From SSB:
Liberty Media Corporation (L)
L: Reports Strong 2Q; Shares Remain Attractive 1M (Buy, Medium Risk)
Mkt Cap: $21,432.6
mil.
August 16, 2002 SUMMARY
* Liberty reported strong 2Q op. results that were slightly
BROADCASTING below our ests, due largely to Adelphia bad debt expense at
Niraj Gupta Starz! Encore. Total proportionate rev. & EBITDA for
Liberty's private developed assets (Discovery, Starz!
Encore and QVC) increased 10% & 17%, resp., to $835 mil.
Roger Chuchen (vs. our $840 mil. est.) and $218 mil. (vs. our $221 mil.
est.), resp. These results compare quite favorably with
those of L's peer group of media and entertainment
companies.
* Discovery Domestics networks had a very strong network
Upfront market with gross billings up 35% and CPM rates up
low single digits.
* We continue to believe L trades at among the deepest
discounts to asset value among large cap, ad-supported
stocks & below a worst case public market liquidation
value. Reflecting the decline in mkt value of its
publicly-traded portfolio & downward adjustment to our
target multiples for its major private assets, we are
lowering our target to $14. Strongly reiterate Buy, 1M
rating.
FUNDAMENTALS
P/ATCF (12/01E) NA
P/ATCF (12/02E) NA
EPS (12/01E) NA
EPS (12/02E) NA
TEV/EBITDA (12/01E) NA
TEV/EBITDA (12/02E) NA
Book Value/Share (12/01E) NA
Price/Book Value NA
Dividend/Yield (12/01E) NA/NA
Revenue (12/01E) NA mil.
Proj. Long-Term ATCF Growth 20%
ROE (12/01E) NA
Total Debt/EBITDA(a) NA
(a) Data as of most recent quarter.
SHARE DATA RECOMMENDATION
Price (8/15/02) $8.10 Current Rating 1M
52-Week Range $15.40-$6.41 Prior Rating 1M
Shares Outstanding(a) 2,646.0 mil. Current Target Price $14.00
Convertible No Previous Target Price $17.00
AFTER TAX CASH FLOW PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
12/00A Actual NA NA NA NA NA
12/01E Current NA NA NA NA NA
Previous NA NA NA NA NA
12/02E Current NA NA NA NA NA
Previous NA NA NA NA NA
12/03E Current NA NA NA NA NA
Previous NA NA NA NA NA
First Call Consensus ATCF: 12/01E $0.35; 12/02E $0.43; 12/03E $0.44
2Q:02 RESULTS
As a reminder, Liberty derives roughly 40% of its value from privately-held
assets. Accordingly, Liberty's operating results are an important but only
partial indicator of the company's overall value.
Liberty reported strong 2Q operating results that were slightly below our
estimates, largely reflecting Adelphia bad debt expense at Starz! Encore.
Total proportionate revenue and EBITDA for Liberty's private developed assets
(Discovery, Starz! Encore and QVC) increased 10% and 17%, respectively, to
$835 million (vs. our $840 million estimate) and $218 million (vs. our $221
million estimate), respectively. We believe these results compare quite
favorably with those of Liberty's peer group of media and entertainment
companies.
Discovery's developed assets (Discovery Domestic and International) saw
proportionate rev. increased 5% to $188 million (below our $196 million), but
EBITDA grew 28% to $61 million (above our $60 million).
Starz Encore revenue was up 11% to $237 million, slightly below our $239
million, while EBITDA increased 9% to $75 million, below our $80 million
estimate. Excluding $10 million of Adelphia bad debt expense, cash flow of
$85 million exceeded our estimate by 6%. As previously reported by Comcast,
QVC (excluding Japan) revenue and EBITDA increased 12% and 18%, respectively.
Reflecting the decline in market value of its publicly-traded portfolio and a
conservative downward adjustment to our target public market multiple (from a
blended average of 18.6x to 15.7x 2003E EBITDA) for its major private assets
(i.e. QVC, Starz! Encore, and Discovery), we are lowering our sum-of-the-
parts price target to $14 (down from $17 previously). We strongly reiterate
our Buy, 1M rating on Liberty.
STARZ! ENCORE GROUP (100%-OWNED)
Starz! Encore grew its total subscription units 24% to 125.6 million in
2Q:02. Although impressive, revenue growth lagged subscription growth in the
quarter, increasing 11% to $237 million, due to the disproportionate increase
in lower-priced pay units (i.e. Thematic Multiplex). Costs increased 13% in
the quarter, leading to EBITDA growth of 9% to $75 million, below our $80
million estimate. However, excluding $10 million of Adelphia bad debt
expense, cash flow increased 23% to $85 million.
