Description

Investment Overview:

GLIBA/LBRDK has been a solid performer YTD, but has seen a material expansion of its discount to publicly traded NAV over the past 3 months. While we certainly can’t claim to be original with this name as members of the VIC community are no strangers to Charter / the Liberty complex, owning GLIBA/LBDRK could quietly yield a double digit IRR over the medium term, as we believe its lookthru stake in Charter will continue to compound and be relatively downside protected/insulated from COVID related headlines, while management will simultaneously work to close the widening NAV discount.

GCI Liberty is merging into Liberty Broadband to simplify its organizational structure, save some overhead costs, create tax advantages related to monetizing its public equity stakes, and move to collapse its discount to NAV. This transaction represents a simplification of the GCI Liberty story and gives investors the opportunity to own what we view as a cheap Charter stock at a widening discount to NAV, with additional upside levers from (i) accretive/opportunistic share repurchases at both Charter and Liberty Broadband (two layers of discount capture), (ii) tangible and intangible synergies from the merger, and (iii) potential tax advantaged transactions to close the disconnect.

GCI Liberty Overview:

GLIBA was created as a merger between General Communications Inc. & Liberty Ventures (formerly LVNTA, for those who were familiar with this complex) in 2018, where QVC (now Qurate Retail) contributed the assets of Liberty Ventures into GCI in exchange for a controlling stake of the PF company. Post transaction, GLIBA is comprised of a few material assets, which I will separate into 2 buckets -- (i) shares in publicly traded companies Liberty Broadband (LBRDK), Lending Tree (TREE), and Charter, (ii) Legacy GCI (Alaskan Cable Business) + Evite. As prior writeups have indicated, the GLIBA / LBRDK complexes have traded at a discount to NAV, much to the frustration of management / John Malone (who have called it out in basically every investor deck possible). While there are certainly some reasons for the discount to persist -- namely the potential tax consequences & a governance restriction on how much of CHTR Liberty is allowed to own, management has historically been fixated on closing the gap.

Current capitalization of the GLIBA is: 

Note that OIBDA here refers to OIBDA of GCI Alaska + cash burn at Evite.

Liberty Broadband Overview:

Liberty Broadband was spun out of the old Liberty Media Corp. (LMCA) in 2014 with a ~25% equity stake in Charter and 100% ownership of SkyHook (which is a location services type GPS co that burns cash, so we attribute 0 value to it). LBRDK has traded at a material discount to NAV historically, but that discount has widened in the past few months.

GLIBA / LBRDK Merger: 

In August 2020, the company announced a reorganization whereby GLIBA would merge into LBRDK. GLIBA shareholders would receive 0.58 GLIBA shares per share of LBRDK, with the transaction expected to close in 1H’21. Consolidating GLIBA into LBRDK allows for (i) the ability for LBRDK to add more shares of CHTR at a discount to market, and (ii) a tax-free “buyback” stock by cancelling the LBRDK shares held by GCI (effectively accreting value to shareholders as a buyback would). The transaction allows GCI shareholders to avoid paying capital gains taxes on LBRDK, as the synthetic buyback just results in a tax-free cancellation of shares.

We view this transaction as a material positive. It (i) simplifies the story in a tax advantaged way (stock for stock sale), (ii) allows for a lookthru share repurchase, (iii) will likely create some cost savings on G&A / corporate, and (iv) adds liquidity to the common stock.

Surprisingly / to the contrary, the discount to NAV has materially widened over the past 3 months. Charter shares have rallied 24% YTD vs. LBRDK shares +9% YTD. We observe a significant widening in the discount post the announcement of the GCI transaction, with rumors of the transaction (and the increase in discount) both beginning in late June / early July. 

Alongside the announcement of the GLIBA merger, LBRDK announced an expansion of its buyback program from $200MM to $1.2BN, citing the widening discount to NAV. We don’t have a great handle for why the discount to NAV has widened so much, but have kicked around the ideas of (i) a lack of sellside coverage (both GCI and LBRDK only have 4 covering analysts, and 3/4 are boutiques), or (ii) current LBRDK investors unhappy with the deal complicating what was once a pureplay way to own CHTR at a discount, or not necessarily wanting to figure out what the Alaskan cable business or Lending Tree do. Ironically on the second point, the current discount implies that investors are buying GCI and Lending Tree for free, and STILL have it trade cheap to NAV.

Charter Overview:

The GLIBA/LBRDK discussion naturally raises questions about the material asset of the combined company, an equity stake in Charter. Quite a bit has been discussed re: Charter in previous VIC threads, so I will keep this relatively brief. Charter is the largest pure-play cable operator and the second largest broadband provider in the US (16.MM video, 28.1MM HSD and 10.6MM voice subscribers as of Q2'20A). CHTR's subscribers are primarily located in New York, southern California, the Carolinas, Central Florida, Ohio and Texas. In 2016, CHTR merged with Time Warner Cable (TWC), which, upon deal close, then acquired Bright House Networks (BHN) combining the second, third and sixth largest operators.

COVID has had basically no material impact on this business - the company cites <$100MM of EBITDA impact in Q2, and this company does $25BN of EBITDA. An economic slowdown likely inhibits the forward growth story / their ability to add subscribers, but we don’t view there to be material downside to current numbers from COVID.

