LINTA has 35% upside as the valuation discount of its main holding QVC to primary competitor HSNI narrows with the issuance of a tracking stock in the first half of 2014.  There is further upside potential based on improved operations at the business units, cyclical recovery in Europe and Japan, and value-creating corporate buybacks.

Summary:

• Listing of tracker stock for QVC in 1H14 will highlight the discount that it trades at to HSNI (about 7.4% free cash flow yield versus 5.5%...this discount should narrow)
• If recent history repeats itself, LDC (Liberty Digital Commerce), the tracker for the other operating businesses, should perform well (LVNTA and STRZA both more than doubled since listing)
• Sum of the parts gets you to about $39 per share today versus a $29 stock price, and you are getting a business that should grow net income in the 10% range and has a history of buying back 5% or more of its stock annually.  The company has bought back 31% of its stock since May 2006, when LINTA was created.

Transaction Description:

On October 10, 2013, Liberty Interactive announced that they were creating two new trackers for its fully owned and operated ecommerce businesses.  In the recapitalization, LINTA stock will be renamed QVC and will hold QVC, LINTA’s 38% ownership in HSNI and an allocation of corporate cash and liabilities.  Shareholders will also receive 1 share of Liberty Digital Commerce (LDC) for each 10 shares of QVC that they own.  LDC will house all the other smaller ecommerce businesses, and will be allocated some amount of LINTA’s cash and liabilities.  They also announced that they had bought back $206 mm shares of LINTA between 8/1/13 and 10/4/13, which indicated a buyback pace of over 10% of the cap if you annualized.  In reality, they probably sped up the buying since these transactions might close their window, but it does highlight the commitment to share buybacks that this company has.

The justification for this recapitalization is to enable better financial analysis and valuation versus comparables, create cleaner mechanisms for QVC share repurchase, create an acquisition currency (for either unit), and allow for tailored equity incentive programs for employees.

There is also a spinoff of Liberty’s holdings in TRIP (22% ownership) to holders of the Liberty Ventures tracking stock (LVNT).  In order to make that transaction tax free, they are attaching a small business from LINTA – BuySeasons (an online seller of costumes and party goods).  LVNT will pay cash to LINTA for this immaterial transaction.

Company Description:

QVC is a multi-channel ecommerce company operating in the US, Japan, Germany, UK, and Italy, as well as China through an unconsolidated JV.  About 2/3 of the sales and 75% of the EBITDA are in the US.  The TTM break down of OIBDA is 72% US, 14% Japan, 9% Germany, 6% UK, (1)% Italy.  QVC runs 24 hour television programming highlighting its products, and runs ecommerce internet and mobile sites.  As the business shifts from by phone (dialing in when you see something on TV) to by the web, there are EBITDA margin expansion opportunities because it is cheaper to close an ecommerce transaction than a phone one.  Last year, sales were 60% by phone and 40% digital.  The mobile business is a big focus here and is growing quickly and up to 30% of their internet sales.  They are the #3 US player in mobile ecommerce after Apple and Amazon. 

Their business currently is 86% existing customers, 6% returning customers, and 8% new customers, with new customers being the most volatile piece. The business category breakdown is approximately 28% fashion, 27% home, 20% beauty, 13% jewelry and 12% electronics.  There are 30 new items every day to keep the customer coming back for more. 

The US business is far more mature than the international ones.  The US business has a 22-23% EBITDA margin, whereas the international businesses are at 18% (and recent new business Italy loses money).  Closing the gap between the International operations and the US remains a strategic opportunity.  There is also a lot of upside value to be had from their China JV with CNR Mall.  Their channel now reaches 67 mm homes in China (up from 42 mm last year), and they think they will have more homes in China in a few years than in the US.  This business did about $80 mm last year, while the #1 and #2 players in the business did $1 bn and $750 mm.  Obviously they are going up against entrenched players, but they also have a giant addressable market.  It’s all option value within QVC at this point.

LDC will house several businesses including Provide Commerce (formerly PRVD and REDE), BackCountry.com, BodyBuilding.com, and Evite.  This group of gift-focused (Provide) and niche-y websites has been growing in the mid-teens, along with general ecommerce rates, but has had some profitability challenges.  2013 sales should be around $1.7 bn but they will only do around $100 mm in EBITDA.  For this reason, the company has structured it such that LDC will get a enough of the corporate cash (14%) to leave it in a slightly net cash position.  The stated corporate goal at the new LDC is to improve free cash flow across all properties.  Several of the businesses have hired new talent in the last year or two to shake things up.  The opportunity here is to really roll up a bunch of niche ecommerce categories and bring them together with a shared infrastructure which allows them to be more profitable than they could ever be as standalone businesses.

