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Nicolas73
Nicola Guida
Articles (24)  | Author's Website |

Liberty Global: Sum of the Parts Shows Significant Undervaluation

The lack of catalysts is negatively influencing market sentiment and producing a big holding discount

Liberty Global PLC (NASDAQ:LBTYA) is a holding communication company which owns several subsidiaries (mostly cable networks) in Europe.

The company is headed by CEO Mike Fries, and the chairman of the board is the legendary investor (and outstanding capital allocator) John C. Malone.

I first became interested in Liberty Global after reading about it in a March 2019 GuruFocus article written in by user Batbeer as part of the Value Idea Contest. His investment thesis (supported by a sum of the parts valuation) is summarized by the following sentence:

"Shares of the company currently trade at $26. This means the market considers Liberty Global's Dutch and British assets to be worthless. That's irrational.
"

Liberty trades for around $22 as of today, so let's check if, after more than one year, that conclusion still holds (in which case, the margin of safety would be even larger).

A tale of M&A deals

At the time of the aforementioned article, the company was in the process of selling its operations in Germany, Hungary, Romania and the Czech Republic to Vodafone (LSE:VOD).

The deal had the potential to unlock significant value for the company (and it actually did, in my view). However, the market was still skeptical about it, and the stock traded for around 5 times free cash flow at the time.

On July 31, 2019, the deal was completed and the company received $21.3 billion (which represented a combined 11.5 times operating cash flow multiple), with net cash proceeds of $11.3 billion. Liberty engaged in significant share repurchasing activities after that event.

Another pending deal was related to the announcement Liberty made in February 2019 regarding the acquisition of UPC Switzerland (a Liberty Global subsidiary) by Sunrise Communication (XSWX:SRCG). The deal was supposed to be completed upon a payment of 6.3 million Swiss francs ($6.8 million), which represented an operating cash flow multiple of around 10. Unfortunately for Liberty, the deal fell apart because Freenet AG (XTER:FNTN), a major shareholder who owned 24.5% of Sunrise, was not happy about Sunrise's proposed equity and rights offering subsequent to the announcement and voted against it.

Fast forward to 2020, two additional important deals have recently been announced by the company.

The first is a 50-50 Joint Venture announced in May 2020, in which Liberty Global and the Spanish operator Telefonica (XMAD:TEF) will merge their U.K. operations.

Liberty's U.K. operations, represented by Virgin Media, are based on a broadband network (but with very little mobile presence), while O2, Telefonica's U.K. business, has the country's largest mobile platform.

Virgin Media is Liberty's most important and valuable asset, and the joint venture is building on the ongoing consolidation momentum in order to power the integration of fast cable (or fiber) speed with the upcoming wave of 5G developments. The newly formed giant will have more than 46 million subscribers and 11 billion British pounds ($14 billion) of revenue. There are significant potential synergies, with the possibility to add more customers and have a better price power than the current stand-alone companies.

With the latest announced deal on Aug. 12, in which Liberty Global is set to acquire Sunrise Communication, the company intended to find a solution for its previously failed deal in Switzerland. The UPC business is currently languishing. Liberty Global will offer 6.8 billion Swiss francs to acquire Sunrise. The deal is intended to integrate UPC Communication with Sunrise in order to create a fixed-mobile operator in Switzerland that can compete with companies like Swisscom (XSWX:SCMN).

This time Freenet is not opposing the deal, adding that it "appreciates the value that Sunrise has created over the past five years." This is a proof that the integration of UPC and Sunrise made sense from the beginning and that Freenet's opposition was purely due to economic reasons and not to strategic ones.

A few days ago, the company announced that the tender offer for Sunrise met the minimum acceptance threshold (which is set to two-thirds of outstanding shares). Consequently, the deal will be closed before mid-November.

Let's do the math

CEO Mike Fries has recently repeatedly suggested that Liberty Globals's shares are undervalued, but he was never so explicit as in the first-quarter 2020 earnings conference call. In order to explain his view, he prepared the following slide:

Commenting on the presentation, he said:

"We're not trying to be prescriptive here. But more than a few investors have asked us to put forward a simple sum of the parts analysis that shows the value gap we talked about[...] there is an implied transaction value for the underlying Virgin Media business when we combine. And we had to agree, as I just mentioned, £18.7 billion, which after debt represents an implied value for the equity today of around $14 per share of Liberty Global. If you add all that up, you get to about $23 per share. That's just on the U.K. business."

Here, Fries is giving his view on the value of 50% of the Virgin-Media/O2 Joint Venture, summing up the deal value, the subsequent synergies and deal proceeds, boiling down to a $23 per share price tag.

