Description

Investment Thesis:

Liberty Latin America and Caribbean (“LiLAC”) group is a long at $44. The Company is a tracking stock recently carved out of Liberty Global (“LGI”) and represents the parents interest in Latin America (namely Chile and Puerto Rico). Video and penetration levels in LatAm are below levels in Western Europe and the US and LiLAC provides LGI a vehicle to roll up smaller cable providers in more quickly growing markets. LiLAC currently operates in two markets: Chile and Puerto Rico, both of which present opportunities to increase penetration levels as LGI has done elsewhere which is leading to solidly double digit FCF growth over the next several years.

Company Overview:

LILA owns 100% of VTR which is the largest cable operator in Chile which contributes ~2/3 of total revenue. LILA also owns 60% of Liberty Cablevision of Puerto Rico (“LCPR”) which is the largest cable company in PR and whose systems pass 70% of homes (“HH”) on the island. Across both markets the company has upgraded their networks with >90% all digital and ~half built out to 1Ghz which means future capex should mostly be success based.

Company Details:

·         They own the #1 Chilean cable operator VTR which passes essentially all Chile’s 3MM multichannel HH (only 54% of HH are multichannel so there could be room for VTR to expand, even if via an HSD-first offering).

o    In Chile networks are ~88% all digital, 86% of network 750Mhz+ (and 50% at 1Ghz).

o    Video competition mostly DTH and data competition mostly copper/ADSL altho ~230K homes are passed w VDSL/fiber.

§  Avg HSD speed 40Mbps while competition closer to 15Mbps

§  Movistar and Claro both offer triple play w DTH and supplement it with some infrastructure based video as well.

§  Movistar passes ~7-8% of VTRs homes with FTTH and Entel passes a modest amt of homes w fiber while Claro offers HFC in major cities

o    VTR allowed to increase prices at inflation rate 2x/year for triple play (ie not MVNO) and in 2H15 they are increasing pricing 2.5%. Beyond inflation they can petition of a greater increase once/year but customers need to approve or else they can terminate their contract

o    Bundling rate (single/double/triple) 31%/22%/47%

o    Mobile is nascent and VTR MVNO has ~1% share

o    Chile has ~18MM people, ~5.7MM HH and only ~3MM multichannel HH. Chile also has ~20MM mobile phones.

o    34% of HP take video (90% of which is digital), 38% of HP take HSD and 28% take voice.

o    DVR penetration low ~41% but Horizon box could be rolled out to Chile by YE15.

o    TV market – VTR currently leads the TV market with c.35% TV market share compared to Movistar (c.20%) and Claro and DirectTV Chile with around 15%.

§  Overall Pay TV penetration ~69% and should continue increasing a few hundred bps/year

o    Broadband market – Fixed broadband penetration is c.42% (~34% when defined as 2+mbps). Liberty currently has 38% market share compared to Movistar at 39% with Claro and GTD Group with c.10% each. Movistars product is mostly DSL so they should be a structural share loser (with the exception of their modest fiber footprint).

Overall market penetration should continue increasing 200-300 bps/year for next few years)

o    Fixed Telephony market – Telefonica is better positioned in fixed telephony with c.45% of the market share. Liberty with c.20% of total subscribers is the largest amongst the rest of the operators.

·         They also own 60% of Liberty Cablevision of PR whose systems pass ~70% of the islands homes (and ~90% of PR’s multichannel homes)

o    31% of HP took video, ~40% took HSD and ~24% took voice

o    Top bband speed 120 Mbps (avg 20 Mbps) while competition averages in 3-5Mbps range and tops out at 20 Mbps

o    Bundling rate (single/double/triple) 36%/19%/45%

o    HSD penetration ~48% and should increase 100 bps/yr or so for next few yrs.            

o    Almost all networks digital (half 850Mhz+).

o    Pricing can increase based on costs (but less stringent pricing that Chile and as such pricing increased ~8-9% in Q115)

o    De minimus commercial exposure which could be LT opportunity

o    Since LCPR is an LLC, taxes aren’t reflected in its standalone filings

o    Overall PR pay-TV penetration ~55% and should be relatively flat as long as economy struggles.

o    Liberty Global’s 100% stake in LCPR covering 40% of the Island became 60% ownership of systems covering 70% of the island after the acquisition of OneLink in 2012 with private equity partner Searchlight (managed by Eric Zinterhoffer, who was with Apollo and helped to lead Charter Communications through its balance sheet restructuring). There are buyout rights related to this partnership with Searchlight, with action windows starting in late 2017 and going through late 2019. At any time, Liberty Global may force a sale of LCPR including a right of first offer in favor of Searchlight. After 9/24/17, as long as Searchlight still owns at least 20% of LCPR, they can force a sale of LCPR with Liberty Global having a right of first offer and an ability to stop a forced sale and instead conduct a dividend recapitalization that could cash out Searchlight.

·         There is a statutory, multi-year increase in the Chilean corporate tax rate that ratchets up from 21% last year to 27% by 2018. However, there will also be a 35% withholding tax paid on behalf of shareholders, and only 65% of the corporate rate can be used as a credit, which takes the final tax burden to 44.45% -- but where shareholders are residents of countries that have a tax treaty with Chile, there is a full credit for the corporate tax paid, so LiLAC’s effective rate is more like 35%.

·         Given high quality nature of their networks (>9)% already all digital) capex should be mostly success based and should trend materially lower over next few years.  

Risk/Reward:

·         Bull: $60 (40% upside) to  6% FCF yield on ’18 bull case FCF ($160MM)

·         Base: $50 (16% upside) to 6.5% FCF yield on ’18 bull case FCF ($145MM)

·         Bear : $38 (11% downside) to 7% FCF yield on ’18 bear case FCF ($120MM)

Chile Market Share

Catalyst

Continued execution on strategy to increase penetration levels by leveraging their superior infrastructure.