Description

Recommendation

Long 1 LTRPA/B and short 0.4125 TRIP (hedged at full control ratio) to capture ~12% gross spread to LTRPA/B’s simple NAV with optionality on a sale of LTRPA/B to TRIP or a third party such as GOOG/FB/BABA/BKNG over the next 12-24 months (LTRPA/B’s “not-so-hidden” asset is its ~57% voting control of separately traded TRIP) accreting an incremental ~13-26% to the spread or more in the event of multiple competing bidders for a ~25-38+% “all in” return with minimal risk of realized capital loss.  Looking through recent idiosyncratic dynamics that have driven the spread to its historical wides (last year the complex traded at a premium to simple NAV), we believe the spread should normalize towards parity in the immediate to intermediate term and begin to trade back at a premium in 2019 as the market appreciates the potential for a change in control of LTRP pursuant to underappreciated insider incentives / contract cadence.

Investment Thesis

Liberty TripAdvisor Holdings (“LTRP”) was spun off from Liberty Interactive Corporation (“Liberty”) in August 2014 in a tax-free, asset-backed distribution to shareholders of the tracking stock Liberty Ventures (“LVNT”) as Liberty sought to simplify LVNT’s complex holding company structure. LTRP is an orphaned spin with no natural owner whose primary asset is voting control of separately traded TripAdvisor (“TRIP”). LTRP has a ~22% economic and ~57% voting interest in TRIP through the ownership of ~31 million TRIP shares comprising ~18 million TRIP common shares, which are entitled to one vote per share, and ~13 million super-voting TRIP Class B shares, which are entitled to ten votes per share (there are ~140m TRIP shares outstanding).  Calling LTRP’s stake a “hidden asset” seems somewhat silly since it effectively accounts for LTRP’s Net Asset Value (“NAV”); perhaps the stake is best described as a “not-so-hidden” asset whose value remains deeply underappreciated due to a constellation of idiosyncratic factors that have recently arisen (more on this below). Inclusive of the after-tax cash proceeds from the sale of LTRP’s small operating business (BuySeasons) last year, LTRP had $21 million in cash and $477 million in debt per its balance sheet for the period ended March 31, 2018.  There are ~75m LTRP shares outstanding consisting of ~72m LTRP Class A shares (“LTRPA”), which are entitled to one vote per share (LTRPA controls ~71% of the LTRP vote), and ~3m super-voting LTRP Class B shares (“LTRPB”), which are entitled to ten votes per share (LTRPB controls ~29% of the LTRP vote). The liquid LTRPA ($12.35) and illiquid super-voting LTRPB ($12.40) trade near parity (LTRPB currently trades at a puny 0.4% premium to LTRPA), presenting a compelling share class trade in its own right were it not for LTRPB’s aforementioned illiquidity.  Big picture, we recommend setting up the LTRP spread by going long 1 LTRPA/B and going short 0.4125 TRIP at the full control ratio (~31m underlying TRIP shares / ~75m LTRPA/B shares) in order to capture a ~12% gross spread to simple NAV plus optionality on an acquisition of LTRPA/B over the next 12-24 months accreting an incremental +13-26% to the spread or more for a ~25-38% “all in” return with little risk of realized capital loss.

Using TRIP’s current market value across the ~31m shares collectively owned by LTRP, LTRPA/B currently trades at a ~12% gross spread to its simple NAV of ~$13.88 per share.  For purposes of simplicity, we use LTRPA’s current share price ($12.35) as a proxy for the share price across the complex (LTRPB trades $12.40). This simple NAV understates the value opportunity because LTRP’s underlying TRIP shares deserve a control premium.  In December 2012 Liberty paid Barry Diller a $116 million premium above the market value of his TRIP shares for control of TRIP. It makes economic sense that LTRP’s board and management team would at least want to recoup that past premium paid. If we capitalize this $116 million and add it to LTRP’s simple NAV to impute an adjusted NAV, we get another ~$1.55 per share in which case the gross spread rises to ~25%.  TRIP is a strategic asset that might be palatable to multiple bidders. There is an argument that the value of control of TRIP has increased since Liberty acquired it from Diller in 2012. If a formal auction process were launched for TRIP, there is a possibility that numerous deep-pocketed strategics such as Google, Facebook, Booking Holdings, and Alibaba could bid multiples of the ~$1.55 per share. The spread currently does not appropriately discount this optionality.