This would mean that the U.K. joint venture's value is currently (slightly) greater than Liberty's market price, and that all other businesses (Telenet (XBRU:TNET), the Dutch JV with Vodafone, UPC and the remaining European assets) plus $12 of cash can practically be acquired for free.

While I won't argue on the huge U.K. deal potential, I prefer to calculate Liberty's current value as if both the U.K. and the Swiss deals would not be consummated. I used the same approach of the above-mentioned article for the appraisal of the single businesses, which values them at 10 times operating cash flow minus outstanding debt (I took the 2019 values for the single businesses).

Referring to the Belgian asset, Telenet, Liberty owns 60% of the company and it is publicly traded, so I simply calculated the value starting from capitalization. For the remaining European assets, the value was calculated with the equity method and reported in first-quarter filings with the Securities and Exchange Commission. Of course, cash divided by outstanding shares was added on the top.

The total per-share value amounts to $49.94 per share, which implies a huge undervaluation for the stock and consequently a more than comfortable margin of safety.

The following picture summarizes the value attributed to the single components:

The per-share value has dramatically improved recently because of Liberty's aggressive repurchasing activity.

Conclusion

Liberty Global´s management has recently tried to highlight the huge undervaluation of its stock. As always, the question is why the market is not buying it. I think there's a simple answer: a lack of catalysts.

If the company would split into more pieces or spinoff some businesses, that value could be unlocked, but at the moment there are no catalysts in sight. I think most investors are simply not comfortable owning a stock that pays no dividends and for which there is no possibility to know when that value will be distributed.

That is not the case for Seth Klarman (Trades, Portfolio), who has held the stock for a long time. Currently, Liberty Global's presence in Klarman's portfolio is a meaningful 15%.

Nobody knows when the market will decide to fully appreciate Liberty's value, but the only way to participate is to stay invested.

Disclosure: The author owns shares of Liberty Global.

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About the author:

Nicola Guida
I'm a Software Engineer with a big passion for Value Investing. I love looking for undervalued companies both to feed my investment pipeline and to write articles in order to share my investment thoughts.

Visit Nicola Guida's Website


Rating: 4.7/5 (10 votes)

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Comments

Praveen Chawla
Praveen Chawla premium member - 1 month ago

Good article, but what is the possible end game here for common shareholders? How do we get paid. Surely management is aware that the market cap is half of what it was 5 years ago. The lack of income and no prospect of a pay-day is a real problem.

A hint may come from what Malone has done recently with Qurate Retail- i.e., split the stock into a preferred share (for income-oriented investors) and a common equity share (which does not pay a dividend).

Nicola Guida
Nicola Guida premium member - 1 month ago

Hi Praveen, thank you for your comment.

This is exactly the point: management is now trying to push for a re-rating without being forced to find alternative solutions (which can cost more time/money/effort). If they can get their shares fully valued, they could sell them without having to pay out big dividends.

The option you mentioned would not be too bad, but I would prefer the company to spin off some of its assets (which would be equivalent to receive special dividends), as I think that way it could extract more value.

What is also interesting is that "behind the curtain", Liberty continues to buy back shares at very low prices, further increasing the per-share value.

Risk of permanent capital loss here is, IMO, negligible, but opportunity risk is not, especially for short-term investors.

This is a risk I am willing to take, as far as the margin of safety is so huge. Time will tell...

batbeer2
Batbeer2 premium member - 1 month ago

Hi Nicola, thanks for sharing your thoughts.

You say:

If the company would split into more pieces or spinoff some businesses, that value could be unlocked, but at the moment there are no catalysts in sight.

Vodafone and Liberty agreed to hang on to their 50% stake for a couple of years when the Dutch JV (Ziggo) was formed. That period is now ending. Off the top of my head it ends in dec 2020. Perhaps VOD will buy out Liberty or Liberty just IPOs its 50% stake. If you put a gun to my head, I'd bet on the latter.

Ziggo is a cash machine. There is nothing there for Liberty's management to do. NL is not a growth market. It is a pretty saturated duopoly. Ziggo is just regularly raising prices while maintaining market share. I know, I'm one of the victims :-).

In my view, Ziggo would be a good candidate to become a seperately listed dividend stock. Liberty could just spin that stake out to shareholders as a "dividend". Nothing revolutionary, it would simply be (re)structured along the lines of the Belgian operation (Telenet).

I'm not saying they will, but in a couple of months they will have the option.

Just some thoughts.

Nicola Guida
Nicola Guida premium member - 1 month ago

Batbeer!

