I recommend a long position in Series A Liberty Ventures Common Stock (NASDAQ: LVNTA).  The stock is worth at least $60 per share and offers a wide margin of safety at its current price, $44.85.  If Liberty management is able to tax efficiently monetize Venture’s stakes in Expedia and TripAdvisor and effectively reallocate that capital, the upside could be much more significant.

(Note: the liquidation scenario is just for illustrative purposes. There is zero chance Liberty would retire its exchangeables before maturity, take a significant tax hit and forgo substantial future tax benefits)

(Figures in thousands, except per share figures)
				Liquidation		Low		High
	Add: Cash			1,325,000	-	1,325,000	-	1,325,000
	Add: Cash from Rights Offering	$34.43		312,429	-	312,429	-	312,429
	Add: Expedia Equity Interest	51.72		1,790,024	-	1,790,024	-	1,790,024
	Add / Less: Expedia Forward Sale	34.32		(208,848)	-	(208,848)	-	(208,848)
	Add: TripAdvisor Equity Interest	33.94		886,170	-	886,170	-	886,170
	Add: IILG Equity Interest	18.83		313,406	-	313,406	-	313,406
	Add: Tree.com Equity Interest	15.38		42,664	-	42,664	-	42,664
	Add: Time Warner Equity Interest	42.19		919,115	-	919,115	-	919,115
	Add: Time Warner Cable Equity Interest	88.96		486,456	-	486,456	-	486,456
	Add: AOL, Inc. Equity Interest	32.38		64,126	-	64,126	-	64,126
	Add: Other Non-Operating Assets			0	-	0	-	0
	Add: Net Tax Benefits of Exchangeables			(978,000)	-	250,000	-	250,000
	Less: Debt			(2,548,000)	-	(2,548,000)	-	(2,548,000)
	Less: Preferred Stock			0	-	0	-	0
	Less: Non-Operating Liabilities			0	-	0	-	0
	Less: Deferred Tax Gain on Debt Retirements			(313,000)	-	(250,922)	-	(250,922)
	Less: Deferred Taxes on Equity Interests			(1,065,898)	-	(1,065,898)	-	0
	Less: Non-Controlling Interests			0	-	0	-	0
	Equity Value			$1,025,643	-	$2,315,722	-	$3,381,620
	Series A Common Stock	25,777
	Series B Common Stock	1,448
	Rights Offering	9,075
	Options	839
	Effective Shares Outstanding	37,140
	Value per Share			$27.60	-	$62.40	-	$91.00
	Margin of Safety - Equity	$44.85		-62.5%	-	28.1%	-	50.7%

 

Liberty Ventures is a tracking stock that was created as a result of Liberty Interactive Corporation’s recent recapitalization transaction.  The goal behind the recapitalization transaction was to unlock the underlying value of Liberty Interactive Corporation by separating the Company’s straightforward operating assets from its more complex bits and pieces, including non-controlling interests in a variety of publicly-traded companies and exchangeable debt securities that have some unique tax attributes.  The new Liberty Interactive tracking stock is the simple one and Liberty Ventures is the complex one.  As an aside, I believe the primary impetus for improving the valuation of Liberty Interactive is to set up a stock-for-stock merger with HSN.

Liberty Ventures’s primary assets and liabilities include:

i) $1.325 B in cash

ii) Expedia – 21.8 MM shares of Common Stock and 12.8 MM shares of Class B Common Stock.  Liberty entered into a forward sales contract on 12 million shares of Common Stock in March 2012 at a per share forward price of $34.316.  The forward contract may be settled, in October 2012, in stock or cash, at the election of Liberty.

iii) TripAdvisor – 13.3 MM shares of Common Stock and 12.8 MM shares of Class B Common Stock.

iv) Interval Leisure Group – 16.6 MM shares of Common Stock

v) Tree.com – 2.8 MM shares of Common Stock

vi) $1.138 B principal amount of 3.125% Exchangeable Senior Debentures due 2023 – each $1,000 face value debenture is exchangeable into 19.136 shares of Time Warner (NYSE: TWX), 4.8033 shares of Time Warner Cable (NYSE: TWC), and 1.7396 shares of AOL (NYSE: AOL).  The exchangeable value of each of these debentures is currently about $1,291.  Liberty still owns the reference shares related to this liability, so it is effectively hedged.  These debentures have a put / call feature in 2013, so it is possible that Liberty retires them in the near-term.

vii) $469 MM principal amount of 4.000% Exchangeable Senior Debentures due 2029 – each $1,000 face value debenture is exchangeable into 11.4743 shares of Sprint (NYSE: S) and 0.786 shares of Century Link (NYSE: CTL).  These exchangeables are way out of the money and Liberty no longer owns the reference shares. 

viii) $460 MM principal amount of 3.750% Exchangeable Senior Debentures due 2030 – each $1,000 face value debenture is exchangeable into 8.3882 shares of Sprint (NYSE: S) and 0.5746 shares of Century Link (NYSE: CTL).  These exchangeables are way out of the money and Liberty no longer owns the reference shares.

