Description

LINTA is the holding company for QVC.  QVC is the leading home shopping business.  At current prices of $5.5 or less per share, LINTA sells at less than 8.0x cash earnings (after servicing all debt) and the company has roughly $4.3 per share in cash and marketable securities which are not included in cash earnings.  If LINTA were to trade at 10-12x Cash earnings power and get full value for the company's stock holdings, LINTA would trade at $20-30 per share in 2-3 years (depending on ones assumptions on debt pay down and earnings power 2-3 yrs out).  Currently, LINTA sells for less than 6.2x EV/EBITDA-Capex.  QVC has strong customer loyalty, organic growth potential from wallet capture of existing customers, attractive long-term growth potential from foreign market expansion and a highly variable operating model that should continue to produce robust cash flow to LINTA equity if sales were to shrink 10-20%.

LINTA is a tracking stock representing the interactive operating businesses and equity holdings of Liberty Media (Liberty's other remaining tracker is LCAPA - which is very well capitalized, so I don't worry about combined b/s risk - also Liberty has been quite successfully at turning trackers in to outright stock and I'd expect them to do the same with LINTA at some point).  Created in May 2006, LINTA allows shareholders to participate in the results of specific assets of Liberty Media.  LINTA consists of publicly traded holdings in: IACI, HSNI, TREE, IILG, TKTM, EXPE & GSIC (19-30% stake in each); and wholly owned business including QVC (acquired for an implied $14bn in 9/2003) and internet retailers; Provide Commerce (acquired for $481mm 2/2006), BUYSEASONS, Backcountry.com, Bodybuilder.com (acquired for $225mm in 2007), Red Envelope, and Celebrate Express.  We'll focus on QVC because it generates over 90% of LINTA's Cash flow (2008 Revenue $7.4bn, EBITDA $1.35bn).

QVC (Quality, Value, Convenience) is the worlds largest home sopping network with operations in four countries (EBITDA is about 80/20 US/International): US (since 1986), Japan (2001), UK(1993) and Germany(1996).  QVC sells its merchandise by presenting "shows" on a TV channel (and internet www.qvc.com) in which a QVC host personality and/or special guest present/demonstrate/show the product and viewers are offered the opportunity to purchase the product via phone/internet or in the UK by pushing the buy button on the remote.  Once purchased, the merchandise is shipped from a QVC warehouse to the customer.  QVC generally carries a limited supply of the product offered on TV and once the product is sold out there can be no assurance that the product will be available in the future.  Note: a little under 10% of revenue is purchased under auto replenish plans in which "purchases" are automatically shipped to the customer's house at regularly scheduled intervals unless canceled, this is typically beauty product.

QVC shows are presented live and unscripted as shopertainment.  The host's job is to present/demonstrate the product in an attractive light, but they do not try to "sell" the product. Hosts are not compensated based on sales.  QVC presents a no pressure buying environment with no false yelling/enthusiasm.  QVC shows are designed to resemble a neighbor peaking over the back fence at another neighbor's neat stuff and hearing that neighbor describe how great the stuff is and why they bought it.  QVC actively monitors sales and adjusts shows in real time based on how sales are going.  QVC hosts will alter their description of the product and focus of the show based on contemporaneous feedback from people monitoring results.  If sales are doing well when a host is taking about a certain topic and then sales begin to fall off when topics are changed, the host is instructed to change topics back to the more popular one.

QVC has slightly over 10mm customers (90% women) with roughly 8mm in the US. Sales mix - 45% Home, 32% Apparel & Accessories and 22% Jewelry.  Average ticket is $50 per order.  QVC sources merchandise form branded merchants and private label suppliers.  QVC benefits from favorable placement of channels -for 85% of subs they are below channel 36 and for 42% of subs they are below channel 15.  QVC is able to achieve such favorable channel placement because they pay the cable/satellite operator 5% of sales to be on the dial, given QVC's size and volume this is a positively reinforcing advantage - the better your channel placement the more customers/sales/commission you generate the better for the cable company the more likely they are to put you on a favorable channel.  QVC has historically had roughly 1.5-2mm new customers each year, but only 30% of these customers become repeat customers or join the "community" - 90% of sales come from repeat customers or members of the "community".  Members of the "community" or repeat customers make up over 90% of dollar volume.  The company has a 95-97% retention rate among customers who make 5 or more purchases per year (members of the "community").  For those who join the "community" there are a number of attributes about QVC shows that cleverly leverage human psychologically to the benefit of the business.  QVC's customer penetration level has historically hovered at roughly 8-9% of the potential audience, which can be seen as a relatively strong/stable following or as underpenatrated.

If one comes to identify as a member of the QVC community there are a number of psychological factors working to ecourage their continued participation and purchase.  The "member" likes the host so their presentation/positive description of a product causes Association Tendency & Social Proof.  Views are encouraged to call in with testimonials, creating a very effective Social Proof for other members watching at home and creating Consistency Bias for the caller.  Only a limited number of goods are on sale for a limited time (with no discounts) - this creates scarcity and potential for Stress-Influence, Envy/Jealousy and Availability-Misweighting Tendency.  The nature of the QVC shows has produced a stable (to date) customer group in which 93% of people who have been customers for over 5 years purchase at least 2 items a year.  On average, a new customer spends $173 and a person who has been a customer for 16 or more years averages $1,261 worth of product per year.

