Liberty Sirius (LSXMA/K)

Liberty Sirius closed at $30.19 / share on March 27th. Its main asset is 3.2B shares of publicly traded Sirius XM (SIRI). Since the start of the year, the  discount between SIRI and LSXMK has increased by close to 9 pts. (Courtesy: Yahoo Finance) Given the fact that LSXMK was trading at a discount at the beginning of the year, it is worthwhile to see the NAV discount that LSXMK is trading at.

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The key to note before we dive into the NAV calculation is that LSXMK financials consolidates SIRI as it holds over 71% of the shares outstanding. This is from an accounting perspective. In reality though, SIRI operates as a separate public listed company and the debt / cash are non-recourse at this point to Liberty Sirius Group or the Liberty Media group. The other way to think about it, the debt and the cash held at SIRI is at an operating company level.

Taking that into consideration, the NAV calculation shows a significant discount to the underlying asset which can be valued using market listed securities.

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There are four possibilities that could cause the discounts to be significant.

  1. The market is treating the SIRI debt as recourse to LSXMK and the given the higher level of debt at SIRI and deteriorating market conditions is discounting LSXMK further. This makes no sense because if that were the case, SIRI should be falling as well. Furthermore, SIRI’s FCF is good and the debt is at operating company level. This was shown clearly at the annual meeting. Furthermore, the churn during the last recession was actually much lower than people expect. It was in low single digit %.
  2. The market is assuming that given the drop in stock price, John Malone might pay a premium to buy Sirius completely. Given the disciplined nature of M&A that the Liberty complex has exhibited so far, that seems improbable.
  3. Ability to roll over debt in the near term (nothing alarming there)
  4. Since LSXMK is a tracking stock, the market has increased the discount considering the possibility of liquidation of entire Liberty Media complex with a deterioration for FWONK and BATRK.  Currently, there is nothing that indicates that FWONK or BATRK is impacted to the point of liquidation that will demand a 35% haircut on NAV of LSXMK.

It seems to be a case of the market discounting tracking stocks in general a lot higher in this environment. Time will tell.

Any comments on what I could be missing is welcome. contact@beowulfcap.com

Disclosure: Long SIRI and action expected in Liberty Sirius

 

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GCI Liberty: Thoughts!

I have been looking at various securities this weekend to work on what is finally turning out to be an idea-rich environment. GCI Liberty, the sole cable provider in Alaska, was an interesting company to look at given that it belongs to the Malone complex. Amongst the dozens of securities and tracking stocks that the Liberty empire has, GLIBP (GCI Liberty Preferred) and GLIBA (GCI Liberty Common A) are two such securities.

GCI Liberty has always traded at a discount to the underlying Liberty broadband and Charter shares. I wanted to do a quick back of the envelope NAV calculation to see the level of discount and whether it would interest me among all the other opportunities on hand. Unfortunately, the discount using a fairly conservative approach turned out to be close to 20% and not much higher that I was expecting. Please note that the below NAV calculation aims to capture only the key components and is a rough guesstimate of the NAV.

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However, the cumulative, non-convertible preferred stock trading at $22.25 with a 7% coupon (payable in 4 quarterly payments) with a $25 liquidation value callable after 2021 with a yield of 8.71% is mildly more interesting play with the common equity providing the cushion required for the dividend payments.

Update: To reflect the cash on the balance sheet. Thanks to Rocco for pointing it out.

Brief thoughts on Discovery Communications (DISCK/A)

We had blogged about Discovery communications before here. On March 20th, the stock closed at $16.87 / share with 711 fully diluted shares outstanding generating a market cap of ~$12B. The company carries debt of $15.4B. The company also generated operating cash flow of $3.4B with a net income of $2.069B in 2019. Capital expenditure was $0.3B and interest payments were $0.7B. Since Discovery always plans to carry a debt load of 3-3.5X, it might be wise to assume the interest payment stays for ever, the FCF adjusted for interest payments is $2.4B. The company is trading at 5 times adjusted FCF and 10 adjusted FCF to market cap.

