costs – The Company has excluded certain costs associated with the wind down of the arrangement with Philidor Rx Services, primarily including write-downs of fixed assets and bad debt expenses. The Company believes it is useful to understand the effect of excluding this item when evaluating ongoing performance.

Other (income) expense: The Company has excluded certain other expenses that are the result of other, unplanned events to measure operating performance, primarily including costs associated with the termination of certain supply and distribution agreements, legal settlements and related fees, Philidor-related and pricing-related investigation and litigation costs, post-combination expenses associated with business combinations for the acceleration of employee stock awards and/or cash bonuses, and gains/losses from the sale of assets and businesses. These events are unplanned and arise outside of the ordinary course of continuing operations. The Company believes the exclusion of such amounts allows management and the users of the financial statements to better understand the financial results of the Company. 

Restructuring, integration, and acquisition-related expenses: In recent years, the Company has completed a number of acquisitions, which result in operating expenses which would not otherwise have been incurred, and the Company may incur such expenses in connection with any future acquisitions. The Company has excluded certain restructuring, integration and other acquisition-related expense items resulting from acquisitions (including legal and due diligence costs) to allow more accurate comparisons of the financial results to historical operations and forward-looking guidance. Such costs are generally not relevant to assessing or estimating the long-term performance of the acquired assets as part of the Company, and are not factored into management’s evaluation of potential acquisitions or its performance after completion of acquisitions. In addition, the frequency and amount of such charges vary significantly based on the size and timing of the acquisitions and the maturities of the businesses being acquired. Also, the size, complexity and/or volume of past acquisitions, which often drives the magnitude of such expenses, may not be indicative of the size, complexity and/or volume of future acquisitions. By excluding the above referenced expenses from our non-GAAP measures, management is better able to evaluate the Company’s ability to utilize its existing assets and estimate the long-term value that acquired assets will generate for the Company. Furthermore, the Company believes that the adjustments of these items more closely correlate with the sustainability of the Company’s operating performance.

Amortization and impairments of finite-lived intangible assets: The Company has excluded the impact of amortization and impairments of finite-lived intangible assets (including impairments of intangible assets related to Philidor Rx Services), as such non-cash amounts are inconsistent in amount and frequency and are significantly impacted by the timing and/or size of acquisitions. The Company believes that the adjustments of these items more closely correlate with the sustainability of the Company’s operating performance. Although the Company excludes amortization of intangible assets from its non-GAAP expenses, the Company believes that it is important for investors to understand that such intangible assets contribute to revenue generation. Amortization of intangible assets that relate to past acquisitions will recur in future periods until such intangible assets have been fully amortized. Future acquisitions may result in the amortization of additional intangible assets and potential impairment charges.

Amortization of deferred financing costs and debt discounts: The Company has excluded amortization of deferred financing costs and debt discounts as this represents a non-cash component of interest expense.

Foreign exchange and other: The Company has excluded foreign exchange and other to eliminate the impact of foreign currency fluctuations primarily related to intercompany financing arrangements in evaluating company performance.

Tax: The Company has (i) excluded the tax impact of the non-GAAP adjustments and (ii) recorded adjustments for the use of tax attributes and other deferred tax items plus any payments made for settlement of tax audits, in order to reflect an expected tax rate for the current period.

TRIP owned by Allan Mecham

Very interesting to see that Allan Mecham of Arlington value capital has been buying TRIP. See articles related to Allan Mecham here.

See our post on Trip Advisor here.

Period Shares % of Portfolio Activity % Change to Portfolio Reported Price
2015   Q4 324,040 3.48 Add 109.89% 1.82 $85.25
2015   Q3 154,389 1.31 Buy 1.31 $63.02

Source: dataroma.com

Trip Advisor and Liberty Trip Advisor (TRIP & LTRPA/B)

Trip Advisor is an online travel booking website that operates in the crowded and competitive online travel segment. It operates mainly through tripadvisor.com and its variants.

The market size for travel spending is about $1.3T annually and is growing. Close to 40% or $500B of this spend happens online through services provided by OTA’s like flight, hotel and car bookings.  Key players include Priceline.com, expedia.com and their affiliated websites and meta-search players like kayak.com, trivago.com etc.  The business models for OTA’s are pretty simple a. Attract users on the website b. Offer the best rates and get users to book the room / flight / car  c. Get a commission from the hotels and use a part of it to market the website and 4. Repeat cycle. OTA’s are a high growth, high margin, high ROIC businesses.

