Description

Summary

Qurate Retail is a collection of well-positioned and well-managed retail businesses, including the dominant video shopping franchise QVC. Qurate has produced tremendous results over the past year, adding record numbers of new customers and substantially increasing profits and free cash flow. QVC’s best-in-class customer loyalty, retention, and unit economics suggest that the company is likely to continue to reap the benefits of this wave of new customers for years to come – and notably, the new customers skew younger than QVC’s traditional base and are more online-savvy. We believe Qurate can continue to sustainably generate $900mm-$1bn of free cash flow per year on a go-forward basis, a 16%-17% yield at the current price. With Liberty Media heavily engaged, we would expect the company to continue to use this substantial free cash flow to drive value for shareholders.

Company History

• 1986: QVC founded by Joseph Segel, initially broadcast live from 7:30pm until midnight each weekday and 24 hours a day on the weekend

• 1992: Barry Diller’s Arrow Investments purchased a stake in QVC, and Diller later became CEO

• 1995: Comcast and Liberty Media acquired QVC. Douglas Briggs became CEO of QVC

• 2003: Liberty Media acquired Comcast’s share of QVC

• 2005: Mike George became CEO of QVC

• 2011: Liberty Interactive split off from Liberty Media

• June 2015: Liberty Interactive is renamed QVC Group

• October 2015: QVC acquired e-commerce website Zulily for $2.3bn

• 2017: QVC acquired the 62% of HSN it did not already own

• 2018: The company adopted the new name Qurate Retail Group and eliminated its tracking stock structure

• 2019: Leslie Ferraro hired as President of QxH (the QVC U.S. and HSN units)

• 2020: QVC remained live through the COVID-19 pandemic, with hosts broadcasting via Skype from around the world. The company initially responded with layoffs to rationalize its cost structure, but ultimately saw meaningful increases in sales and customer interest

• November 2020: Qurate announced that CEO George extended his contract until the end of 2021, when he will be retiring

Business Overview

Qurate Retail is a leading force in video and online commerce globally. The company consists of four segments: QxH, QVC International, Zulily, and Cornerstone.

QxH (60% of 2020 Revenue, 69% of OIBDA)

QVC is the dominant player in the U.S. video shopping business. QVC curates and sells a variety of consumer products via highly engaging, video-rich, interactive shopping experiences. In the U.S., the company reaches 94mn television households including 99% of households subscribing to services offered by television distributors. QVC also reaches consumers via a number of other platforms, including its own apps and websites as well as many non-traditional TV platforms (Facebook Live, Roku, Apple TV, etc.). It has been a primary goal of the company over the past few years to expand its range of distribution and it has been impressive to see what they have achieved on this front.

One of the key strengths of QVC’s model is its incredibly loyal and sticky customer base. The unique, entertaining, and endearing nature of QVC’s video content leads the audience in many cases to feel lasting relationships with hosts and community with other shoppers. This customer loyalty shows through in QVC’s unit economic metrics, which are best-in-class. Existing customers of QVC U.S. typically purchase over 25 items per year for a total spend of greater than $1,300 per customer, with customer retention of ~90%. Fundamentally, video shopping is a very unique and attractive business with a loyal customer base. This is likely why Amazon has attempted several times (without much success) to create its own offering in the space, first via “Style Code Live” (launched in 2016, canceled abruptly in 2017), and more recently with Amazon Live (launched in 2019).

A key reason the fantastic customer economics of QVC are particularly relevant right now is the fact that the company added more customers than ever before during the COVID-19 pandemic. Over the last 12 months ended March 2021, QxH added 3.6 million new customers, 35% higher than the same figure over the preceding 12 months. We expect that this wave of new customers will continue to drive strong results for QVC over the medium-term, as they mature in their purchasing habits and some of them become recurring customers of the business. While there are certainly some unknowns with respect to consumer behavior exiting the COVID-19 lockdown period, several factors give us confidence in the trajectory of the business over the medium and long term:

• QVC has adapted very well to changes in the media landscape, and secured placement on the platforms where consumers increasingly spend their time. Online sales represented 60% of QxH’s total business in 2020 (compared to 44% in 2015) – notably, 89% of QxH’s new customers for the year made their first order online. Additionally, QVC has built impressive positions on OTT services (Roku, Amazon FireTV), vMVPD’s (YouTube TV, Hulu + Live TV), social media (Facebook, Instagram Live), and via the company’s own apps.

