Description

Liberty Media Corp. Class A (LMCA)

Recommendation:

Buy shares today at recently widened discount to NAV, with the option of two transactions occurring that would be significantly accretive and drive a +20% IRR in the shares over a 5yr period.  The first transaction is the acquisition of the remaining SIRI shares not already owned by Liberty.  The second transaction is the deployment of capital into a CHTR acquisition of TWC.  The first transaction is actually a significant positive for the stock, despite being perceived as a negative and thus widening the discount to NAV in LMCA shares.  Several hard catalysts exist, including the aforementioned transactions, to drive the share price performance towards my expected IRR.

Description:

Liberty Media is a holding company with interests in a broad range of both private and public media, communications and entertainment businesses.  The largest components of the NAV are its 52% stake in SIRI (~60% of NAV), and its 27% stake in CHTR (~20% of NAV).  The company is managed by Chairman John Malone, CEO Greg Maffei, and is headquartered in Denver, CO.

Opportunity:

On Friday January 3^rd, Liberty Media announced a proposal to make Sirius XM Holdings a wholly owned subsidiary.  The proposal put forward a plan to issue 0.076 shares of a new Liberty C class to existing SIRI shareholders, as well as 2 Liberty C shares for every outstanding Liberty A and B share.  As of Friday’s close, the proposal valued SIRI shares at $3.68, a 3.1% premium.  Since the announcement, Liberty has been downgraded by a bulge bracket sell-side research firm, SIRI shares have traded up ~6% to $3.77, and LMCA shares have traded off ~4% to $139.54.

I think the downgrade is a good barometer for short-term sentiment on Liberty’s stock.  The Liberty sell-side downgrade was because the analyst had previously counted on SIRI remaining a “clean” levered equity story, appreciating in share price, and therefore driving LMCA’s share price higher with it.  His concern with the transaction is that SIRI will not be properly valued within LMCA, and therefore LMCA shares will not rise.  I understand the rationale but think it is short-sighted.  I think that the transaction will not only allow Liberty to fund a CHTR bid for TWC more cheaply and with lower risk, but will also help them create more value in through SIRI.  On the latter, I think that Liberty management will take leverage at a wholly-owned SIRI to at least 4.5x (vs current 3.5x and only recently revised strategy of 4x), and use that larger amount of capital to buy SIRI through Liberty C shares cheaper than SIRI would be trading in the public market as a “clean” levered equity.

Valuation:

My starting point for LMCA’s valuation is the current NAV.  I then adjust the corporate structure for the SIRI deal share issuance, assume an acquisition of TWC by CHTR with funding from Liberty, and then from there I project my thesis / expectations for CHTR, SIRI, and the significant excess capital provided from SIRI to Liberty (after the CHTR/TWC contribution).

SIRI Deal and Resulting Liberty Corporate Structure:

• I expect the SIRI deal to get done, and that the Special Committee of SIRI independent board members will negotiate a slightly more favorable exchange ratio – I use current prices to come to my assumption
• With an assumed exchange ratio of 0.078, I expect Liberty’s share count to be approximately 590m pro forma for the transaction

CHTR Acquisition of TWC

• I assume that CHTR acquires TWC for $140/share
• I assume that Liberty uses approximately $4.5b from its current balance sheet, and SIRI’s balance sheet, in order to maintain its current 27% stake

CHTR Thesis / Expectations:

• I expect CHTR to experience growth as Tom Rutledge continues to use the same playbook he used at CVC – drive EBITDA per home passed higher by increasing data and telephony penetration, as well as lowering churn
• I expect Rutledge to continue to do this through better marketing, plant upgrades, and better customer service
• My favorable view on CHTR as an asset relates to its low overlap with FiOS, cable as a competitively advantaged broadband access mode, and the potential for further monetization of cable’s broadband product (compare the “delivery charge” of cable’s video product to what they are charging for broadband per GB)
• I also expect Rutledge to be able to extract synergies from TWC, by managing the asset more in sync with his CHTR strategy, as well as realizing some content cost and capex synergies
• CHTR’s large NOL and tax asset position also make a TWC acquisition compelling

SIRI Thesis / Expectations:

• I expect SIRI to experience growth as they continue to benefit from a robust SAAR, pricing power, and its significant opportunity with respect to the used car market
• EBITDA and FCF growth should be further enhanced by high incremental margins and a large NOL
• My favorable view on SIRI as an asset relates to its unique positioning from both a content standpoint (the most, with much exclusive), and distribution standpoint (better coverage than wireless and significantly lower cost to the consumer)

Excess Capital Deployment:

• After using a significant amount of SIRI’s balance sheet capacity to fund their stake in the CHTR/TWC deal, I expect Liberty to go to work using SIRI’s cash flow to retire a significant amount of the issued C shares
• I estimate that over the next 5yrs they could use +$10b to retire +150m of Liberty C shares

Putting it all together, I arrive at a Liberty EV in 2018 of greater than $50b, with a significantly reduced share count, driving an IRR from the current price (adjusted for the SIRI deal as discussed above) of more than 20%.

Risks:

• Deterioration of fundamentals at either SIRI or CHTR
• Inability to close SIRI deal
• Ironically, if this deal does not close, we could see LMCA shares rebound from the recent sell-off

• Lack of CHTR / TWC deal

  • Mitigating this is that I believe that CHTR remains a compelling investment on a standalone basis

Catalysts:

• Acquisition of remaining SIRI shares by Liberty – anticipated within the month
• CHTR acquisition of TWC, partially funded by Liberty capital – anticipated within the next 6mos
• Significant repurchases of newly issued Liberty C shares – anticipated over the next few years
• Tax-free spin of SIRI to Liberty shareholders – anticipated within a few years

Catalyst

• Acquisition of remaining SIRI shares by Liberty – anticipated within the month
• CHTR acquisition of TWC, partially funded by Liberty capital – anticipated within the next 6mos
• Significant repurchases of newly issued Liberty C shares – anticipated over the next few years
• Tax-free spin of SIRI to Liberty shareholders – anticipated within a few years