A sale of LTRP is not a remote, theoretical scenario.  Liberty readily admits in its financial filings that the catalyst to collapse the LTRPA/B structure would be an acquisition of LTRP by a third party.  Specifically, Liberty focuses on an acquisition of LTRP by TRIP. Liberty bluntly lays out the logic for such a transaction in LTRP’s S-1 filing: “Liberty believes that separating our company from Liberty's other businesses will help facilitate a potential combination of our company with TripAdvisor by eliminating any negotiations regarding the valuation of Liberty's other businesses, thereby making it more likely that a potential agreement could be reached. Liberty believes that a combination of our company with TripAdvisor could be beneficial for our stockholders, on the one hand, and TripAdvisor, on the other hand, by eliminating the control of a large stockholder and the overhang associated with the current dual-public company structure.”  Of course, Liberty adds the legal caveat: “No assurance can be given that any investment, acquisition or other strategic opportunities will become available following the Spin-Off on terms that TripCo finds favorable or at all, nor can any assurance be given that a combination of TripCo and TripAdvisor will ever occur.”  Notably, Liberty’s Gregory Maffei (well respected in the industry as John Malone’s right-hand man), serves as both Chairman/President/CEO of LTRP and Chairman of TRIP.  Maffei owns ~95% of outstanding LTRPB shares, no LTRPA shares, and barely any TRIP shares (only 20,018 in total as of April 2018 per TRIP’s most recent proxy statement).  He is economically incentivized to exit his LTRPB stake for maximum value. He obtained his LTRPB stake in December 2014 when he signed a five-year compensation agreement with Liberty beginning January 1, 2015 and ending December 31, 2019 as well as a separate letter agreement with Malone.  In our view, it is logical that the probability of a LTRP sale increases as we approach December 31, 2019.

How would a control premium on LTRP’s underlying TRIP shares be distributed among LTRPA (which controls ~71% of the LTRP vote) and LTRPB (which controls ~29% of the LTRP vote)?  At public conferences Liberty has suggested that a theoretical sale of LTRP would be an arms-length process subject to a shareholder vote. There is an argument that Maffei may want to structure a transaction to keep a higher proportionate share of the control premium for himself – that is, arguing that LTRPB shares should get ~29% of the premium (based on LTRPB’s voting rights) rather than ~4% (LTRPB as a percentage of total LTRPA/B shares outstanding).  From a pure corporate governance perspective though, LTRPA holders will ultimately have the final say (Maffei has a blocking stake but not enough to unilaterally dictate terms). Liberty has historically been shareholder friendly, and the LTRP spread does not currently discount a reasonable probability of a control premium accruing to LTRP’s underlying TRIP shares (we are not at the point of debating what proportionate split of such a premium the spread may be discounting).  As a final mitigant, since Maffei owns more than 15% of LTRP he is defined as an “interested stockholder” under Section 203 of the Delaware General Corporate Law. This would effectively prohibit a business combination involving Maffei and a third party for a period of three years unless the deal were approved by holders of 66⅔% LTRPA/B shares not owned by Maffei.

It is important to note that there is no tax treatment uncertainty with regard to LTRP’s TRIP stake since the LTRP spin has been grandfathered by the IRS.  LTRP reported in conjunction with the spin that it received a formal Private Letter Ruling (“PLR”) from the IRS blessing the tax integrity of the structure.  LTRP began trading a year before Yahoo’s aborted spin of Yahoo Small Business catalyzed the IRS to more closely scrutinize the distribution of large, separately traded equity stakes alongside small, almost token operating businesses.

Why does this opportunity exist?  LTRPA/B actually traded at double-digit percentage premium to its simple NAV on a gross spread basis last year.  The spread widened materially as TRIP stock rose ~26% from ~$39 to ~$49 following 1Q18 earnings on May 8 and LTRPA/B did not fully co-participate in large part due to a lack of natural buyers of LTRP.  This dynamic has been exacerbated by event-driven de-risking due to volatility in large, concentrated, consensus arbitrage positions such as NXP Semiconductors (“NXPI”) over the past month as well as ahead of the upcoming court decision in AT&T / Time Warner (“TWX”) on June 12 (a victory for TWX is seen as thematically spread-tightening and vice versa).

Looking through these idiosyncratic dynamics, we believe the LTRP spread should normalize towards parity by year end and begin to trade at a premium in 2019 as the market appreciates the potential for a change in control of LTRP.  On a near-term mark, the risk would be event-driven volatility following a TWX loss catalyzing a mass widening of spreads, where we could see the current ~12% gross widen towards ~15-20%. In addition, LTRP trends to lag TRIP directionally in the nearer term, so when TRIP moves sharply up (down) the LTRP spread tends to widen (narrow).  Such events present opportunities to add to a LTRP spread that is already at a historically wide level with little conceivable probability of realized capital loss given the math of the simple NAV in context of the incentives in play. The more realistic risk is LTRP trading like a range-bound “dead money” spread for longer than 12-24 months if Maffei renews his contract beyond year-end 2019 and sees little rush in collapsing LTRP into TRIP to simplify the structure.

Reference Links

LTRP S-1 Filing: https://www.sec.gov/Archives/edgar/data/1606745/000104746914006875/a2221042zs-1a.htm

Filing Confirming Receipt of PLR (“private letter ruling issued to Liberty by the IRS”): https://www.sec.gov/Archives/edgar/data/1606745/000110465914063370/a14-11716_8ex8d1.htm

Catalyst

* Acquisition of LTRPA/B by TRIP or a third party (GOOG/FB/BABA/BKNG).

* Normalization of the spread towards parity from current ~12% as idiosyncratic backdrop falls away.