2023-10-03 04:07:31 ET
Summary
- Liberty Global's price rises will kick-in in the second half of the year.
- Share buybacks are accelerating and extremely accretive at current prices.
- The share prices can return a 30% CAGR (or much more) to patient investors.
Editor's note: Seeking Alpha is proud to welcome Masoud Bahraini as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »
Investment Thesis
This article explains the attractiveness of Liberty Global's ( LBTYA , LBTYB , LBTYK ) current price compared to its valuation. The primary reasons behind this assessment are rooted in the ongoing share buyback program and the consistent generation of free cash flow. To substantiate these points, I introduce the company and its business model, revisit its historical free cash flow and share repurchases, and present a valuation analysis.
Background
Understanding Liberty Global becomes challenging without a brief introduction to John Malone and his business background. Malone is a savvy investor with a focus on optimizing shareholder value through strategic deal-making and tax-efficient transactions and investments. One can read "Cable Cowboy: John Malone and the Rise of the Modern Cable Business" book by Mark Robichaux to get familiar with Malone's background and his approach to deal-making. One of his principles involves legally minimizing tax payments, which is why his businesses often do not report positive net incomes. However, these businesses typically generate positive cash flows because depreciation and amortization expenses surpass maintenance capital expenditures. Consequently, it makes sense to consider the free cash flow generated by the business as the primary metric for assessing the value of Liberty Global.
Two examples of tax efficient deals made by Liberty Global are specified in the latest Quarterly filing:
- "In connection with the sale of UPC Poland, we recognized a gain of $848.9 million during the six months ended June 30, 2022, which includes accumulative foreign currency translation gain of $10.9 million. No income taxes were required to be provided on this gain."
-
"In connection with the completion of the Telenet Tower Sale, we recognized a gain of $693.3 million during the six months ended June 30, 2022. No income taxes were required to be provided on this gain."
Another prevalent characteristic in businesses associated with Malone is the presence of both super-voting and non-voting shares. Liberty Global has Class A shares, each with a single voting right, Class B shares with ten voting rights per share, and non-voting Class C shares. Malone possesses a majority stake in Class B shares at 67.6%, holds a 2.7% interest in Class A shares, and has a 6.8% ownership in Class C shares, collectively affording him 30.7% of the overall voting power, as stated in the company's Proxy Filings . Also note that Malone and two other insiders collectively hold 97.4% of Class B shares, as depicted in the following image.
Ownership of Class B shares (Proxy Filings)
As of July 17, 2023, Liberty Global possesses the following ordinary shares: 171,341,598 Class A, 12,994,000 Class B, and 239,995,206 Class C. Since these shares possess equal rights to the company's earnings, their prices should closely correlate. While this is generally accurate, it's worth noting that Class B shares have a limited float, with at most 2.6% of the 12,994,000 shares (equivalent to 337,844 shares), which can occasionally lead to observed price spikes.
LBTYB price chart (Seeking Alpha)
Business
Liberty Global offers communication services to both residential and business-to-business (B2B) sectors. These services encompass wholly-owned subsidiaries like UPC Holdings in Switzerland and Slovakia, a 61.2% ownership stake in Telenet in Belgium and Luxembourg, and wholly-owned VM Ireland in Ireland. Furthermore, Liberty Global holds a 50% stake in the VMO2 JV in the United Kingdom, a 50% stake in the VodafoneZiggo JV in the Netherlands, a 50% stake in the AtlasEdge JV (an edge data center platform operating in Europe), and a 25% stake in the nextFibre JV (focused on constructing new fiber cable infrastructure in the United Kingdom). While these companies comprise the core operations of Liberty Global, it has stakes in many more businesses:
Liberty Global's equity investments (Quarterly Filings )
The company's revenue has been flat recently. During the latest quarter, the company has made $1.848 billion in revenues from consolidated subsidiaries (with Switzerland and Belgium segments as the largest contributors); furthermore, the company's subsidiaries have made $3.391 billion in U.K. (50% ownership), and $1.088 billion in Netherlands (50% ownership), which equates to overall revenue of $4.088 billion if these two subsidiaries are also consolidated.
