LILAK - How Liberty Latin America Can Unlock Its Value In 2023 And Beyond

2023-04-19 17:31:56 ET

Summary

• I believe LILA has an implied upside of 45.42% from current levels.
• Multiple catalysts for growth are occurring or developing over the course of 2023.
• The company has strong growth prospects, driven by underpenetrated markets, M&A, and developing partnerships.
• LILA has a proven track record of improving its operational performance and cash flow generation.
• The market seems to overlook the positives and focus on the negatives, such as its high debt and complicated corporate structure both of which are just misunderstood in my view.

Liberty Latin America (LILA), (LILAK) is a hidden gem in the telecommunications sector. It serves millions of customers in Latin America and the Caribbean with video, internet, phone, and mobile services. It has a huge market opportunity and a strong competitive edge. Most investors and analysts are overlooking it, and I believe that’s a big mistake.

Company Overview

As an entity that commenced as a spin-off of Liberty Global (LBTYA), Liberty Latin America provides high-speed internet, data services, video, and mobile services across its target markets in the Caribbean and Latin American nations. The company is expected to benefit significantly from the rising demand for modern communication methods in these areas while maintaining a relatively low penetration rate compared to developed nations. With established operational excellence procedures and strategic merger & acquisition activities, LILA enjoys broadened diversification and scalability opportunities. Furthermore, with John Malone's significant stakeholder position backing it, LILA can tap into his history of delivering noteworthy returns for shareholders. In comparison to its peers and intrinsic value, the market is currently undervaluing LILA which presents a discounted opportunity. Investors who are seeking exposure in the Latin American telecom sector and are looking for a good risk-reward proposition should consider investing in LILA for the long-term.

Liberty Latin America enjoys a dominant position in its key markets, where it faces limited competition, benefits from large scale, and earns customer trust. The company has an edge over its peers who mainly operate in one or two segments, while Liberty Latin America provides a comprehensive range of services. As per its investor presentation, the company holds the top spot in broadband and video in most of its markets, and the runner-up spot in mobile in Puerto Rico and Chile. It also owns a leading subsea cable network that spans 40 markets in the region, delivering high-speed and low-latency connectivity. The company capitalizes on its diversified portfolio of services to offer bundled packages and cross-selling opportunities to its customers, boosting its revenue and retention.

Liberty Latin America has very impressive growth opportunities in the Latin American markets. The aforementioned low competition and high demand for its broadband, video, and mobile services mean that the company has various opportunities to extend its market leadership. This includes upgrading and expanding its network coverage, launching new products and bundles, and pursuing strategic acquisitions and partnerships. For example , the purchase of AT&T’s operations in Puerto Rico and the U.S. Virgin Islands has diversified LILA’s revenue mix and created synergies and cost savings. Moreover, LILA operates in markets that have low penetration rates compared to mature markets like the U.S., implying a long-term growth potential from rising data consumption and customer adoption. LILA’s management, among its leadership ranks, the legendary media investor John Malone, has a proven track record of creating value through operational excellence and capital allocation.

Catalysts

Liberty Latin America has several drivers for unlocking value in the near future. These include: finalizing the purchase of Telefonica’s wireless business in Costa Rica, which will add millions of new customers and expand its service offerings; bouncing back from the impact of Hurricane Maria on its Puerto Rico operations, which will improve its financial performance; pursuing more deals and partnerships in the highly fragmented Latin American and Caribbean markets, where Liberty Latin America has a competitive edge; and rolling out new digital services powered by Plume, which will increase its customer satisfaction and retention. Let’s take a closer look at these drivers.

In an effort to revolutionize their service offerings and stave off competition from rival companies while expanding its footprint across Central and South America, Liberty Latin America announced a ground-breaking move in 2020 - acquiring Telefonica’s wireless business in Costa Rica. With the conclusion of this transaction, Liberty has added another feather to their cap by acquiring over two million new mobile connections alongside hundreds more broadband offerings via its subsidiary firm named Cabletica. This sizable expansion has surely bolstered their presence in existing markets while making it easier than ever before for consumers who need internet or phone services without breaking bank accounts. Liberty Latin America's portfolio will experience diversification through mobile services inclusion in Costa Rica, complementing their existing broadband and video offerings. Such a move presents cross-selling and bundling opportunities, ultimately resulting in higher customer value delivery.