There are two basic questions that we need to probe further.

a. Is there any possibility of running into liquidity issues or rolling over debt for the company?

b. Effect of Coronavirus and its implications for the company?

Debt position: Since Discovery has $15B of debt on its book, it might be worthwhile to see the amount that might come up for renewal in the near future. As seen below, $600M of 2.8% senior notes are coming for renewal in June. $600M in 2021 and close to $1.2B in 2022.

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It is clear that the company can cover the interest principal payments very well with internal cash flow even if they are not able to tap the capital markets in 2020 and 2021. Liquidity and capital positions look solid from that point of view. Unless the cash flow falls completely off the cliff that would put the debt covenants in default, it looks like Discovery might be well placed.

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Covid impact: On one hand, since the entertainment options for people have reduced in the last few weeks due to Covid, it is possible it might be a positive for the company. However, given the economic crunch that is sure to follow, one must consider whether the cord cutting will accelerate costing subscribers and a permanent FCF reduction to Discovery. This will be a function of the length of the slump and it is too early to call that.  I have no insight except that the markets have priced in a massive slump and China and Korea recovered in a 2-3 months.

Discovery also had rights to broadcast Olympics in some countries but the CFO came out at the end of Feb and said that the financial impact would be minimal in case of a Olympics cancellation. In addition, the company holds insurance against cancellation.

With $1.6B of cash, $2.5B of accessible credit facilities, strong FCF generation YTD, a manageable debt to extinguish over the next 12-24 months, the company seems to be unnecessarily priced to extinction. Unless the economy turns into a depression type scenario, the unique content of discovery communications, coupled with the strong financial cushion allows it to weather short short term shocks well. It sure looks like a case of Mr. Market voting the company down in the short term creating interesting possibilities for cash rich investors.

Disclosure: Own DISCK

What are we reading?

  1. You got a free internet upgrade and then your bill went up (here)
  2. Interesting q2 investment commentary from horizon kinetics (here)
  3. Interview with Liberty Media founder and John Malone partner, Peter Burton (here)
  4. A dozen things I have learnt from John Malone (here)
  5. PershingSquare Holdings buys Berkshire Hathaway – Page 10 (here)
  6. Netflix’s content budget seems greater than it seems (here) (Worthwhile to read the entire series)
  7. How I spotted a fraud before it was too late (here)

What are we reading?

  1. Charter executive questions 5G (here)
  2. Dawn of 5G: Will wireless kill the broadband star? (here)
  3. Here’s why your cable company wants to be your wireless provider (here)
  4. Charter tests 5G in six cities (here)
  5. T-Mobile calls Comcast irrelevant but results disagree (here)
  6. John Malone thinks cable and wireless are destined to consolidate (here) — dated post
  7. Liberty Global quietly reshapes its 5G strategy (here)
  8. Why the US cable industry is poised for recovery (here)
  9. Case for cable (here)
  10. Charter looks beyond MVNO and prepares to launch wireless next year (here)
  11. Charter is testing 6G Wireless (here)

Discovery Communications (DISCK/A)

It has only been 25 short days since we published our blog on Discovery (here) Few things have happened since then. Discovery is up 26% since then. Not that the short term vindicates the thesis. It just indicates how dirt cheap DISCK was at one point.

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This was necessarily driven by two things: a. John Malone talking about it here

b. John Malone putting his money where his mouth his here.

Will be interesting to watch what happens with DISCK/A.

Disclosure: Own DISCK.

 

 

Discovery Communications

Note: I have used a lot of approx. calculations as a proxy to quickly look through DISCA/K’s numbers.

Discovery Communications (DISC(A/K)) entered into a merger agreement with Scripps Networks on July 31st, 2017. Discovery will pay $90/share to Scripps shareholders in a combination of cash and stock. The transaction is expected to close in Q1 2018.   Below outlines the transaction details on how Scripps SH will get paid.

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Furthermore, the amount of Discovery stock that Scripps will get paid depends on the 15 day VWAP of Discovery shares before the close.