I'm happy to hear from you :)

Thank you for adding a "Dutch" perspective to the story, I didn't know about the Vodafone-Ziggo JV exit rule.

I think you're (almost) right, here's what I've found on the documents:

"Each shareholder has the right to initiate an Initial Public Offering of the JV after the third anniversary of closing, with the opportunity for the other shareholder to sell shares in the IPO on a pro-rata basis. The parties have agreed to restrictions on other transfers of interests in the JV until the fourth anniversary of closing. After the fourth anniversary, each shareholder will be able to initiate a sale of the entire JV to a third party, subject to a right of first offer in favor of the other shareholder."

A restricted IPO was already possible from the beginning of 2020 (closing was on Dec 31st, 2016), but they'll have complete freedom starting from the end of this year.

What will they do? That's a good question analysts could ask in the next call, or maybe we contact their IR to get an answer.

asawhneyy
Asawhneyy - 1 month ago    Report SPAM

Liberty global has been a bad security for the last 6 years,Seth can be wrong too. Malone is involved in too many liberties-he has his land -I don't trust him. When you are young you are vibrant, law of nature.

It is a good speculation to tell bedside story to your spouse,about spinoff and special dividend.

Nicola Guida
Nicola Guida premium member - 1 month ago
Hello Asawhneyy, thanks for your comment.

I respect your opinion but don´t share it.

Of course I could be wrong, but I´m comfortable with the (kind of) risks I´m taking. Having said that, yes, Seth Klarman (Trades, Portfolio) can be wrong too, it just has a very low probability.

I suggest you also give a look at what Wally Weitz recently said.

Referring to my spouse, actually she´ll fall asleep before I can tell her the first sentence about Liberty :)





Praveen Chawla
Praveen Chawla premium member - 1 month ago

They have a lot of cash on the balance sheet now. It will be interesting to see how they leverage it. There likely will be a big deal. It's now all about fixed-wireless convergence and scale.

Nicola Guida
Nicola Guida premium member - 1 month ago

Hello Praveen, I agree with you.

Actually in my calculations I was a bit conservative, taking into account only cash and equivalents of $4.36 billion, but they also have around $3 billion in SMAs (equivalent to $5 per share) which will be used at some point.. they've plenty of options

Praveen Chawla
Praveen Chawla premium member - 1 month ago

What is SMAs?

Nicola Guida
Nicola Guida premium member - 1 month ago

SMAs = Separately Managed Accounts.

From LBTYA documents:

"Investments held under SMAs are maintained by investment managers acting as agents on our behalf"

Praveen Chawla
Praveen Chawla premium member - 1 month ago

So arguably they have 11 to 12 billion of cash & investments they could deploy. They could leverage that x 3 and make a big $35 billion acquisition.

Nicola Guida
Nicola Guida premium member - 1 month ago

Yes, indeed.

They could continue to build on the consolidation wave and acquire additional strategic assets (preferably fiber or 5G-related).

On the other hand, I'd like to get paid from time to time :)

P.S. Please note that the Vodafone-Ziggo and other equity stakes are included in Long Investments, that's important to avoid double-counting

Praveen Chawla
Praveen Chawla premium member - 1 month ago

Yeah, but not holding my breath. Not Malone's style.

Like Buffett says if you want some money, you can always sell some shares.

asawhneyy
Asawhneyy - 1 month ago    Report SPAM

thanks-Nicola

I am always skepitical-I owned liberty global for 6 years -Seth and Buffet have thier own issues.

I believe when you loose money there is no body around--so one has to be careful following holding companies and gurus.

Remember Leucadia and now Handler of Jeoffries,-bad outcome/

You have to go sweden to follow Investor AB.

Thanks

Nicola Guida
Nicola Guida premium member - 1 month ago

Hello Asawhneyy,

I understand the frustration, 6 years are quite a long time, but there must be a difference between a company that is simply losing ground and one (like Liberty) which is actually increasing per-share value over time, even if that value was not yet unlocked. Or not?

Every investor chooses his/her own investment horizon. Honestly, I don't care if value will be realized this year or the next year, until the company does the right moves. Of course entry price is also very important (IMO in 2015 the company was not undervalued like it is today).

Don't get me wrong on gurus. As you can see, I did my homework, and my investment decisions are not not relying on any guru. I foolishly followed some gurus in the past without fully understanding the investment thesis, but I'm not going to do that mistake again. I actually don't know why Klarman still owns the stock (he could already have sold it), I am not a Baupost investor so I can only imagine that.

Investor AB is a great company, and I will have a closer look at it, thanks.

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Modsapkstores - 1 month ago    Report SPAM

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