QRTEP - Qurate Retail: Diving Into The Specter Of Bankruptcy With The 22.5% Yielding Preferreds

2023-07-21 09:37:34 ET

Summary

• Qurate's share price has plummeted by 61% in the last year and 92% over the last five years as bears predict a potential Chapter 11 bankruptcy filing.
• This is against a negative free cash flow profile and $5.8 billion in long-term debt.
• The Series A preferreds offer a 22.5% yield on cost with the likelihood of a bankruptcy filing leading to a large 65% discount to par.

Qurate Retail (QRTEA) (QRTEB) price returns are abysmal. The common shares are down by 61% over the last year and have lost around 92% of their value over the last half-decade. In the view of bears who form the 4% short interest in the commons is a Chapter 11 bankruptcy filing on the back of Qurate's long-term debt balance of $5.8 billion as of the end of its fiscal 2023 first quarter. This risk is real with Qurate now barely trading above Nasdaq's minimum listing requirement and with quarterly interest expenses of $94 million for its first quarter. Qurate is the largest player in video commerce with the group comprised of six retail brands; QVC, HSN, Ballard Designs, Frontgate, Garnet Hill, and Grandin Road. These cover video-driven shopping across linear TV, digital streaming, social platforms, and e-commerce sites.

At the core of the collapsing share price is a total cratering of sentiment as measured by Qurate's trailing 12-month price-to-sales multiple. This is currently running at 0.034x , its lowest level on record and 96% lower than its peer group median and around 88% lower than its 5-year average. To be clear here, the market is valuing every $1 of revenue earned by Qurate at around 3 cents in market cap gains. Hence, the company's current market cap of $470 million stands as a minnow to a pre-pandemic market cap of $10 billion in 2019. What's the play here against long-forgotten special dividends to common shareholders?

Free Cash Flow Moves Up From Year-Ago Comp

Qurate's business model bears have often been described as broadly out of touch with the internet age and the pulldown in Qurate's sales multiple has been led by revenue that peaked in 2018. This is against net income that has meandered from high profitability to deep losses to drive an inversion in cash generation.

Qurate recorded a free cash outflow of $38 million for its first quarter. This was on the back of a $16 million positive movement in cash from operations and was set against a capital expenditure of $54 million. Positive cash from operations was a marked improvement from a loss of $180 million in the year-ago comp and was due to working capital improvements. Hence, whilst Qurate's free cash flow is still negative, it improved by around $185 million over its year-ago quarter with a large cash and equivalents position of $1.29 billion as of the end of the first quarter.

Management noted during their first-quarter earnings call that they expect to see a material improvement in profitability in the second half of 2023. I expect more revenue weakness on the back of the sale of Zulily , which comprised 7% of total revenue for the first quarter, but drove a negative adjusted operating income before depreciation and amortization that compromised a larger negative 17% movement. Adjusted OIBDA fell by 47% year-over-year with revenue of $2.6 billion during the first quarter falling by 8% over its year-ago quarter.

The Series A Preferreds And The 22.5% Yield On Cost

Qurate Retail's 8% Series A Cumulative Preferred Stock Due 3/15/2031 ( QRTEP ) pays out an $8 fixed annual coupon for a 22.5% yield on cost. This yield is around 2.8x the headline coupon rate as the preferreds have broadly tracked the commons lower since they started trading in 2020 . Whilst there is no near or medium prospect of the commons seeing the type of dividends that have previously been declared, the preferreds are cumulative and are not perpetual. These clauses mean any unpaid dividend has to accrue as a liability for repayment at a later date, most likely at maturity on the 15th of May 2031.

These are currently swapping hands for $35.10 per share, a roughly 65% discount to their $100 par value. Hence, the yield to maturity stands at 24% with the yield to the September 18th, 2025 call date substantially larger at 59%. However, there is a very low likelihood of Qurate redeeming the Series A at call. The company would have to pay a larger redemption price of $104, a 4% premium on the core $100 par value. The Series A preferreds are essentially trading for 35 cents on the dollar with the potential for its owners to capture some upside if the company skirts Chapter 11 through to maturity.

To be clear here, this discount to par is a direct reflection of stock market expectations that the probability of a Chapter 11 filing is greater than the likelihood of the company remaining a going concern. Crucially, a position in the preferreds is a risky long-term play on Qurate surviving up until its maturity date. The company could very well still suspend the dividend on the preferreds well before maturity, a move which would further crater a security that's been under sustained pressure since 2020. Preferreds are essentially half bond half equity.

Hence, whilst the Series A risk versus the pure common shares seems lower, Qurate's Series A has the same bankruptcy exposure as the commons with arguably less upside potential if the company was to shatter current market expectations of a Chapter 11. They've outperformed the commons over the last year on a total return basis, but future returns might look a lot less stark if Qurate meanders back into positive net income. I'll skip both the preferreds and commons with continued macro uncertainty and a possible recession set to place more pressure on revenue.

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