For example: Priceline with its flagship priceline.com and booking.com . Priceline has a market cap of $66B and a PE of 27 and is richly valued.

In Millions of USD

2015 2014 2013 2012 2012-2015 CAGR
Revenue 9,223.99 8,441.97 6,793.31 5,260.96 20.4%
Gross Profit 8,591.81 7,584.13 5,715.89 4,083.68 27.8%
Selling/General/Admin. Expenses, Total 5,060.41 4,303.00 3,185.50 2,188.75 31.9%
Net Income 2,551.36 2,421.75 1,892.66 1,419.57 21.3%
Net Income % 27.7% 28.7% 27.9% 27.0%
Total Equity 8,795.47 8,566.69 6,909.73 3,896.97 30.8%
Long Term Debt 6,158.44 3,824.20 1,750.58 936.65 86.2%
ROE % 29.0% 28.3% 27.4% 36.4%

Example two would be Expedia which primarily derives its revenue from the large US market. It mainly operates through hotels.com, Orbitz and expedia.com. Expedia is trading at 19 times earnings and TripAdvisor was a spin off from Expedia in 2011. Also, it has John Malone’s fingerprints all over it through its 18% stake that is being spun off through Liberty Expedia (a post for another day)

In Millions of USD

2015 2014 2013 2012 2012-2015 CAGR
Revenue 6,672.32 5,763.48 4,771.26 4,030.35 18.1%
Gross Profit 5,362.76 4,584.40 3,733.22 3,131.74 19.4%
Selling/General/Admin. Expenses, Total 3,955.00 3,233.70 2,573.22 2,066.39 23.9%
Net Income 764.47 398.1 232.85 280.17
Net Income % 11.5% 6.9% 4.9% 7.0%
Total Equity 4,864.39 1,784.27 2,145.46 2,280.26 28.4%
Total Long Term Debt 3,201.28 1,746.79 1,249.41 1,249.35 36.4%
ROE % 15.7% 22.3% 10.9% 12.3%

What is Trip Advisor’s beef in this space?

Trip Advisor has an annual revenue of about $1.5B and is a growing business. TRIP has a rich base of user content and reviews that makes the site an ideal one-stop shop for travel planning. It currently has around 1.8M accommodations, 3.8M restaurants and 600K+ attractions that can be researched and planned on its website. It attracts over 350M unique visitors every month and has over 300M reviews on its sites. No other website can provide the breadth and depth of content and research that TRIP does today. This content is similar to how Amazon reviews drives traffic for Amazon. TRIP is also available in 46 languages making it accessible globally.  (All data are from its 2015 annual report)

When users research and plan trips through its website, one can search for hotels using Trip Advisor’s meta search and price compare with all other websites and book the best option available for the user. TRIP then takes a cut from the OTA (Priceline, Expedia) and the commissions thus derived are the major source of revenue today for TRIP.

In Millions of USD 2015 2014 2013 2012 2012-2015 CAGR
Revenue 1,492 1,246 945 763 24.8%
Gross Profit 1,434 1,206 927 751 23.8%
Selling/General/Admin. Expenses, Total 1,109 797 597 429 36.8%
Net Income 198 226 205 194 0.7%
Net Income % 13.3% 18.1% 21.7% 25.4%
Total Equity 1,412 1,125 865 727 24.5%
Total Long Term Debt 200 259 300 340 -16.1%
ROE % 14.0% 20.1% 23.7% 26.7%

TRIP through its huge user generated content has been attracting a lot of users and has been growing at a good clip. However, TRIP get a cut of the OTA’s commission that the hotels pay the OTA for directing traffic. So, TRIP is a marketing spend for OTA’s to attract  users.

Recently, TRIP has also been investing heavily in its business to enter the OTA business itself. Currently, one can book hotels directly on TRIP without having to leave its website. Over time, the company believes that it will reap rewards for this feature. However, in the short term, it has depressed margins. Furthermore, as seen through Priceline and Expedia, the margins in the OTA space are mouthwatering. If TripAdvisor is successful in entering the OTA space, its past growth and margins will not be a good indicator for the future. It must also be noted that PriceLine and Expedia are also getting into the content ranking space for hotels etc. in order to intensify competition with TRIP.