To summarize our thoughts on Charter, we tend to believe there is still room to run, despite the strong performance YTD. While video subscribers are certainly challenged as more people continue to cut the cord, we would note that (i) this decline has been slow to prove out (the company actually grew video subs in Q2’20!) and (ii) the company has been able to more than offset the decline in low margin video subs with an increase in higher margin / stickier broadband subscribers. Cable is still one of the dominant / most efficient broadband technologies today, so we see value in the technology platform relative to competing technologies. In conjunction with the growth we expect in top-line / EBITDA, this company will generate significant amounts of FCF (normalized $10BN+ / close to $55-60 / share, implying a double digit FCF yield) and will likely continue to use it for significant share repurchases and accretive M&A. At today’s share price, we still believe that shareholders can earn a HSD / low double digit IRR by owning Charter, particularly as the company buys back stock accretively. 

CHTR's management team is regarded as one of the most experienced teams in the cable industry. Tom Rutledge has ~40 years of experience as a CEO, and all our channel checks suggest that he is a very well respected persona. He joined CHTR from Cablevision, where he was the COO from 2004-2011 and led industry innovations such as triple-play bundles / made the company one of the most profitable US operators. Through his tenure at CHTR, Rutledge heavily invested in infrastructure as well as product/package improvement, and was able to close the gap in digital voice and broadband penetration relative to peers. The company has also successfully executed transformational M&A under his leadership, going from the 4th largest cable provider to the 2nd largest in the US. CFO, Chris Winfrey, joined Charter in 2010 and previously served as CFO of Unitymedia Gmbh from 2006 to 2010. John Bickham, COO, joined Charter from Cablevision in 2012 with ~30 years of industry experience. 

Looking at forward numbers post margin expansion + significant share repurchases (note that we credit $10-15BN / annum), we can see Charter being worth ~$800 / share (with realistic upside cases that can value the business at ~$1,000 / share). Over a 3-4 years horizon, these levels imply a HSD/low double digit equity return, and do not give credit for (i) any material value of CHTR’s nascent mobile business, (ii) material return on the current growth capex the company is spending, (iii) the ability to reprice the debt stack upon deleveraging from all its cash generation, or (iv) cash tax shields from its heavy expected capital expenditures (as we are overly onerous in our cash tax assumption today). Our valuation compares favorably to cable comps trading around 9-10x today.

LBRDK SOTP:

Putting all of this together, we value LBRDK using the following SOTP (with our input valuation for Charter equity).  

Investors can choose to hedge out the CHTR stake to the extent they want to do so, but we are comfortable with the risk in Charter as outlined above, so don’t mind owning it outright (especially given the embedded downside protection from buying at a discount).

Obviously, this price target involves a complete closing of the discount to NAV. Historically however, the discount has consistently been in the 10-15% range, so assuming that we attribute a discount of 15%, the FV table at the bottom looks something like this:

One important note: LBRDK may not be the beneficiary of buybacks improving its discount to NAV in Charter as much as an ordinary shareholder. LBRDK has a governance agreement with Charter whereby it cannot own more than 26% economic interest in CHTR, and its current ownership stake sits at around 24.4%. As a result, when Charter buys back stock in the future, 26% of the total shares repurchased in the market must be LBRDK shares -- meaning, if Charter does $10BN of buybacks, ~$2.5BN must be sent to LBRDK in exchange for shares. LBRDK is hoping to restrike the terms of the governance agreement such that its ownership can go over 26%, but such efforts are hard to underwrite to.

The governance construct materially changes the IRR profile + equity returns for LBRDK as it pulls forward the CHTR stake tax liability (which management thinks will happen at an 8% rate given that a portion of the dividends will be tax deductible), but notably, it improves the ability of LBRDK to buyback stock at a discount with more cash on hand. If we treat CHTR share repurchases as fully-taxed “dividends” - where LBRDK receives the cash upon a buyback program being put in place, the CHTR IRR profile seems worse (as LBRDK cannot fully benefit by holding out upon a buyback. However, we would note that LBRDK would be able to buy a significant amount of stock back as CHTR does so. See below for our assumptions with a CHTR buyback program flowing to LBRDK as dividends / tax-free interim CF (which LBRDK then uses to buyback stock) instead of accreting to equity value at a discount, and the subsequent impact it has on LBRDK discount. We assume Charter buys back stock with substantially all of its generated FCF:

Bottom line: any way we really cut it, there is a huge discount to NAV here that is hard to justify post the aforementioned transaction. 

NAV Discount / Considerations:

The blowout of the discount clearly made us interested today -- the previous wides on the discount were in 2016, when it got as wide as 17% -- but an important consideration is obviously how management will deal with closing it. As mentioned previously, management has significantly expanded its buyback program in light of this transaction, and is obviously aware of the growing NAV discount.

A very important consideration on the discount is tax-related, as LBRDK has a relatively low basis in CHTR as compared to its current trading price (the last material investment was made when CHTR stock was <$200 / share). However, of note, the current discount implies well in excess of full taxes paid out on a sale of CHTR stock -- as the taxable gains liability may be ~$4-5BN, but the NAV discount is $7BN+ at current CHTR prices.

One idea we have tossed around is that of a stock for stock takeout of LBRDK by CHTR, which feels like a logical path forward. This would allow LBRDK / John Malone to defer taxable gains on CHTR stock, serve as an implicit buyback for CHTR and expand its discount to NAV, simplify CHTR governance, and also allow Charter to roll up GCI’s Alaska business (which has ~$350MM+ of G&A that CHTR may be able to rationalize / simplify). 

Without getting too deep into the nuances, buybacks or a potential merger represent catalyst driven opportunities for management to cut the discount, which they are fixated on doing. While we don’t have a view on which path management will explore to create value, we take comfort in knowing there are multiple paths.

Risks:

Cord cutting accelerates faster than the company can add broadband subscribers

5G/newer satellites are fast growing threats to cable technology much earlier than anticipated

Catalyst

Share Buybacks by LBRDK and by CHTR

CHTR M&A of LBRDK