ix) $373 MM principal amount of 3.500% Exchangeable Senior Debentures due 2031 – each $1,000 face value debenture is exchangeable into 5.2598 shares of Motorola Solutions (NYSE: MSI).  These exchangeables are way out of the money and Liberty no longer owns the reference shares.

x) $414 MM principal amount of 3.250% Exchangeable Senior Debentures due 2031 – each $1,000 face value debenture is exchangeable into 9.2833 shares of Viacom (NASDAQ: VIAB) and 9.2833 shares of CBS (NYSE: CBS).  These exchangeables are moderately out of the money and Liberty no longer owns the reference shares.

xi) $830 MM of net taxable income to be recognized ratably in tax years 2014 through 2018 related to the cancellation in April 2009 of $400 million in principal amount of 2029 Exchangeables and $350 million in principal amount of 2030 Exchangeables

The exchangeable debentures have a material tax benefit associated with them.  Liberty is able to deduct an implied interest rate of 9.0% - 10.0% per annum on the face value of these debentures for tax purposes while only paying a low single digit cash interest rate.  The excess of the deduction over the cash payment builds a tax liability that will reverse when these exchangeables mature or are retired otherwise. 

Liberty had to value three of these exchangeable debentures when it reattributed them between tracking stock groups in February 2010.  The valuation included the value of the net tax benefits and was disclosed in the 10K for fiscal 2010.  That valuation implied a value for the net tax benefits for those three series of exchangeable debentures of $250 MM - $300 MM.

(As of March 31, 2010)
			Fair Value
	4.000% Exchangeable Senior Debentures due 2029		$248,000
	3.750% Exchangeable Senior Debentures due 2030		230,000
	3.500% Exchangeable Senior Debentures due 2031		295,000
	Total Fair Value		$773,000
	Valuation Used for Reattribution	$482,000	-	$526,000
	Implied Value of Net Tax Benefits	$291,000	-	$247,000

I also did a DCF valuation of the net tax benefits of the exchangeables, excluding the 3.125% exchangeables that may be called next year, and came to a valuation of around $250 MM using a 6.0% discount rate. 

Liberty's reported deferred tax liability related to its investments is based on the carrying value of its investments. Most of its investments - and most notably Expedia and TripAdvisor, its largest investments - are equity method investments, and the carrying values are well below cost. Here is how I estimated the deferred tax liability related to Liberty's investments based on their current market value:

 

(As of December 31, 2011)
	Carrying Value of Investments:
	Time Warner		$787,000
	Time Warner Cable		348,000
	AOL		30,000
	Expedia		621,000
	TripAdvisor		184,000
	Other		100,000
	Total Carrying Value of Investments		$2,070,000
	Deferred Tax Liability Related to Investments		$210,000
	Assumed Effective Tax Rate		38.5%
	Implied Excess of Carrying Value over Tax Basis		$545,455
	Estimated Tax Basis of Investments		$1,524,545
	Current Market Value of Investments		$4,293,113
	Less: Estimated Tax Basis of Investments		(1,524,545)
	Potential Taxable Gain		2,768,567
	Assumed Effective Tax Rate		38.5%
	Potential Deferred Tax Liability		$1,065,898

 

 

There is a rights offering related to the recent recapitalization transaction.  For every three shares of LVNTA received in the recapitalization, a stockholder also received a right to buy an additional share of LVNTA at a 20% discount to the 20 trading day VWAP of LVNTA immediately following the recapitalization. The rights will start trading once the subscription price is established and will expire 20 days after that.

 

This opportunity exists for a few reasons.  First, Ventures is clearly the red-headed step child of the recent recapitalization transaction, so there is certainly some indiscriminate selling occuring by newly minted LVNTA holders who don't want to or can't own it. Second, the rights offering is probably also putting some technical pressure on the stock through tail-swallowing.  Finally, tracking stocks have historically traded at varying discounts to intrinsic value.

 

While I think TRIP and EXPE are within a range of fair value, you could hedge out your exposure to them. Just keep in mind the forward sale and the rights offering when calculating the hedge ratio.

 

I'll add one more point - and this is speculation on my part - but the structure of this transaction is very similar to the one used to originally create Liberty.  At the time, John Malone was the CEO of TCI, but he was primarily a manager. He owned something like 1% of the company. The spin-off and associated rights offering are how he gained his large stake in Liberty. Its possible that this is the opportunity for Greg Maffei to do the same thing. Will be interesting to watch.

- End of rights offering should eliminate associated technical pressure

- Diminishing technical pressure from "spin-off" dynamics over time

- Liberty will likely highlight the underlying value in presentations

- Tax efficient monetization of Expedia and TripAdvisor stakes

- Reallocation of capital (e.g. acquisitions, investments, etc.)

- Sell-side coverage - Lazard recently initiated with a Buy