Today, TRIP can definitely be counted to create value to end users for their travel planning needs. The bigger question is can TRIP appropriate the value in the process? After researching, users are usually looking for the cheapest available room at a selected hotel. At the risk of being biased through personal experience and of those around me, today almost everyone uses TRIP for planning. However, when it comes to booking, there is almost always a cheaper option available (5-10%) than found on TRIP’s site or any of the other links that it provides. This is the significant difference between Amazon and TRIP. On Amazon, one is almost guaranteed to get the cheapest price for things. In the case of TRIP, there are significant discounts available today through mobile apps that take the price way below the advertised price on TRIP (mobile or website) with a very reasonable investment of a few minutes. How long will this continue is a question but it is possible that it is preventing TRIP from appropriating value from what it is creating.  It is creating a ceiling for the booking process than the floor and that is a significant problem that TRIP has to address quickly  if it needs to be competitive long term.

Valuation:

Currently TRIP is valued at $9B at a PE close to 47. However, this company has fingerprints of John Malone / George Maffei all over it with their 21% economic interest and 56% voting interest. Going by John Malone’s play book, free cash flow might be a better indicator of value for TRIP. TRIP generated around $873M of free cash flow in the last three years making its FCF yield at close to 3% of market cap per year. The Malone play book of levered buybacks, rising debt to be at an acceptable multiple of EBITDA, delaying the taxman’s liabilities are yet to play out at TRIP. Even with all the above unexplored levers and its foray into the OTA space, TRIP is richly valued today at 3% FCF yield and is not a slam dunk investment in our opinion.

Liberty Trip Advisor holdings (LTRPA/B) owns about ~31M shares in TRIP valued at $1.9B. The market cap of LTRPA is $1.6B at a 15% discount to TRIP. (LTRPA is trading at a premium as it has a $400M margin loan on LTRPA and LTRPA at this point does not have access to the cash flows of TRIP) However, it is a holding company with the money losing buyseasons business. LTRPA is designed to be a tax free way for TRIP (TRIP buying LTRPA will not be tax free) or other OTA’s to buy TRIP through LTRPA. In other words, LTRPA is a vehicle for John Malone to cash out on TRIP in a tax free manner. In August 201(7)6, LTRPA would complete two years enabling it to make tax free swaps with other entities (another leaf from John Malone’s playbook)

Disclosure: No Position

Liberty Media Corp. Tracking Stocks

During the shareholders meeting in November, Liberty Media announced that it would create three tracking stocks for its Liberty Media stock. Liberty has filed its 388 page registration prospectus here

As per this registration document, Liberty Media will have three tracking stocks, Liberty Sirius group, Liberty Braves Group and Liberty Media group. In typical Malone style, each of these stocks will have three series of stocks, A, C and the super voting B shares that will largely be held by John Malone and his insiders. Essentially,  LMCA, LMCB and LMCK will cease to exist and will be replaced by 9 tracking stocks — LSXMA, LSXMB, LSXMK for the Liberty Sirius group; BATRA, BATRB, BATRK for the Liberty Braves group and LMCA, LMCB and LMCK for the remaining Liberty Media group. BATRB and LMCB will trade on OTC and the rest will trade on NASDAQ.

Each shareholder of one Liberty Media common stock will now receive one share of Liberty Sirius group, 0.1 share of Liberty Braves and 0.25 shares of Liberty Media stock. Each shareholder of of Liberty common stock will get new stocks in the corresponding series. For example: LMCA holder will get BATRA, LSXMA and LMCA etc. Furthermore, A series will have one vote per share, B shares will have 10 votes per share and C series of the three families will have no votes unless otherwise required by Delaware law (For Example: Liquidation of the parent Liberty company). Economic exposure will be the same for all three classes. However, there is always a possibility that the B class super voting shares might be taken out at a premium (it exists today as well). No fractional shares will be provided and shareholders will get paid in cash (taxable) in lieu of fractional shares.John Malone will continue to be a 10%+ economic owner with 47.7% of aggregate voting power in the newly formed companies through his B series shares.

In this tracking stock proposal, the holders of the securities can track the performance of the individual segment and can own the stock of the separate segments. However, these are tracking stocks and the shareholders will have no claim over the assets of the tracking stocks and will still be exposed to Liberty Media as a whole. However, the shareholders can mix the proportion of economic exposure they get to the three segments in the event of a buyout of the individual segment. Shareholders will ultimately have to be dependent on the board of directors of Liberty Media to maximize shareholder’s value which John Malone and his lieutenants seems to have a good track record for.