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Essentially, if the 15 day VWAP is less than $22.32, Scrips SH will get paid 1.2096 shares of DISCK; if 15 day VWAP of DISCK > $28.70, then 0.9408; if 15 day VWAP of DISCK between $22.32 & $28.7, then it will be the 15 day VWAP averaging to $27.

The strategic rationale explained by Discovery for the acquisition was to create a scaled up independent media company. Discovery will own 0.3M hours of programmable content with 8K hours being produced annually between the two networks. The potential for Scripps to grow outside the US will provide top line synergies while the cost synergies are expected to be around $350M annually. The two companies together will account of 20% of ad supported paid TV network in the US.

The combined network of discovery and Scripps is shown below.

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Top line & bottom line synergies are shown below:

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Since the acquisition has been announced, DISCK has been on a slide clearly indicating the market’s reaction to the deal and the fact that Discovery is losing subscribers at the rate of 3% a year and 5% in the recent quarter driven by its smaller network. The Scripps deal will give it faster access to the skinny bundles / OTT as shown here by Bloomberg. (Article link here)

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The stock is in doldrums crashing to low of $15/share and currently trading at $16.46/share. DISCK was trading close to $26/share at the time of the announcement of the merger.

The key reason behind this crash seems to be the suspension of buybacks in order to fund the merger, dilution, higher indebtedness and the industry fears of cord cutting and Discovery’s move to double down on the pay TV video model.

So, how does DISCK plan to pay for the $63/share to Scripps shareholders?

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The additional $8.6B meant that DISCK has to suspend buybacks till it pared down debt to manageable proportions (3.5X OIBDA as stated during the transaction). The expected leverage at the time of closing is 4.8X. Going by the playbook of John Malone, at 3.5X, it will be a debt that will stay on the books forever and then the buybacks will start again. Before they start buying back stock, Discovery will have to retire $6B+ worth of debt.

Let us take a look at how the two companies put together look like (using full year 2016 numbers)

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At first glance, one would wonder why would you put together two companies that are making $1.8B/year separately into a merger to generate $1.0B?

A closer look reveals that combined NI is $1.06B. Because of the huge premium paid, the D&A will shoot up. This is part of the price being paid to acquire intangible assets of Scripps and will be amortized.  When you look at Capex for Discovery and Scripps, combined they do not spend more than $200M.

NI + D&A – Capex = $1.06B + $1.57B – $0.2B = $2.4B over 770 million SOS. A good proxy for owner’s earnings.  See below tables for calculation on the SOS.

Screenshot from 2017-11-26 19-22-00

So what happens to the increased debt and taxes? Interest expense goes up and taxes come down. The additional debt is at weighted average of 3.6% and additional $316M of interest expense is offset by $506M of income tax savings. If there is further reduction in the tax rate, that would be an additional cherry on the top. Further, the cost synergies of $350M will translate to approx. $100M in year 1 and approx. $200M post tax dollars starting year 2 and drive both cash flow and the NI to grow.

$2.4B + OIBDA Growth (Assume 10% year year initial two years from sales synergies) + Cost synergies growth ($100 1st year, $200 second year), Discovery & Scripps combined will generate $2.7B and $3.2B in year 1 and 2 or $9.5B in first 36 months.

At 770 M shares (post dilution) at $17/share, the market is valuing Discovery at $13B or at 5.5 times owner’s earnings. The market has priced Discovery for failure. If they succeed in realizing the synergies, it will be a blockbuster stock. If they manage okay with the integration, it will still be a great bet with acceptable returns.

Even though Discovery is losing subscribers, it is growing its OIBDA every year and with the Scripps merger,  it will greater access to the OTT market. Discovery’s international platform will also benefit Scripps. Currently, the market is pricing Discovery Communications to be dead in the water.  It will be interesting to see how this plays out.

Disclosure: Not to be taken as investment recommendation. Might trade in DISCA/K

Sources for this post: S-4 Form, Merger Presentation, 10-Q’s