Value Investors Club / LIBERTY BROADBAND CORP (LBRDA)

Description

Broadband shares present an exceptional risk/reward due to the perceived

uncertainty from a Charter / Time Warner Cable deal. There have been

numerous write-ups on VIC on Charter, so I’ll skip details about the quality of the

business both on the internet and video side and focus on the opportunity that the

rejection of the Comcast / Time Warner Cable deal presents.

I think Liberty Broadband basically has two scenarios which could occur over the

next 5 years. One scenario is that they end up acquiring Time Warner Cable and

potentially roll up additional properties such as Brighthouse, Cox, Cable One,

Suddenlink, Mediacom, etc. The other scenario is that they don’t acquire Time

Warner Cable and end up rolling some of the other properties mentioned above.

First of all, if I think about the probabilities of the two scenarios, I think it’s highly

likely that Charter will be able to acquire Time Warner Cable. There are a couple of

reasons I think this. First of all, we can explore why the Time Warner Cable /

Comcast deal didn’t go through. The primary pushback from the FCC and DOJ was

that there would be a high level of concentration of the broadband market in one

company (56.8% market share of the broadband market in the USA defined as

25Mbps or above) and this could lead to a Comcast / Time Warner Cable combined

company attempting to impede emerging video competitors. Below is a table

highlighting Comcast market share post a TWC transaction which Comcast filed with

the FCC in December 2014.

When Comcast structured divestitures to Charter and Greatland Communications,

they were focused on appeasing regulators in terms of keeping video subs below the

30% market share threshold without giving due consideration to broadband market

concentration. Of course, when Tom Wheeler suggested a change in the definition of

high speed broadband to 25Mbps or above, it dramatically changed the perceived

market power of a Comcast combination due to the drop out of DSL as a high speed

competitor. What’s interesting to note in the table above is that Comcast’s market

share only changes by 1% due to a transaction with TWC (from 55.8% to 56.8%).

The reason that this is the case is that Time Warner Cable has virtually no

broadband customers at speeds above 25Mbps. A combined Charter / TWC would

have dramatically less market share of the high speed broadband market (likely less

than 20%). It’s difficult to know exactly what percentage of the high speed

broadband market Charter / TWC would have, but this is what we do know.

Comcast has 22 million high speed internet subscribers of which it is unclear how

many are subscribing to 25Mbps or above. Time Warner Cable has 12mm internet

subs of which very few are subscribing to 25Mbps or above. Charter has 4.8mm

internet subs of which a very high portion are subscribing to 25Mbps or above. This

results in a combined Charter / TWC having substantially less market share of the

high speed broadband segment. When combined with the fact that this combined

entity would have no programming assets like a Comcast entity (NBCU assets), it

reduces regulatory fears of having to protect an incumbent programming business

from online video. These facts leads me to believe that the odds of a Comcast / Time

Warner transaction getting through regulatory hurdles through the DOJ / FCC is

very high and significantly higher than the initial odds of a Comcast / Time Warner

Cable transaction due to the significantly lower broadband market share for a

Charter / Time Warner Cable combination.

So aside from the regulatory, then we have to think about the probability that

Charter wants to acquire Time Warner Cable and that Time Warner Cable

shareholders / management wants to be acquired by Charter. First off, let me say

there are no other credible bidders for the Time Warner Cable asset. The other cable

players are smaller and don’t have a currency (stock) with which to buy Time

Warner cable. Given their smaller size, they also wouldn’t reap as much synergies

from a deal. There are similar issues with private equity buyers in terms of lack of

synergies from a deal which prohibits them from bidding on this asset (synergies

resulting in scale from programming costs, marketing, capex, etc.). In terms of

Charter’s appetite for Time Warner Cable, it is clear that they are very interested in

acquiring the asset. When Craig Moffett asked John Malone during the Liberty

Broadband Investor Day in November as to whether he would be interested in

acquiring Time Warner cable, he quickly responded very enthusiastically with a

“Hell Yes.” In addition, right after the Comcast / Time Warner Cable deal collapsed,

there were Bloomberg articles citing that Charter advisors had already approached

Time Warner Cable advisors. This was merely hours after Comcast publicly

announced that the deal was broken. In terms of Time Warner Cable’s management

and shareholder appetite for Charter it seems there is interest. With regards to

management, it bears mentioning that Time Warner Cable management was set to

receive a significant payout upon conclusion of the Comcast deal. Given that it didn’t

happen, they may be inclined to be looking to cash out and receive a massive payday

from a sale rather than continue to run the Time Warner Cable asset. Even if

management does resist to a Charter bid, I think that Charter will likely go hostile as

they did previously and appeal to Time Warner Cable shareholders who would

likely be willing to sell at the right price. From a shareholder perspective, a good

chunk of Time Warner Cable shareholders are likely playing the merger arb game.