A few key things to keep in mind. Liberty can dispose any of the three groups of stocks (Sirius, Braves or Media stocks) without further shareholder approval. If any of the groups are taken over in a M&A, then under the new charter, the company will either pay a dividend, redeem the common for cash or securities or convert all the existing shares into a different security. Here’s the kicker, if Liberty Media were liquidated as a whole, shareholders of different stocks will get paid on the proportionate ‘liquidation units’  determined by the first twenty days trading prices of the three classes of stocks (Sirius, Braves and Media) If an enterprising investor were to need exposure to the possibility of Liberty Media being liquidated as a whole, post the first 20 days, one can pick the tracking stock that will give the highest exposure.

Liberty Sirius group will have the 60%+ interest in Sirius corporation. In addition, it will have a $250M margin loan secured by Sirius shares and $50M cash and deferred tax liabilities.

Liberty Braves group will have assets attributed with the Atlanta Braves team. It will have $61M in cash and $165M in loans by Braves holdings. Further more, Braves will have a rights offering for $200M allowing shareholders to purchase C class shares at 20% discount to prevailing market price.

Liberty Media group will own 34% in Live Nation, $420M after tax proceeds from Vivendi settlement, some public securities in Time Warner, Viacom etc, $50M in cash and 1.375% cash convertible senior notes due 2023 of $1B with the relevant warrant and bond hedges. It will also own a 20% interest in Liberty Braves.

Below are the attributable Assets, Income and Cash Flows to the three units as of Sep 30, 2015.

Liberty_Balance_SheetIncome_StatementLiberty_Cash_FlowsLiberty_AFS

All these complexity comes at a cost. Tracking units are not standalone entities. If Liberty Media were to be liquidated as a whole company, your exposure and proceeds may not be necessarily connected with the attributed assets and liabilities. Even while owning a single family of tracking stocks, an investor might be exposed to the risks associated with the whole company or risk associated with a different family of tracking stock. Liberty is trying to unlock the complexity discount, ‘Liberty might overpay for Sirius’ discount and the sum of the parts discount that the stock holds today and it is not very clear how this will help reduce those concerns. However, it will give a deeper insight into the functioning and returns at a more granular level. Liberty’s contention is that tracking stocks would reduce the sum-of-the-parts being lesser than the whole discount remains to be seen.

Disclosure: Long LMCK

Note the following excerpt from the earnings call filed with SEC from the earnings call:

And in terms of the strategy?
Gregory B. Maffei
Well, I think we’ve expressed in the past with our actions and our words that we would love to be an owner, 100% of SiriusXM. I think we’ve also expressed in the past with our actions and our words,there’s a limit of what we’re willing to pay for that. And we – our position has gone from being 40.1%– or 40.4% when we struck the transaction back in February and March of 2009 to being 62%-plus today. And time is on our side in terms of eventually, I believe, we’re likely to be the 100% owner at some reasonable price.

Liberty Vivendi Settlement

Vivendi settled with Liberty early this month for $775M for hidings its financial difficulties 13 years ago when negotiating a deal with Liberty. This settlement will result in after tax proceeds of close to $440M for Liberty Media (~4% of market cap). When we had done our thesis on Liberty, we had chalked down this settlement to zero and thought of it as a real option on Liberty Media’s stock. Once in a while, it is fun to see a real option play out. For link on the settlement news, click here

For our prior thesis on Liberty Media, click here

Liberty Media — Q4 2015 Shareholding

As I continued to dig into Libery Media (LMCA/K) ownership, I came across a few interesting names that are invested along with John Malone. While it is true that LMCA/K have declined quite a bit since 12/31, we will  only know who else added in Q1 only by April 15th. I knew that Berkshire Hathaway was invested with LMCA/K but I was frankly amazed that it was close to $900M as of 12/31. Looks like one of Warren’s deputies Todd or Ted or both are dabbling with Malone’s entities. You can find our previous thoughts on Liberty Media Corporation here

Datasource: Dataroma.com

LMCA Portfolio Manager % of portfolio Shares Value as on 12/31/2015
Markel Corp 0.5 426,000 $                         16,720,500.00
Berkshire Hathaway 0.23 7,800,000 $                       306,150,000.00
 
% of portfolio Shares Value as on 12/31/2015
LMCK Weitz Value 5.75 1,150,000 $                         43,792,000.00
Century Management Advisors 2.35 39,650 $                           1,509,872.00
Markel Corp 0.54 522,000 $                         19,877,760.00
Berkshire Hathaway 0.44 15,386,257 $                       585,908,666.56