• The 2020 cohort of new QxH customers skewed younger than it has in the past, with the company gaining traction in the 25-44 demographic, showing that the model resonates with 21st century consumers:
  

• Key customer behavior metrics for the 2020 new customer cohort look just as attractive as they have in the past; specifically, there has been stability in the % of new customers that go on to make additional purchases, and in the % of new customers that become “Best Customers” (super users that order 20+ items per year):
  

• On a category-by-category basis, QxH’s recent strength has been broad-based. While the results for 2020 were driven mostly by strength in the Home category, in recent months QVC’s fashion categories (Accessories and Apparel) have shown strength as well, as consumers continue to turn to QVC for reopening-linked purchases.

• Fundamentally, QVC has improved its use of digital paid marketing in recent years and will be able to use these channels to maintain momentum going forward to efficiently introduce new customers to QVC. The company has many channels it can use in this respect: social media (one of the more costly channels, but one which produces very high-quality customers), affiliate/influencer marketing, paid search, and audience development arrangements with companies like Roku. Pivotally, QVC’s ability to measure the ROI it gets on spend on these various programs has increased in recent years, allowing management to efficiently toggle across the business.

• In a world where consumers have a deep appetite for unique and high-quality video content, QVC still has significant competitive advantages. The company has talent, resources, and scale that dwarf the competition in video-based shopping – and critically, management has proven adept at experimenting with different formats and media approaches to figure out what works. 

QVC International (21% of 2020 Revenue, 23% of OIBDA)

QVC International brings the QVC shopping experience to approximately 124 million households outside the U.S., primarily in Germany, Austria, Japan, the UK, Ireland, and Italy. The international business follows the same format as QVC in the U.S. – a unique, relationship-driven and engaging model across various product categories.

QVC International has performed particularly well over the past year, with OIBDA growing 14% in 2020. Over the last several years, the international business has generally had stronger growth and stability vs. QxH, due to a variety of factors including less cord cutting impact and a more favorable fashion cycle. We expect that QVC International will continue to produce solid results given its differentiated position.

Zulily (11% of 2020 Revenue, 4% of OIBDA)

In 2015, Qurate acquired Zulily, an online retailer that focuses on a variety of flash sales (typically lasting 72 hours). Zulily was launched in 2010 and has a differentiated model of helping customers find unique bargains on products they would be unable to encounter elsewhere. Zulily’s core customers traditionally have been moms aged 25-45. The business also benefits from a unique inventory and working capital model, as it typically takes orders prior to purchasing stock from vendors, resulting in very quick inventory turnover. The business has had some struggles in recent years, particularly in its customer acquisition via paid and unpaid marketing. However, performance for Zulily improved markedly in 2020, with improvements to the business’s buying/merchandising as well as its marketing strategy. Similar to QVC, Zulily will benefit through 2021 from a significant number of new customers onloaded over the past year.

Cornerstone (8% of 2020 Revenue, 4% of OIBDA)

The Cornerstone business is comprised of a portfolio of home and apparel brands. The home brands are comprised of Ballard Designs, Frontgate, and Grandin Road. Garnet Hill focuses primarily on apparel and accessories. Cornerstone’s brands focus on differentiating themselves through unique design and exclusive distribution in order to limit price competition. The business has traditionally marketed its products via catalogs, but notably online sales represented 76% of Cornerstone’s total business in 2020.

