Description

While the thesis behind LMCA is well-known, we believe the recent pullback of shares of Liberty Media Corp (LMCA) is providing a compelling risk/reward opportunity.  Liberty is a holding company controlled by John Malone that owns ~58% of Sirius XM, ~27% of Live Nation, and some other public and private assets (including ownership of the Atlanta Braves, and small positions in Time Warner and Viacom). We mainly view Liberty as a cheaper way to buy Sirius XM since it accounts for over 80% of the value of LMCA.  Liberty currently trades at a ~12.5% discount to its net asset value (NAV).  Furthermore, we are happy to invest alongside John Malone, one of the greatest wealth creators of all time.

Sirius XM is a high quality satellite radio business with a substantial opportunity to increase its subscriber base due to increased used car sales with previously installed radio equipment. Subscriber growth, along with operating leverage and substantial share repurchases, should allow Sirius to grow free cash flow per share by a 17% CAGR over the next 5 years. By investing in Sirius via LMCA we are essentially buying Sirius at an 8.5% 2017E fully taxed free cash flow yield, a valuation we find attractive for such a high quality business. Furthermore, at today’s share price Sirius would repurchase its entire public float by 2018, creating a creeping takeover with Liberty as the 100% owner.

If Sirius XM hits our target price and the discount to NAV collapses, LMCA should trade to ~$45.75 per share or ~30% upside. 

Key Investment Points:

·         Growth Potential at Sirius: As a ~58% owner of Sirius XM, LMCA is a cheaper way to play the significant free cash flow generation potential of Sirius. Sirius is a high quality satellite radio franchise with a large competitive advantage due to its offering of superior content (e.g. Howard Stern, Oprah, NFL games, commercial-free music, etc.) and its agreements with auto OEMs (e.g. GM, Ford) to install satellite radios in over 70% of all new cars sold in the US. With a growing installed base due to a higher level of new car sales and the increased number of used cars sold with previously installed satellite radio equipment, Sirius has a large opportunity to grow its subscriber base. With subscriber growth at high contribution margins (70% vs. 35% EBITDA margins in 2014) and significant net operating losses that should defer cash taxes until 2019, Sirius will generate $1.3-1.6bn of annual free cash flow over the next 4-5 years. As management has committed to using the vast majority of this cash and increasing leverage up to 4x (versus current levels of ~3.3x) for share repurchases, we think Sirius can grow free cash flow per share ~17% per year for the next 4 years. In this scenario and at current prices Sirius would repurchase the entire public float by 2018, creating a creeping takeover where Liberty owns 100%. In our base case scenario we think Sirius is currently worth ~$4.25 or ~17% above the current market price.

·         Used Car Opportunity Should Lead to Growth: We estimate that used cars sold with installed Sirius radios will double from 2013 levels (from 4.8 mm to 9.5 mm vehicles) as Sirius continues to penetrate more of the U.S. car base. This will provide Sirius with an opportunity to convert used car purchasers into paying subscribers at virtually no cost, as Siri will avoid paying the ~$35 subsidy per vehicle it currently provides to OEMs to install its radios. Although Siri’s used vehicle customer conversion rate is lower for used vehicles, the volume and economics of used car activations should provide Siri with a material customer growth tailwind and account for a significant percentage of new, lower-cost subscribers. 

·         High Barriers to Entry: Creating a service that directly competes with Sirius would entail launching a satellite constellation and securing deals with content providers, which is likely to be both very expensive and time consuming. Free competing service offerings such as Pandora are likely to have a muted impact on Sirius due to their lack of unique content. Sirius differentiates itself by offering subscribers talk show programs, such as Howard Stern and Oprah, and sports channels that online streaming radio services do not provide. Only ~1% of Sirius’s subscriber base subscribes to “music-only” packages, with the most popular offerings comprised of packages that combine talk and music, which demonstrates the high value that customers place on Sirius’ content and the defensibility of its business model . In addition, services like Pandora may be less appealing to consumers due to the burden of data usage and the annoyance of listening to commercials

·         Closure of NAV Discount: Liberty currently trades at a ~12.5% discount to its NAV as it has historically had a diverse asset mix with various public stakes.  Last year the company split off Liberty Broadband (mainly the company’s positon in Charter Communications) and pro-forma for the transaction Sirius XM represents over 80% of the remaining LMCA NAV. With single large publicly held stakes as the vast majority of the remaining entities and Liberty’s track record for tax-free monetization of its assets, we think the discount to NAV will close as it is highly likely that there will eventually be a transaction to collapse SIRI and LMCA together.  In 2014 LMCA made an offer to SIRI minority shareholders that was rejected.  Instead, we think SIRI will continue buybacks and lower the float, essentially turning this into a creeping takeover.  We assume that another offer will be made to SIRI minority shareholders in the next couple of years after the float is significanly diminished.    

·         Investing Alongside John Malone: John Malone is one of the greatest wealth creators of the past century. At TCI, his original cable business he achieved compounded annual returns of 30% per year, which doesn’t include the massive wealth creation of all of the Liberty entities and spin-offs. Malone and Liberty CEO Greg Maffei are prudent and patient capital allocators who wait for substantial opportunities to invest at substantial returns. As a case in point, Liberty’s original investment in Sirius XM in 2008 rescued the company, but also gave Liberty a large portion of the equity at virtually no current cost basis. Based on its track record of capital allocation, we feel very comfortable investing alongside the Liberty management team.

Valuation

The primary drivers of our Liberty Media valuation are the valuation of Sirius and the discount to net asset value the public market puts on Liberty’s assets.  Under our assumptions we think Sirius can grow fully-taxed free cash flow per share to ~$0.28 per share in 2018, which is when we expect the NOLs to substantially run out. Using a 17.5x FCF multiple (5.7% free cash flow yield) Sirius would trade at ~$5.00 per share. Discounted back to today yields a price target of $4.25 per share. From a Liberty Media perspective, should Sirius trade to $4.25 and the discount to NAV narrows to 0%, Liberty Media would be worth $45.75, or ~30% above the current price.

Risks:

Increased Internet Competition (Sirius): Sirius faces competition from terrestrial radio, current internet offerings like Pandora and Spotify, and future internet/in car offerings from Google, Apple, etc. Though we believe competitive offerings will increase over time, we think this risk is mitigated by the amount of high quality, exclusive content offered by Sirius.

Increased Churn (Sirius): Sirius’ current customer base is composed primarily of higher income car buyers. As the installed base increases from the used car opportunity, Sirius’ marginal customer may increasingly skew lower in income. Lower income customers likely churn more, increasing the risk of lower than expected subscriber growth or even subscriber losses.

New Auto Sales Slowing (Sirius): The growth in annual new auto sales in the US has been high over the past few years due to recovery from the recession.  This growth is decelerating but the risk is that growth actually turns negative at some point due to recession or other exogenous event.  Watch auto sales data on a monthly basis for signs of weakness.

Tax or Other Unforeseen Corporate Expenses (LMCA): Future transactions could create significant tax liability at LMCA. However, Liberty has a superb track record of monetizing and swapping assets to prevent tax leakage. We expect this to be the case with Liberty going forward and is one reason why we believe the discount to NAV should close.

Catalyst

- Increased used car penetration for SIRI

- Further buyback announcements

- Eventual collapse of holding company structure