As for the operating businesses, Provide Commerce, formerly public as PRVD, is the Proflowers/Proplants business which obviously has a big focus on gifting and high seasonality around holidays (particularly Valentine’s Day and Mother’s Day).  They compete with FTD.com, 1800Flowers.com, and a fragmented array of local florists.  This business probably does around $350 mm/year in revenue.  Also within the Provide segment is Red Envelope, formerly public as REDE, which probably does about $400 mm in sales and focuses on gifting.  You’ll find an eclectic mix of products on their site – everything from cashmere and jewelry, to sport-themed stuff, baby gifts, corporate gifts, etc.  This is obviously a really competitive area so they need to be sharp on merchandising to succeed, and they also put an emphasis on high quality packaging so you know the gift will look good when it gets there.  There are also smaller businesses in the Provide segment providing personalized items (PersonalCreations.com) and gourmet foods for gifting (Cherry Moon Farms & Shari’s Berries) – both are probably around $50 mm each.

Backcountry.com is a niche site that caters to cyclists (road and mountain), campers, backpackers, skiers, snowboarders, rock climbers, kayakers, mountaineers, etc.  They compete in a highly competitive space with companies like REI, EMS, and Dick’s, as well as Amazon, and try to differentiate with content and merchandising.  They have weather sensitivity as about 40% of the business is in the fourth quarter, and presumably a lot of that is skiing and snowboarding.  It probably does about $400 mm /year in sales.

Bodybuilding.com is the most visited bodybuilding website and probably does about $300-350  mm/year in sales, primarily selling supplements.  Their biggest competitor would be GNC.  Bodybuilding.com is targeting international as a growth opportunity. 

Evite.com, known as Celebrate Holdings, is also part of LDC and does marginal revenue – maybe $50 mm, primarily through advertising and from some party supplies and costume sales.  They compete with Paperless Post and Punch Bowl in online invitations.

Valuation:

I get a fair value of around $34 to $46 depending on what multiples you use. 

I think the right range is 6.0-6.5% free cash flow yield on QVC, primarily based on the fact that HSNI trades at 5.5% on the TTM free cash flow.  Since HSNI is the more likely acquiree than acquirer in a transaction, I would expect it to be at a premium.  Many other retailers (such as WMT and TGT) trade in the 5-7% free cash flow yield range.  I estimate 2014 free cash flow at $2.06 so you get somewhere between $31.70 to $34.30 for QVC.

I think the right range on an OIBDA (EBITDA) multiple for LDC is 9-13x.  This is based on looking at 6 small cap ecommerce peers – FLWS, NILE, OSTK, PETS, SFLY, and FTD.  The low multiple in the group is FLWS at 8.1x, the high multiple is NILE at 32.4x, and the average is 16.2. I think NILE is wildly overvalued and I think SFLY has better growth prospects, so it you throw them out of the group the range is 8.1x-16.6x.  There is a scarcity of small ecommerce assets out there to invest in, so I think 9-13x is fairly conservative.  This gets you a valuation range of $2.65 to $3.80 for LDC.

HSNI at the current stock price assuming a tax payment of 20% of their current gain if they were to dispose of it is worth $2.00. 

At the widest points in this valuation, I get $36.30 on the low end and $40.10 on the high end.  A 6% free cash flow yield on QVC with an 11x EV/EBITDA for LDC gets me to my $39 target ($34.33 for QVC, $3.21 for LDC, and $2.03 for HSNI stake = $39.57). 

Possible Catalysts:

• Issuance of trackers allows the valuation gap between QVC and HSNI to close
• LDC doubles like all other recent Liberty spins/trackers did
• I think the goal is to improve profitability at LDC and get the value up, and then once that’s done it’s likely they spin off the whole thing
• Long-term, a merger between QVC and HSNI would have a lot of synergies and create a lot of value
• New market entries for QVC – they have said they will enter one new market every 1-2 years – France, Spain, Brazil, and Russia are the four they are likely circling
• Results at QVC improve as both Japan and Europe have been cyclically challenged
• Significant buybacks continue – based on stated target leverage, there should be $500 mm available for buybacks at the time this closes

Risks:

• Deal gets a negative tax opinion (unlikely as these guys are masters of the corporate tax code, have done this kind of thing many times before, and surely did their homework already)
• Deal doesn’t get approved by shareholders (unlikely as it should create value)
• Some strange unforeseen Malone move – for this reason, I would recommend holding on to both pieces

• Issuance of trackers allows the valuation gap between QVC and HSNI to close
• LDC doubles like all other recent Liberty spins/trackers did
• I think the goal is to improve profitability at LDC and get the value up, and then once that’s done it’s likely they spin off the whole thing
• Long-term, a merger between QVC and HSNI would have a lot of synergies and create a lot of value
• New market entries for QVC – they have said they will enter one new market every 1-2 years – France, Spain, Brazil, and Russia are the four they are likely circling
• Results at QVC improve as both Japan and Europe have been cyclically challenged