Revenue based on geography (Quarterly Filings)
The $1.848 billion in revenues from the consolidated subsidiaries are reported based on business segments next. The biggest portion of the revenue is made through the residential segment (Broadband internet, Video, Fixed-line telephony, and Mobile services), which has been mostly flat. The B2B segment provides a smaller portion of the revenue but it is showing a mid-single-digit growth.
Revenue based on business segments (Quarterly Filings)
The adjusted EBITDA has declined slightly with Central and Other being the culprit for this decline.
Adjusted EBITDA based on segments (Quarterly Filings)
Return to Shareholders
Liberty Global does not distribute dividends; instead, it returns surplus cash to its shareholders via opportunistic tax-efficient share-repurchases. Since 2016, the company has consistently decreased its outstanding shares and is currently pursuing a plan to repurchase up to 15% of its shares during 2023, see Earnings Call Presentation .
Number of shares outstanding (Company's latest presentation)
The company has returned more than $2 billion on average, based on my calculations, to its shareholders through share repurchases during recent years :
Year | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
buybacks () | (1,968) | (2,976) | (2,010) | (3,219) | (1,072) | (1,580) | (1,703) |
The company is also on track to return $1.6 billion to shareholders during 2023:
2023 Guidance (Company's presentation)
Latest Updates
The significant development in the recent quarter pertains to price increases, ranging from a low of 4% in Switzerland to a high of 14% to 17% in the United Kingdom, according to the latest Earnings Call Transcript . These price adjustments are anticipated to have a favorable impact on the second-half revenue. Additionally, the company has obtained shareholder approval for relocating its headquarters to Bermuda. Management asserts that this decision is not primarily motivated by tax considerations but rather to enhance the company's ability to engage in strategic transactions.
Furthermore, the company has no material maturities until 2028 and interest rates are either fixed or hedged.
Debt Maturities (Company's Presentation)
Management's Incentives
Liberty Global encompasses multiple business operations and engages in equity investments, hedging activities, as well as ongoing acquisition and divestiture efforts, rendering its analysis a complex task. I believe a quick method for evaluating the company's trajectory is to examine management's incentives. As evident in the company's Proxy Filings, a substantial portion of the compensation is derived from option awards.
Managements' Compensation (Company's Proxy Filing)
A close look at the CEO's option exercise prices suggests that the management does not believe that share prices will be lower than $15 and it will potentially be higher than $42 (for all options to expire in the money).
Options' Exercise Prices (Company's Proxy Filing)
However, it's important to understand that the company's management doesn't possess a crystal ball, and the options granted may undergo adjustments, as indicated in the latest quarterly report, where the duration of options awarded between 2016 and 2018 was extended from 7 to 10 years. Also note that while the share-based compensation is a non-cash item, it dilutes the ownership of shareholders and such dilutions should be considered in the valuation of the company.
Share based compensations (Quarterly Filings)
Risks
I think there are three major risks facing the business:
Inflation: The company is susceptible to inflationary pressures stemming from labor, programming, and various other costs. Although the company is increasing prices to counter these cost pressures, there is no assurance that revenue will rise at a pace sufficient to offset the escalating costs.
Interest Rates: The company carries a substantial amount of debt, and a persistently high interest rate environment could have an adverse impact on available free cash flow.
Competition: The company faces competition across all the markets it operates in. This has had a detrimental effect on revenues. For instance, in the Earnings Call Transcript, it was noted that "KPN remains aggressive on fixed-front book pricing, which, coupled with the timing of our price rise announcements, had a negative impact on broadband results in the quarter."