Liberty Latin America's recovery of its Puerto Rico business has been a necessary hardship given the aftereffects of Hurricane Maria that propagated damage throughout the island and its entire infrastructure in 2017. With an investment of over $300 million to restore and enhance network infrastructure, along with improving customer service, the company has pushed off adverse impacts. Its introduction of new services such as 5G mobile, fiber broadband and streaming content has helped them maintain a healthy customer-centric approach leading to a strong rebound in revenue and cash flow in Puerto Rico.

The rapidly evolving telecommunications industry has opened up plenty of opportunities for Liberty Latin America to consolidate with other companies operating within the fragmented markets of Latin America and the Caribbean. Leveraging its extensive expertise and strong market presence within the region, Liberty is perpetually seeking out lucrative acquisition opportunities that will help it expand its reach even further. Having already acquired several key entities such as Cabletica, AT&T's assets in Puerto Rico and US Virgin Islands, Telefonica’s operations in Costa Rica – Liberty remains highly motivated to continue transforming how modern communication technologies operate across these evolving markets. Liberty Latin America has fortified its foothold in the market, expanded its range of services and products, boosted its income stream and cash flow, and harnessed collective advantages through these strategic acquisitions.

Another catalyst for Liberty Latin America is its partnership with Plume, a leader in personalized communications services. In October 2022, Liberty Latin America launched WOWfi powered by Plume HomePass, a new service that provides customers with customized smart home solutions. These include fast and reliable WiFi, parental controls, cybersecurity, motion detection, guest access, and privacy protection. By using Plume’s cloud-based platform and open source software, Liberty Latin America can offer these services more quickly, efficiently, and satisfactorily to its customers. Puerto Rico is the first market to receive this service, but Liberty Latin America plans to roll it out to other markets in its footprint over time.

Latin America’s Liberty and Claro have teamed up to form a new company called VTR Claro, which will merge their fixed and mobile assets in Chile. This strategic partnership is expected to offer several benefits for both sides, including cost savings, increased synergies between the companies, and enhanced competitiveness within the Chilean market. In addition, this deal will reduce Liberty Latin America’s debt by $2.5 billion. This is a big win. As per recent announcements, VTR Claro is gearing up for significant gains in Chile's telecommunications arena over the next two years. By mid-2023, experts anticipate that VTR Claro will command around 30% of the fixed-line broadband space and roughly 25% of national mobile services. Such projected success demonstrates immense potential for substantial growth and progress within this industry.

Valuation

To value Liberty Latin America, I am using a relative valuation approach based on the company’s valuation multiples compared to its peers and the industry averages. It is difficult to assess the company based on a DCF.

Valuation Multiples

First up we will look at enterprise value to revenue (EV/Revenue) and enterprise value to EBITDA (EV/EBITDA) multiples, which are commonly used for telco companies.

The table below shows LILA’s EV/Revenue and EV/EBITDA multiples, along with the averages for its peers: Globalstar ( GSAT ), Lumen ( LUMN ), EchoStar ( SATS ), AST SpaceMobile ( ASTS ), Cogent ( CCOI ) and the industry.

Source: Seeking Alpha, Yahoo Finance

As you can see, LILA trades at a significant discount to its peers and the industry on both multiples, indicating that it is undervalued by the market.

Price to Book (P/B) Multiples

The company is also discounted based on book value or net assets of the company.

The table below shows LILA’s P/B multiples, along with the averages for its peers and the industry.

Source: Seeking Alpha, Yahoo Finance

Calculated out LILA's book value per share is roughly $8.87. Yes you read that right. The company is nearly trading at book value.

Undervaluation Factors

Why is LILA trading at such a low valuation compared to its peers and the industry? I believe there are several factors that explain this discrepancy, and that also provide an opportunity for value investors to buy LILA at a bargain price.

Let’s start with the elephant in the room: debt. LILA has a lot of it: $8.43 billion to be exact. That’s 5.7 times its EBITDA, which is higher than the industry average of 4.5 times. This might scare some investors away, but I’m not worried. Here’s why.

First, LILA’s debt is mostly long-term and fixed-rate. It has an average maturity of 7 years and an average interest rate of 6.5%. This means LILA doesn’t have to worry about refinancing or interest rate hikes anytime soon.