Starz Encore's 2002 revenue and cash flow growth guidance remains unchanged
at 10% and mid-teens, respectively. We are slightly revising our 2002
estimates for Starz! Encore, reflecting $12 million in total bad debt expense
for Adelphia. Our new revenue and EBITDA estimates of $969 million (up 12%)
and $364 million (up 16%), respectively, compare to our prior estimates of
$971 million and $369 million. For 2003, we estimate EBITDA of $428 million
(versus our prior estimate of $422 million), representing growth of 16%.
This estimate could prove conservative if Adelphia restructures during this
period of time.
DISCOVERY COMMUNICATIONS, INC. (50%-OWNED)
Discovery's developed assets (Discovery Domestic and International) saw
proportionate revenue increase 5% to $188 million (below our $196 million),
but EBITDA grew 28% to $61 million (above our $60 million). Including
contributions from Discovery International Ventures and Consumer Products,
total Discovery proportionate revenue and EBITDA were $212 million and $44
million, respectively, reflecting 4% and 38% growth. The impressive cash
flow growth was fueled by affiliate fee and advertising revenue growth (up
10% and 4%, respectively) and tight cost controls (3% decline in operating
expenses).
Discovery's Domestic Networks (66% of total Discovery revenues) grew
advertising revenues by 1% driven by increased audience delivery and sell-out
rates. Importantly, the domestic networks had a very strong upfront market
with gross billings up 35% and CPM rates up low single digits. Numerous
product categories (including autos, financial services, computers, and home
products) stepped up their spending in this year's Upfront. Notably,
Discovery completed the largest cross platform deal of any of the cable
networks, a $40 million deal with Procter and Gamble. The 35% increase in
billings should set the stage from strong growth in 2003.
Discovery's International Networks delivered proportionate revenue and EBITDA
growth of 12% and 100% to $48 million (in-line with our estimate) and $7
million (above our $6 million estimate), respectively. The strong operating
results were driven by robust growth in all operating metrics (i.e. ratings,
subscriber, and advertising and affiliate revenue), offset by increased
operating expenses (up 4%) associated with new network launch costs.
2002 Guidance and 2003 Outlook. Discovery Domestic Networks raised its 2002
revenue and cash flow guidance to up low-mid single digits and mid-high
single digits, respectively, from up low single digits each. Despite the
upward revision, we believe full year 2002 guidance is still conservative
given the solid 2Q:02 cash flow growth and strong Upfront market.
That said, to incorporate some degree of conservatism into our forecasts, we
are modestly reducing our 2002 proportionate Domestic Networks revenue
estimate to $517 million (down from $529 million), representing 5% growth (at
the high-end of guidance and compares with our previous estimated growth of
7%). Moreover, given the aggressive cost containment measures implemented in
2H:01 and the possibility of the company stepping up its marketing spending
in 2H:02, we now expect second-half operating expenses to increase
considerably over the same period last year. Accordingly, we are lowering
our full year 2002 proportionate Domestic Networks cash flow to $185 million,
reflecting 12% growth (down from our 24% previously estimated growth but
above revised guidance). Year to date, Discovery domestic cash flow is up
25%, suggesting that there is some cushion in our revised estimates.
Discovery International Networks revenue growth guidance remains unchanged at
10% but EBITDA growth guidance was fine-tuned to 125%-150%, down from 150%.
This compares to our revised proportionate revenue and cash flow growth
estimate of up 14% (versus 15%) to $197 million and 133% (versus 100%) to $31
million, respectively.
Taken together, we have reduced total Discovery Domestic and International
EBITDA to $216 million from $230 million, representing 21% year-over-year
growth. For 2003, our EBITDA estimate for Discovery Domestic and
International remains unchanged at $271 million, up 25%.
Total Discovery revenue growth (including the Discovery stores and start-up
international cable networks) guidance calls for increase of high single
digits (versus 10% previously), while EBITDA growth guidance remains
unchanged at 40%. Our full year 2002 total Discovery proportionate revenue
and cash flow stand at $868 million (up 8%) and $166 million (up 37%),
respectively. These revised estimates compare with our previous
proportionate revenue and cash flow estimates of $893 million and $185
million, respectively, representing 11% and 53% growth.
QVC NETWORK (42%-OWNED)
QVC delivered stellar operating results in 2Q:02, demonstrating the
resilience of the electronic retailing industry, despite the soft U.S.
economy.
For the quarter, total QVC revenues and EBITDA were up 13.5% and 21.7%,
respectively, to $994.5 million (well above our $976 million estimate) and
$194.5 million (also well ahead of our $182 million estimate). We believe
the cash flow results were driven by the strong performance of the domestic
base business, which accounts for 84% and 99% of total QVC revenue and cash
flow, respectively.