While predicting the trajectory of inflation can be challenging, it's worth noting that inflation has shown signs of moderation in the relevant markets. According to the Earnings Call Presentation, inflation rates have been at 7.3% in the U.K., 1.7% in Switzerland, 4% in Belgium, and 5.7% in the Netherlands.
To manage the risks associated with the interest rates, it's important to highlight that the company doesn't have any significant debt maturities in the near future, and the interest rates on its existing debt are either fixed or hedged, as indicated in the Quarterly filing.
In terms of competition, the management's perspective is that differentiation is crucial, particularly in highly penetrated markets. For instance, Liberty Global stands out as the first operator to successfully deliver 15 gigabit-per-second speeds during a live trial, as can be seen in the Earnings Call Transcript.
Valuation
Liberty Global's price to cash flow is less than 3, while the sector's median is more than 7, which shows an attractive relative valuation. While the quant rating for the company is Hold, the major negative factor in that rating is negative revenue growth, which will be positively impacted going forward due to the discussed price rises. Additionally, it's important to recognize that the company has not consolidated the revenue from the U.K. and Netherlands in its reports recently. As a result, I think the decline seen in consolidated revenue is an accounting adjustment rather than a genuine decrease in revenue.
Next, I provide an absolute valuation based on the following assumptions:
- A perpetual constant free cash flow going forward (no terminal valuation is assumed),
- A 10% discount-rate (the company's average interest rate on its debt is less than 5%. I use 10% discount rate as compared to the average return of S&P 500).
Assuming that the free cash flow will be
- $1 billion with a 25% chance (a conservative assumption),
- $1.5 billion with a 50% chance (2023 projected FCF is $1.6 billion),
- $2 billion with a 25% chance (average cash used in share buyback since 2016),
the fair market cap for the company is
0.25*(1/(1-0.9091))+0.5*(1.5/(1-0.9091))+0.25*(2/(1-0.9091))=$16.5 billion
(versus its current $7.6 billion price) based on DCF (note that 0.9091 is 1 divided by 1.1). This suggests a fair value per share of $37, in contrast to the current market price of $17.
Since the free cash flow is used to buyback shares at very attractive prices, it is appropriate to reduce the share counts based on the buybacks, minus an average of $200 million expense due to share-based compensations. I assume that it may take one to five years for price to reach its fair value, and compute the annual return of buying the stock at $17 per share.
Year | 2024 | 2025 | 2026 | 2027 | 2028 |
Annual Return | 163% | 72% | 50% | 40% | 34% |
Fair Value of the Share Price | 45 | 51 | 57 | 65 | 74 |
Although the market capitalization's price-rise toward the fair value may not follow a linear trajectory, an alternative assumption can result in a potentially higher return. This is because either the share repurchases will transpire at lower prices, or the price may rise faster, allowing for a more favorable return upon selling the shares. In the unlikely scenario where the stock price remains stagnant, no shares would remain at the end, leaving the remaining share as the predominant one and its holder as the owner of the business, which, admittedly, is unrealistic. However, even if the share price remains stagnant for a few years or it experiences declines, this would be a blessing, as the buybacks would prove more advantageous to the remaining shareholders.
In cases where the free cash flow is negatively impacted in a permanent way, i.e., less than $750 million per year, or the management starts to waste cash on projects with unattractive returns or expensive acquisitions, I would reconsider lowering my strong buy rating into a buy or hold rating.
Conclusion
Liberty Global is a robust generator of free cash flow, mostly used to repurchase its shares at highly appealing prices. Unless there's a substantial reduction in free cash flow that hinders the company's ability to meet its debt obligations, acquiring shares at the current price is a rare opportunity that occasionally presents itself to patient investors. I think retail investors can also consider Class B shares instead of class A or class C, which could potentially yield unexpected price surges and significantly enhance the return. I recently acquired a few Class A shares and I am eagerly anticipating how Liberty Global's future will unfold.
For further details see:
Liberty Global: A Bargain For Patient Investors