Management

Mike George (age 59) has been CEO of QVC/Qurate since 2005. Mike came to QVC from Dell, where he was the Chief Marketing Officer and also led its U.S. Consumer business. Prior to this, Mike was a Senior Partner at McKinsey & Co. and led the firm’s North American Retail Industry Group. Mike is Chairman of the National Retail Federation Board of Directors, and also serves on the Board of Directors of Ralph Lauren. Mike earned his bachelor’s degree from Northwestern University and his master’s degree in finance from Northwestern University’s Kellogg School of Management.

Recently, Qurate announced that Mike will be retiring from the CEO position at the end of 2021. While we have high respect for Mike’s leadership and the strategic direction he has provided the business, we are confident in the bench of executives below him and believe the company will remain in good hands going forward.

Qurate has benefited over time from its association with Liberty Media and with John Malone, who has served on the company’s board for many years. Liberty is instrumental in the company’s financial and capital allocation policies. Most recently, Liberty helped to drive Qurate’s novel capital return policy, which utilized a dividend of preferred stock in order to efficiently “divide” Qurate's common stock into a bond-like instrument and a more levered common equity. Liberty has created immense shareholder value over time across a number of entities, and we expect that they will continue to help Qurate make value-accretive financial decisions.

Notably, on May 19, 2021, Qurate announced that Chairman Greg Maffei delivered a written offer to John Malone to acquire all of his super-voting Series B Qurate shares at a price of $14.00/share. The transaction is subject to a call agreement that gives Qurate the right to now acquire all (but not less than all) of Malone's Series B shares at the lower of the offer price ($14.00) or 110% of the average closing price of Series A shares over the past 30 trading days ($13.62). The disclosure surrounding this offer stated that Malone provided written notice to the Board of his desire to accept the offer, but that if Qurate exercises its call right, he would prefer to be paid in Qurate Series A shares. This has led some to extrapolate that Malone may be trying to increase his exposure/total number of shares owned in advance of a big special dividend, or even a sale of the company. 

Financials/Valuation

Despite the strong performance of Qurate stock over the past year, the stock still trades at bargain-basement multiples. It’s worth pointing out that Qurate generated $2 billion of free cash flow in 2020, roughly $5.00/share, and also paid its shareholders special dividends worth $6.00/share. These figures compare quite favorably to the current share price of $13.88. While 2020 was of course an exceptional year for Qurate, given the benefits the company received from the lockdown-influenced environment as well as the significant influx of cash Qurate recorded from changes in working capital, the results were extremely impressive. Additionally, the significantly increased customer count suggests strong financial results can continue going forward.

Looking ahead, we believe that Qurate can sustainably generate approximately $900mm-$1bn per year in free cash flow (after adjustments for television distribution rights payments and the dividends to Mitsui, QVC’s Japan JV partner) and grow over time. This represents roughly $2.20-$2.40 per share, or a 16-17% free cash flow yield. We do acknowledge that the company is levered; nevertheless, we would argue that the current price is far too cheap for a company with Qurate’s differentiated position, loyal customer base, and compelling unit economics. Qurate’s strong free cash flow gives Liberty significant firepower to continue with value-accretive capital allocation.

Risks

• Cord cutting. Pay TV subscribers in the U.S. and elsewhere have declined in recent years, and these trends are likely to continue. While this represents a clear headwind to QVC’s video shopping business, the company has managed through it in recent years, and the company has made significant progress in evolving its business and securing placement on digital platforms.

• Price competition. Retail broadly is a competitive industry. Qurate combats this with its highly differentiated model, as well as a healthy mix of proprietary products, but the company must continually invest in providing good values to its customers.

• Consumer behavior exiting COVID-19. There are meaningful unknowns around exactly how consumers will respond to increasingly open social conditions in 2021-2022. While we are optimistic based on what we have seen thus far of QVC’s 2020 cohort behavior, there is still uncertainty.

• Financial leverage. Qurate produces significant cash and has manageable debt levels, but the company does run with a healthy amount of leverage.

Conclusion

In sum, Qurate is a high quality, well-managed, and well-positioned business. We believe that the current price is exceptionally cheap, and that an investment in Qurate is an attractive risk-reward looking forward over a 3-5 year period.

Catalyst

- Continued business growth

- Capital allocation