QVC does not know what they will be selling in 6mths or 1 year - they simply seek compelling products and form shows around those compelling products (within some broadly consistent categories and consistent hosts).  Merchandising is very important, but the company doesn't need to carry much inventory and can reposition the product offering to match current trends/demand in real time.  QVC says that they are able to reset their "floor" 24 times a day while most retailers do it 3 to 6 times a year, thus allowing for less merchandise risk at QVC vis a vi traditional retailers.

            Business Model

QVC offers department store type goods at below department store prices - QVC has gross margin of roughly 37% (inline with major department store operators like Federated or Bon-ton). Variable cost are roughly 9% of revenue (primarily driven by commission of 5% paid to the cable operators, and also bad debt exp, credit card fees and telecom/customer service exp). Other expenses are fixed or at least sticky and include the cost of producing shows, running the web site, call centers, corporate, distribution centers, merchandising and advertising.  QVC is able to earn a higher margin, roughly 20% EBITDA, while offering a lower price than traditional retailers because its model produces structurally lower costs for advertising, lower for employee costs per sale, no rent/space expense, low inventory carrying costs and little to no mark downs. QVC operates a highly variable cost model, 80-90% of the company's costs are variable.

Margin - QVC's domestic EBITDA margin is roughly 20% and international is 17%. The difference is almost entirely explained by fixed costs and over time the company expects to to increase margin internationally as sales continue to ramp.

Growth - In the past 10 years, QVC has grown revenue at roughly 10% annually - from a combined "same store" growth (volume and ASP increases among existing customers), increased cable penetration, increased number of customers, and international expansion (Japan).  Over the same time, cash flow has grown roughly 18% annually - all while the business has retuned essential 100% of earnings to its owners.  (John Malone on the QVC business "It grows and throws") QVC has not needed capital to grow - there are no stores to open or refresh.  The grows and throws model is particularly beneficial in an inflationary environment, because the company has limited needs for capital, can grow on the back of increasing prices (taking the same margin on higher nominally priced merchandise) and continue to produce cash to benefit the owners.  

In the future QVC will have more limited opportunities to grow.  Cable penetration is nearly 90% in QVC's markets, so there is little chance for new customer growth from increased penetration; notable exception is Japan where QVC is only at 36% penetration.  QVC is pursuing greenfield international expansion in Italy, slated to open in 2010.  The likely sources of growth are ASP (2-4% per year) and volume increases driven by increased customer wallet share.  Long-term QVC customers consume QVC product at a much higher rate than new customers, so if that dynamic continues QVC should get 2-5% growth from the maturing of the customer base.  QVC is also constantly improving the product offering (more exclusive merchandise, celebrity tie-ins, and higher quality products) and the improved offering should lead to greater wallet share of existing customers and or increases in new customers.  QVC's customer base has also tended to skew older (mid 50's) so demographics should be working in the company's favor.

COMPETITORS

Traditional shopping, HSN (owned nearly 30% by LINTA) is roughly half the size, and Shop NBC (VVTV), has a bigger focus on jewelry and is 10% of QVC's size.  QVC has a 65% share in electronic retailing.

Management/Culture

            LINTA is controlled by John Malone who has a three decade record of value creation through M&A and appropriate treatment of outside shareholders.  Since creating the LINTA tracker, the company has consistently repurchased shares, retiring a little over 10% of the float.

 QVC management has largely been with the company for 15 plus years and is responsible for the company's strong position and international development.  QVC has had 3 (CEO, CFO and Chief Merchant) key management changes in the past few years, but the changes came with 1 to 2 years of notice and appear to have been successfully transitioned.

It is important to note that QVC does not set quarterly operating performance targets or manage the business for comp or other sales metrics.  QVC aims to present compelling, specific merchandise, at a good price and gross margin in an attractive manner and believes results will take care of themselves.  QVC seeks to maintain margins instead of chasing sales, hence the do very little discounting (and almost none during the shows).

Show hosts are not paid commission.  No part of their payment is based on sales.

Risks

            QVC Stub is leveraged roughly 5.3x gross debt to EBITDA and 3.0x net debt to EBITDA.  The nature of TV and VOD will change the way people consume television over the next decade or two and likely lead to a reduction in the importance of channel placement (QVC gets over 20% of its sales online).  HSN has new management and should be expected to remain a viable competitor.  QVC must remain relevant to its core customer while pushing to expand the business, product offering and appeal to new consumers.  Continued successful merchandising is key. QVC's products are discretionary in nature and the company's results will suffer in a significant consumer downturn in the US.

 There is some element of black magic to the phenomenon that people like to watch shopping based TV and purchase things that they didn't previously know that they needed - despite my difficulty in understanding this behavior; "shopertainment" resonates with some aspect of common humanity as the concept has been very successful in multiple cultures for over 20 years. Despite the persistence of this black magic, the largest risk facing QVC is loss of its customer base or "community".

Opportunities -

            China. QVC has demonstrated an ability to execute in 4 different cultures and China should ultimately prove to be a massive opportunity both by direct sourcing - currently they pay a broker (in 2006 QVC opened a Shanghi office) and also as a TV market.  QVC's entertainment based retail could some day grab a greater audience share in existing markets.

QVC's size allows for a positive scale in attracting new and improved brands.  QVC's ability to offer better product and celebrity tie-ins is driven in part by the company's size and demonstrated ability to increase retail sale of product following their appearance on QVC. QVC's scale can allow it to launch a product or company, at some point QVC may be able to get paid (in equity) for offing such low cost distribution.

Catalyst

value