Excluding approximately $1.5 million in Japan start-up losses, QVC second
quarter cash flow growth increased 17.8% to $196.0 million. Total operating
margins (excluding Japan) increased by 100 basis points year-over-year to
20.0%.
Domestic. Domestic revenue increased 10.6% to $837.3 billion, while EBITDA
was up 16.0%, to $193.2 million. We believe 2Q operating performance was
driven by the following: (1) 3.5% homes growth; (2) 7% increase in average
revenue per home; (3) shift to a more profitable product mix; (4) reduction
in telecommunication expense (3 cents per minute in 2Q:02 versus 3.7 cents
per minute in 2Q:01); and (5) other operational efficiencies.
U.K. While the company's UK operation encountered a number of competitive
challenges in 2001, its operations appear to be back on track. During 2Q:02,
revenues and EBITDA increased 3.3% and 24.4%, respectively, to $66.1 million
and $3.9 million.
Germany. Revenues increased 49.7% to $62.5 million helped by 6% growth in
distribution. EBITDA was slightly above break-even, an improvement from
2Q:01 loss of $2.7 million.
Japan. Revenues increased nine-fold to roughly $17 million in the quarter,
up from $1.6 million in 2Q:01. More importantly, cash flow loss moderated to
$1.5 million, a dramatic decrease from a loss of $6.6 million in the year ago
period. Management noted that its efforts in building infrastructure and
tightening cost controls have yielded handsome dividends thus far. We would
point out that it typically takes 36 months for a QVC startup operation to
reach cash flow break-even. Based on its current performance, we believe QVC
Japan (launched in 1Q:01) appears to be on an accelerated track.
QVC results (excl. Japan) are expected to remain strong in 2002, with revenue
guidance in the "low double digits" versus our 12% estimate and EBITDA
guidance of "low-to-mid teens" versus our estimate of 14%. For the full-
year, we expect total QVC (excluding Japan) revenue and cash flow of $4.37
billion and $845 million, respectively. Including $9 million of Japan start-
up losses, we expect cash flow to grow 16% to $836 million.
SHARE REPURCHASE ACTIVITIES LIMITED BY LACK OF CLARITY IN IRS AGREEMENT
We continue to believe that Liberty shares are worth considerably more than
the current trading price and, accordingly, view repurchase of the company's
stock as a compelling investment opportunity in the current environment.
During 2Q:02, Liberty spent roughly $270 million on the repurchase of 24.8
million L shares, representing an average price of $10.92 per share ($10.80
including proceeds from sale of puts on 6 million L shares). All of this
repurchase activity took place prior to the company's analyst investor
meeting on May 23. The company has refrained from additional repurchases
until it receives further clarity from the IRS on its ability to buy back
stock without restraints.
To be clear, in connection with the split-off of Liberty from AT&T, Liberty
originally agreed to the IRS request that it issues $250 - $500 million of
equity (for cash or other assets) within 1 year of the split-off transaction
(or by August 10, 2002) and $500 million - $1 billion within 2 years of the
transaction (or by August 10, 2003). While the company received a 1 year
extension on the fulfillment of the obligations, Liberty is uncertain if the
IRS agreement would require the company to issue equity equivalent to the
value of the repurchased shares over this time period, in addition to the
agreed upon amounts referenced above. Accordingly, Liberty has refrained
from an aggressive stock repurchase program until it gains greater clarity on
the IRS' interpretation of the agreement, which it hopes to gain before the
end of the third quarter.
BALANCE SHEET AND LIQUIDITY
Liberty is in excellent financial condition with total attributable debt of
$9.3 billion ($6.1 billion of corporate debt and $3.2 billion of attributable
debt associated with its private assets) and $2.1 billion of pro forma cash
(including all announced acquisitions and divestitures except Casema) as of
2Q:02.
The company highlighted the following liquidity metrics as of June 30, 2002:
* Floor value of hedge securities (valued at $7.4 billion) is about 2.5x the
face value of straight debt (roughly $3 billion).
* Hedged securities (excluding shares underlying exchangeable) are currently
in the money by $4.8 billion
* Unrestricted public assets (assets not covered by exchangeable debt) plus
cash covers straight debt by 6.5x
WORST CASE VALUATION ANALYSIS SUGGESTS LIBERTY IS DEEPLY UNDERVALUED
On a fully-taxed basis, we estimate that Liberty's portfolio of private and
publicly-held assets could easily be liquidated for a higher price than the
company's stock is selling for today. We estimate a worst case, fire sale,
liquidation value of $9.06 per share, 12% higher than yesterday's close.
This is obviously a highly improbable tax-inefficient assumption in that we
do not believe Liberty would entertain such a scenario, but it demonstrates
how extreme we believe Liberty's valuation has become.
