In my last article, I analyzed my biggest mistake of the year - J.C. Penney (JCP, Financial). I concluded that it was a soggy cigar butt bought unwisely.
Fortunately, I've also invested in a company that has rewarded me nicely using Joel Greenblatt's spin off framework. Looking back, it was obviously cheap and it was not too hard to analyze. It did take me some time to read and take notes on the SEC filings but once I did it, I was happy to find a wonderful business at a wonderful price.
This wonderful business is called Starz and below are the notes I took back in Jan 2013.
Background:
According to Liberty Media's press release:
Liberty Media Corporation and Starz announced the completion of the spin-off of Liberty from Starz at 5:00 p.m on Jan 11, 2013. As a result, Liberty and Starz are now separate publicly traded companies. As announced earlier, in connection with the Spin-Off, Liberty changed its name from "Liberty Spinco, Inc." to "Liberty Media Corporation," and Starz changed its name from "Liberty Media Corporation" to "Starz." Both companies will begin trading regular way on The Nasdaq Stock Market, under the symbols listed above, on Monday, January 14, 2013.
Following the spin-off, Liberty's principal businesses and assets include its consolidated subsidiaries Atlanta National League Baseball Club Inc. and TruePosition Inc., equity affiliates Sirius XM Radio Inc. and Live Nation Entertainment Inc. and minority investments in public companies such as Barnes & Noble Inc., Time Warner Inc., Time Warner Cable Inc. and Viacom Inc.. Starz' businesses and assets consist of those of Starz LLC, its wholly owned subsidiary.
As spin-offs usually create unusual profit opportunities for special situation investors and John Malone is a master in creating wealth using the spin-off technique, I decided to take a closer look at the spin-off.
I. Reasons for spin-off:
Per the company's filing:
The board of directors of Liberty Media periodically reviews with management the strategic goals and prospects of its various businesses, equity affiliates and other investments. As a result of a review undertaken during the summer of 2012 the Liberty Media board determined that the Spin-Off would allow each of Starz and Spinco to pursue strategic opportunities that are not otherwise available to them in Liberty Media's current configuration and, over time, enhance the operating performance of the two companies. Among the factors considered by the Liberty Media board in arriving at its determination were the following:
• By separating the more complex collection of businesses and investmentsthat currently comprise Liberty Media from Starz, LLC, Liberty Media believes that the conglomerate or "holding company" discount inherent in Liberty Media's common stock will be eliminated, as Starz will become a "pure play" media company valued in a manner consistent with other companies in the premium television industry. The elimination of the holding company discount at Starz will create a more efficiently priced equity security for Starz to use to effect a complementary business combination using its equity and enable Starz's stock to be more accurately valued by potential acquirors.
• The Spin-Off is expected to cause the holding company discount with respect to the Spinco common stock to be reduced, as separating Starz, LLC and its subsidiaries will better highlight the discount at which the Liberty Media common stock historically has traded relative to its underlying asset composition. This reduction of the holding company discount associated with the Spinco common stock would enhance the ability of Spinco to issue its equity for purposes of making strategic acquisitions with less dilution to its stockholders.
• By effecting the Spin-Off, both companies will be better positioned to take advantage of business opportunities that are not available to them under Liberty Media's existing configuration. Each of Starz and Spinco will have greater flexibility in structuring strategic alliances, acquisitions and other business combinations and a stronger acquisition currency.
• The contribution of cash to Spinco in connection with the Spin-Off will provide Spinco with greater liquidity to acquire additional shares of its equity affiliates, invest in complementary businesses and pursue other strategic objectives and acquisitions.
• In connection with the internal restructuring and the cash contribution to Spinco, Starz will optimize its capital structure, through the draw down of the Starz credit facility, which is expected to provide for more attractive leveraged equity returns for Starz's stockholders.
Conclusion: The reasons for the spin off seem compelling. If things go as expected, not only will Starz benefit from the removal of discount associated with being part of a complex conglomerate but also it will benefit from a leveraged equity position, which may provide better returns.
II. Insider Ownership and Equity Compensation:
1. John Malone will mostly likely continue to own a significant amount of ownership in both Spinco and Starz, given that he owned 1.8% of Class A shares and and 83.8% of Class B shares prior to the spin-off.
2. The new option awards and the new SAR awards are set up in a way that the lower the stock price during the first three trading days of Starz and Spinco's stocks after the spin-off, the more attractive the option awards and the SAR awards. Therefore, there's a reason to believe that insiders want Starz and Spinco's stock to trade low during the first three trading days starting Jan. 14.
III. Back of Envelope Valuation:
Upon completion of spin-off, Starz will have approximately 124 million shares of outstanding common stock. Starz made $240 million net income, or $1.94 per share duirng 2011. Applying a P/E multiple of 12, which is mildly conservative for a premium subscription video programming distributor, I come up with a value of $23.3 per share. Comparable companies such as Scripts Networks Interactive and Discovery Communications are valued at 17 plus P/E multiples. At an implied price of $14.20 per share (1/11/2012 closing price of LMCA 124.03 - 109.03 LMCAV), Starz looks fairly attractive.
IV.Possible Indiscriminate Dump by Institutions:
Before the spin-off, Liberty Media is a large cap stock with a $13.5 billion market cap. After the spin-off, Starz, with a implied $14.2 share price and 124 million shares outstanding, will have a implied market cap of $1.7 billion. Institutions with cap size limits may be forced to sell Starz's stocks after the spin-off because it won't meet the large cap requirement, which in turn may also create good buying opportunities.
After the above analysis, I initiated a big position in Starz with big convictions. The result? Starz has since returned nicely - more than double from my initial purchase price of just above $14 per share. I have sold the majority of the position for a gain of approximately100% within a year and throughout my holding period, Starz never gave me any headache. Compared to J.C. Penney's endless troubles, Starz took off and never looked back.
Why was Starz such a good investment while J.C. Penney was not? As always, the Oracle of Omaha had summed it up nicely in his 1989 letter: Easy does it!
