Description

I feel like this could be a case study in a hypothetical 25^th anniversary edition of You Too Can Be a Stock Market Genius.  Greenblatt could even keep all the Ginsu Knives jokes! 

How’d you like to participate in a publicly traded LBO of QVC???  Anyone?  Anyone?  Bueller?  

For the three of you still reading, I’d reference you to Hal’s 10/19/18 write-up on QVC.  In fact, you can probably even use the same financials as QVC has been remarkably flat since that time period (and for many years before that too!).  Meanwhile, the stock has halved since then…

Hal’s write-up does a great job of outlining the key positives of the business and the bear thesis, which seems to be essentially the same today.

I’m going to focus my write-up primarily on the recently announced special dividend, which will turn QVC into a highly levered stub equity that trades at an absurd equity FCF yield pro-forma for the special dividends.

Today, QVC trades at $10.28 per share or a $4.3Bn market capitalization.  The Company has $948mm of cash, $71mm of investments, $6.7Bn of debt, and $0.1mm of minority interest for a total EV of $10.1Bn.  Yesterday, the Company declared a special cash dividend of $1.50 per share or $633mm.  But wait there’s more…you also get $3.00 per share or $1.3Bn of 10-year, 8% preferred stock.  But wait there’s more…you also get….a SET OF GINSU KNIVES!! 

OK, you don’t really get the knives, but maybe next dividend... 

After these distirubtions, here's what the Company's market capitalization and EV will look like:  

The Company generated $1.9Bn of LTM EBITDA, meaning you are buying QVC for 5.2x EBITDA.  The Company has an interest burden of ~$380mm per year and spends ~$275mm per year in CapEx.  The Company also loses $160mm on investments each year (sounds like my track record!) in renewable energy products with favorable tax attributes, which results in minimal cash taxes paid.  Further, you will have $100mm of preferred dividends payable per, and so I think owner earnings through the equity are $1Bn.  Resulting in a 43% equity free cash flow yield. 

But Mustang, this is just financial engineering.  Everyone knows QVC is a declining business.  Plus, how do we know that preferred equity is going to really trade for $3 per share.  I mean who wants an 8% yield on a 10-year piece of preferred to QVC.  Also, won’t they eventually have to pay some taxes?

I’ll answer those in reverse order even though you would probably like them answered in order.  

Taxes: 

You’re probably right, I mean everyone eventually has to pay up and I don’t really know how their investments are structured, etc.  That said, I do gain some comfort from that John Malone has an extraordinary talent for delaying the day of tax reckoning. 

Oh, I probably should have mentioned him earlier (maybe more people would have read on if I wasn’t making terrible Ginsu Knives jokes and put John Malone up front in the write-up).  Especially since it’s John Malone week on VIC!  I probably should have asked, “How’d you like to participate in a publicly traded LBO with John Malone!!!”.   Anyway, he owns 27.7mm shares or ~$280mm worth of stock.  He’s worth $6.6Bn, so obviously he’s got bigger things going on, but hey no one likes to lose $280mm either. 

Back to the taxes, I don’t think on a normalized basis you would have both losses from investments and a tax burden.  If that’s the case, then you’d have about $1bn of taxable income, which at 21% is $210mm or about $50mm more than the loss on investments I’m assuming above, which really doesn’t change the story that much from an equity FCF yield perspective.

Preferred Value:

Admittedly, there aren’t a lot of preferred securities that go this deep in the capital structure from a capitalization standpoint.  I did a search of non-energy and non-financial preferred and only found three, one of which had recently suspended distributions.  Of the two remaining companies (CAI and ATP), each were levered through the preferred in the 7s and 8s v 3.9x at QVC and had much worse distribution coverage (1.2x – 1.3x v 3.5x for QVC).  CAI and ATP are both perpetuals, while QVC’s preferred is a 10-year.  CAI trades at an 8.9% yield and ATP trades at a 7.5% yield.  So, we are all good if the preferred trade at ATP yields.     The preferred would need to trade a 94% of face to get to CAI’s yield or in other words would add $0.18 per common share to our purchase price, resulting in a 42% equity free cash flow yield. 

QVC is a Declining Business:

Probably, but at what rate?  EBITDA has declined at a ~3% CAGR for the past five years, and the secular issues (Amazon, cord-cutting, etc.) have all been around for a while now.  If you model out a 3% decline in EBITDA for each of the next five years, owner earnings decline about 6% per year.  Even assuming a 20% cost of equity given the levered nature of the business and a 6% decline per year in equity earnings into perpetuity results in a 3.8x equity FCF multiple or 26% FCF yield, which still implies material upside at today’s prices.

But wait there’s more…The Company grew last quarter! 

“What?” you say.  “QVC? Oh, must be because everyone was at home and bored?  That’ll change.”

Maybe that’s right and Q2 2020 will be an anomalous quarter, but QVC does have a strong history of driving repeat business once they get a new customer (see Hal’s write-up) and the stock price makes even flattish results really exciting from here.  Plus, it demonstrates the resiliency of the business.  

Financial Engineering:

I do gain comfort that you are buying the business at a 5.2x EBITDA multiple relative to compared to the 3, 5, and 10 year average multiples of 6.7x, 7.4x, and 8.0x, respectively.  Alternatively, you can look at it as buying the business for a 16.7% EBITDA less CapEx yield.  Even if EBITDA continues to decline at 3%, that seems attractive.

Catalyst

- Special dividend occurs