Second, LILA’s debt is mostly siloed and non-recourse. This means each business unit has its own debt and there is no cross-default or cross-guarantee between them. This reduces the risk of contagion and gives LILA more flexibility to manage its capital structure.

Third, LILA’s debt will go down by about $2 billion once it closes the joint venture with Claro in Chile by the end of 2023 as mentioned in my catalyst section. This deal will also save LILA about $300 million per year in capital expenditures, which will free up more cash flow for debt repayment or growth investments.

Finally, LILA’s debt is backed by high-quality assets that generate stable and growing cash flow. LILA operates in attractive markets with low penetration rates, high demand for broadband services, and limited competition. LILA has a leading market position in most of its geographies, with a diversified product portfolio and a loyal customer base. LILA also has a strong track record of improving its operational performance and cash flow generation over the years.

So, I'd say LILA’s debt is not as bad as it looks. In fact, it might be an advantage in some ways. As David Einhorn once said: "Debt can be good if it creates more value than it costs."

- David Einhorn (2010). Fooling Some of the People All of the Time: A Long Short Story

Corporate Structure

Another reason why LILA is undervalued is its complex corporate structure. LILA has three types of shares: LILA, LILAB, and LILAK. LILA and LILAK are regular shares with one vote each. LILAB is a special share with 10 votes each. LILAB is owned by John Malone, the boss of Liberty Global and a media legend. LILAB also has a 25% say in Liberty Global.

LILA also operates in more than 20 countries in Latin America and the Caribbean. Each country has different rules, economies, and currencies. LILA uses U.S. dollars to report its numbers, but some of its businesses use local money. This means LILA faces currency risk and translation changes.

LILA also has some joint ventures and minority stakes in some of its markets, like Chile, Costa Rica, and Panama. These deals may limit LILA’s control and influence over these businesses. They may also create potential conflicts with its partners.

But I think LILA’s corporate structure also has some benefits that make up for its drawbacks. For example:

LILA’s different shares let investors choose their preferred voting rights and liquidity. LILA and LILAK are more liquid and cheaper than LILAB, while LILAB offers more voting power and a higher dividend.

LILA’s geographic diversity lowers its risk to any single market and lets it capture growth opportunities across the region. LILA also gains from economies of scale and scope, as well as cross-selling and bundling synergies among its products and services.

So, LILA’s corporate structure is not as bad as it seems. In fact, it might be a plus in some ways. As Warren Buffett once said: “You don’t have to understand every bit of a business to invest in it.”

- Warren Buffett (1996). Berkshire Hathaway Annual Meeting

Using an EV/EBITDA valuation model I will assert a price target, which includes a few assumptions based on my analysis.

1. LILA has an EBITDA of $1.34 billion and an EV/EBITDA ratio of 6.33x.
   • These two figures (6.33 x $1.34 billion) give us an enterprise value of $8.48 billion.
2. LILA would have a net debt of $5.42 billion making some assumptions about Its JV operations.
   • Subtracting this from the EV ($8.48 billion - $5.42 billion) gives us an equity value of $3.06 billion.
3. 214.15 million shares outstanding.
   • After dividing the equity value by the number of shares outstanding ($3.06 billion / 214.15 million) I assign a price target of $14.29.

Conclusion

I believe that LILA, is undervalued by the market and has significant upside potential. The company has strong growth prospects, driven by underpenetrated markets, M&A, and developing partnerships. Liberty Latin America also has a proven track record of improving its operational performance and cash flow generation. However, the market seems to overlook these positives and focus on the negatives, such as its high debt and complicated corporate structure. These factors may explain why LILA trades at a discount to its peers and the industry on EV to EBITDA, EV to Revenue, and P/B. I believe that this discount is unwarranted and will narrow over time as LILA continues to execute on its growth strategy and deleverage its balance sheet. Therefore, I assign a buy rating to LILA with a price target of $ 14.29 target price per share, which implies an upside of 45.42% from its current level based on my EV/EBITDA model. I chose to assign a conservative estimate because certain factors like debt reduction are not guaranteed. I expect this target to be reached within 16-18 months. This is an exceptionally rare opportunity to buy a high-quality company at a bargain price. Don’t miss it. What do you think of LILA? Let me know in the comments below.

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