Indeed, the fact that Time Warner Cable stock went up post a failed bid from

Comcast suggests that the market is pricing in significant odds that a Charter / Time

Warner Cable transaction occurs. The Comcast / Time Warner Cable arb spread

reached roughly 15%-16% in the last couple of days. If you look at rumored prices

on Time Warner Cable in the $160 - $170 range, the spread has presumably shrunk

to 5-10%. I believe Time Warner Cable’s stock price would be significantly lower if

there wasn’t a good chance of it being acquired by Charter (primarily due to no

synergies, plus a mediocre management team running the business).

In terms of likely accretion to Charter shareholders from a TWC deal I think it’s

tricky to quantify given the presence of numerous unknown variables. The way I

think about it is that a Time Warner Cable deal now would likely be more accretive

than a deal as was contemplated under a previous scenario with Charter receiving

the divestitures, a portion of the spin, and Brighthouse. The primary reason I think

this is that the synergies from scale are much higher. Not only does Charter now

have more heft against programmers due to the sheer number of subscribers, but

they also have potentially much more synergy and scale from geographical

consolidation not only of Time Warner Cable but subsequent acquisitions they may

structure from Cox, Cable One, etc. As I wrote in my previous write-up in December

2014 that Charter could do $30 / FCF / share 5 years out resulting in a 2-3x return, I

think that under a future contemplated deal with Time Warner Cable this is likely to

result in higher FCF / share numbers with a resulting return likely being more

towards the 3x than the 2x over a 5 year period. From a financing perspective, this

deal is likely to be accretive to Charter shareholders given that Time Warner Cable

is underlevered at less than 3x, Charter has more leverage firepower being levered

under 4.5x (and potentially even more debt capacity if they strike a simultaneous

deal with Brighthouse given that the Advance / Newhouse family wants a good

chunk of stock rather than cash given that they are smart and know this thing will

compound at good rates in the future), and the 10-year Treasury is at 1.91% and

Charter was recently issuing debt at less than 6% pre-tax for bonds with a longer

maturity than 10 years. I think the outlook is even brighter for Liberty Broadband as

Liberty Broadband shareholders are likely to receive better terms and compounding

than Charter shareholders. Part of this has to do with the fact that Liberty

Broadband is trading at a 10% discount to a sum of the parts and this is likely to

completely collapse in the next couple of years a la previous Malone holding entities

such as DirecTV and Discovery. In addition, you have big optionality with the $697

million of cash that Liberty Broadband raised during the rights offering. In the

Brighthouse deal, Liberty Broadband shareholders were getting a sweetheart price

of $173 for incremental Charter shares when the equity was trading above $190.

Given that Charter needs incremental equity to fund a Time Warner Cable deal, John

Malone is likely to extract highly favorable economics for Liberty Broadband

shareholders given the need for equity to structure this massive acquisition.

I think the main risk is that a Time Warner Cable deal does not occur. In the long

term, even if a Time Warner Cable deal doesn’t happen, I think you are unlikely to

lose money over a 5 year period given future consolidation opportunities combined

with a levered equity shrink at Charter. Given the 10% discount at Liberty

Broadband, that provides additional cushion. However, I think the probability of this

happening is extremely low given the history of interactions between Time Warner

Cable and Charter as well as John Malone’s track record and history. However, given

all the very smart people on VIC around cable, I would welcome comments on the

bear case as well as why a Time Warner Cable / Charter deal will not occur or why it

won’t be extremely accretive over the next 5 years to Charter/ Liberty Broadband

shareholders. Thank you for your time and especially for thoughts / comments

contrary to my arguments above!

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Time Warner Cable acquisition by Charter. Additional acquisitions in the future. Higher broadband penetration. Higher FCF / share in the future.

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			2015	2016
Price:	53.33	EPS	0	0
Shares Out. (in M):	104	P/E	0	0
Market Cap (in $M):	5,556	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0