Our worst-case valuation analysis, as detailed below, suggests significant
price appreciation potential from current levels.
Publicly-traded assets. We estimate the current value of Liberty's publicly
traded holdings at $20.4 billion or $7.70 per share. Based on an estimated
tax basis of $5.3 billion and tax rate of 40%, we estimate the after-tax
value of its public holdings at $15.1 billion or $5.70 per share.
Private assets. As it relates to the company's major private assets (i.e.
Discovery, QVC, and Starz! Encore), if we apply a 15x 2003E EBITDA multiple
to these businesses, we arrive at an enterprise value of $16.2 billion. We
believe this target multiple is conservative given the superior long-term
growth of these assets relative to the media industry. Moreover, in a true
liquidation analysis, these three assets are likely to sell for more than the
15x public market multiples that we are using in this exercise. Subtracting
out $1.6 billion of attributed debt would give us equity value of $14.6
billion, or $5.51 per share.
If we include $4.6 billion of equity value of its other private assets (i.e.
Liberty Media International, CNBC's retransmission agreement, and interests
in other cable networks), we arrive at equity value of $20.8 billion for its
entire private asset portfolio (or $7.88 per share). Assuming liquidation of
its private assets at these valuations and applying a 40% tax rate, we
estimate the worst-case after-tax equity value of Liberty's private assets at
$11.2 billion (or $4.25 per share).
Liberty has roughly $2.1 billion of pro forma cash on hand (including all
announced acquisitions and divestitures except Casema) and corporate debt of
$6.1 billion. Adjusting for option proceeds of $912 million and $800 million
of expected tax credit associated with estimated $1 billion in existing NOL
and $1 billion of losses from investments in ICG and Teligent, we arrive at a
worst case valuation scenario of $24 billion of equity value or $9.06 per
Liberty Media share, representing potential upside of 12% from current
levels.
We would argue that investors value assets based on their future cash flow
streams rather than their liquidation value. Accordingly, while we consider
this analysis to be unduly conservative, we believe it is nevertheless a good
illustrative exercise for determining a floor valuation for Liberty shares.
PROPOSED ACQUISITION OF CASEMA
On 8/1, Liberty announced an agreement to purchase cable operator N.V. Casema
from France Telecom for $750 million euro (or USD $733 million) in cash.
Casema is a cable MSO in the Netherlands passing 1.5 million homes in major
cities, including Hauge, Utrecht, and Breda.
The cable MSO offers video (analog and digital) and high-speed Internet
service to its residential customers as well as voice and data to the
business market. Based on 1.3 million customers and 1.4 million revenue-
generating-units (RGU), Liberty paid roughly USD $560 per subscriber, USD
$525 per RGU and 9.5x estimated 2002 EBITDA.
The purchase price appears reasonable given that the cable systems are
largely upgraded and rollout of new services (i.e. digital and high-speed
Internet) are well underway.
We believe this announcement is consistent with company strategy of amassing
a dominant European cable distribution platform, thereby achieving scale and
operational efficiency.
Liberty already has a 40% economic ownership stake in pan European cable MSO
UPC (through its 76% economic stake in UCOMA), which has 2.3 million
subscribers in the Netherlands. Accordingly, regulatory approval is not
certain. Casema and UPC do not compete in the same markets, however,
implying that Liberty's purchase of Casema will not have a negative impact on
competition.
VALUATION
Given its diversified collection of publicly-traded and private media assets,
we value Liberty shares based on sum-of-the-parts analysis. Applying a
blended 15.7x 2003E proportionate EBITDA of its major private assets (i.e.
Starz! Encore, Discovery, and QVC) and valuing its other private assets at
$4.6 billion yield an enterprise value of $21.6 billion. Adding in $21.7
billion of publicly-traded securities (including value of hedges), we arrive
at total target enterprise value of $43.3 billion.
Subtracting total debt of $9.3 billion ($6.1 billion of corporate debt and
$3.2 billion of attributable debt associated with its private assets), option
proceeds of $912 million, and $2.1 billion of pro forma cash (including all
announced acquisitions and divestitures except Casema), our target equity
value is $37.0 billion. Based on an estimated 2.65 billion shares
outstanding, we arrive at our revised price target of $14 per share (down
from $17 previously).
RISKS
Market Exposure of its Portfolio. The value of Liberty's portfolio of
publicly-traded assets (roughly 60% of asset value) has plummeted along with
rest of the market. To the extent public asset values remain depressed, we
believe Liberty shares could be impacted as well.
Questionable Transactions. While Liberty has created significant amount of
value since its founding in the mid 1990's, investors have questioned several
recently completed deals. Notably, the investment in United Globalcom,
Teligent, ICG, and USAI-Vivendi share swap have not been as successful as
Liberty's historical transactions.
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