LDIG initiated as a strong buy by Thomas Weisel:
September 12, 2000 Thomas Weisel Partners LLC
e*Media Liberty Digital1-STRONG BUY
NASDAQ: LDIG-$24.63 Interactive TV Keiretsu Master
Gordon Hodge 415.364.2575 ghodge@tweisel.com
Ray Schleinkofer, CFA 212.271.3595 rschleinkofer@tweisel.com
Christa Sober 415.364.7154 csober@tweisel.com
Executive Summary
* We have initiated coverage of Liberty Digital with a STRONG BUY rating and a
12-month price target of $42.
* Liberty Digital has quietly assembled key elements to develop, program, and
distribute up to 12 digital, interactive television networks. We believe this
could lead to a robust new media business with T-commerce, advertising and
subscription fee revenue streams.
* The pending acquisition of a 50% interest in the Game Show Network from Sony
puts the Company on the map with one of the first interactive television
channels in the US. We expect Liberty Digital to invest in additional
programming for GSN with a cash-flow-positive target date of 2002. We expect
EBITDA losses to be less than $10 million in 2001.
* Management has an impressive operational and investing track record. CEO
Lee Masters has built several successful media businesses, including MTV and
E! Entertainment Television. Parent companies AT&T and Liberty Media ensure
programming and distribution. As of September 11, 2000, the Company's public
investment portfolio was up 148%.
* A portfolio approach to interactive television infrastructure reduces LDIG's
technology risk. In addition, LDIG has built a Keiretsu of sorts by linking
digital content with e-commerce companies. Combined, LDIG's portfolio
companies could influence which iTV technologies win in a broadband,
infinite-channel universe.
* We estimate that each iTV channel that LDIG launches could be worth more
than $4.00 per share based on a discounted cash flow analysis. Our 12-month
price target of $42 assumes the launch of two interactive channels in 2001
(excluding GSN) and the rollout of two channels each year thereafter.
Company Description: Liberty Digital develops and markets interactive cable
networks based on existing internet platforms. The company also holds
investments in a variety of ITV enabling technologies and has access to 6Mhz
of bandwidth on AT&T Broadband's Cable Systems giving it access to at least 16
million households. LDIG shares are 90% owned by Liberty Media.
Coverage Initiated with A STRONG BUY Rating
We have initiated coverage of Liberty Digital with a STRONG BUY rating and a
12-month price target of $42. Beginning this year, LDIG plans to initiate its
launch of up to 12 interactive digital television channels focused on key
demographic and consumer segments of the population. We believe that each
channel that LDIG launches could add $1.0 billion, or more than $4 per share,
in net asset value. Forrester Research projects that, by 2005, interactive
video will have penetrated over 65 million households versus just 4.9 million
today, and that TV-based commerce can grow to $30 billion per annum versus the
$7 billion currently spent on home shopping, infomercials and direct response
commercials. The top five T-commerce players (QVC, Home Shopping Network,
E4L, ValueVision, and Shop at Home) totaled $4.3 billion in sales for 1999.
The $7 billion US market for video games could also be a potential interactive
television market.
While the opportunities for interactive television networks are large, there
are several challenges that interactive channels face, including: 1)
programming interesting interactive content; 2) garnering adequate access to
cable distribution; 3) developing channels that are compatible with multiple
operating systems, middleware solutions, and applications; and 4) supplying
the proper "back office" and fulfillment functions. We believe that Liberty
Digital is uniquely positioned to address these challenges. CEO Lee Masters
has a proven television network track record, having led both MTV and E!
Entertainment to programming success. The Company's parent, Liberty Media, is
one of the most successful cable network companies and offers LDIG a wealth
of industry and financial support.
Liberty Digital currently has the right to negotiate for 6Mhz of bandwidth
(equivalent to 12 channels under current compression technology) on AT&T's
Broadband cable systems that serve more than 16 million households. Liberty
Digital has also taken ownership positions in dozens of online commerce and
content businesses, as well as ITV-enabling technologies. In addition to
providing an attractive return on the Company's invested capital, these
investments secure distribution and fulfillment for LDIG's channels and, in
some cases, could even serve as partners in channel program development.
Positioned For Interactive Media
Much has been made of the "death of television," and the end of the "idiot
box" or "#### tube" due to the rise of the Internet and the PC as an
entertainment platform. Still, 51 million people tuned in to the #### tube
this summer to watch the final episode of CBS's Survivor. Through digital
technology and upgraded cable plant, we believe that television can stave off
a PC incursion into the living room by offering broadband interactive
content-including Internet access.
An advantage of television is shelf-space. There are nearly 103 million US
households, and 100 million of these have television sets. More than 97
million of those households have access to cable, and 68 million of them are
subscribers. In addition, people spend on average 30 hours a week watching TV
compared to only 1.5 hours surfing the Internet. Having said that, Internet
usage has been growing rapidly each year and cannot be rejected as a potential
form of competition.
An investment in Liberty Digital, fortunately, is not a vote for television
over the personal computer, but rather for interactivity. Through investments
in potentially promising Internet media and commerce companies, as well as
through the development of interactive cable networks (including the pending
acquisition of a 50% interest in the Game Show Network), Liberty Digital can
win on both the TV-platform and PC platform, in our view.
The key question, then, is "How big are the potential E-Commerce and
T-Commerce markets as well as the traditional online and television
advertising markets?" The answer is: BIG. "Big" as in $56 billion for the
current TV advertising business (cable and broadcast) and an estimated $5
billion for the current, rudimentary T-Commerce business (Home Shopping, QVC,
etc.) Consumer e-Commerce of $28 billion and online advertising of $7 billion
make the total current opportunity close to $96 billion. Forrester estimates
that T-Commerce can increase to $30 billion by 2005. We estimate that TV and
online advertising can increase to over $110 billion, and given the
projection for e-Commerce to reach $86 billion (by 2003), we arrive at a $225+
billion potential market in 2005, a 19% CAGR.
Target Price of $42 per Share
We estimate that LDIG is currently trading at a premium to its net asset value
based solely on its existing portfolio of investments, assigning book value
to its non-public investments and a 12x EBITDA multiple to DMX. However, this
analysis ignores the Company's access agreement with AT&T Broadband and the
potential for the 12 interactive channels, which, in our view, account for the
bulk of the company's value. Using a 20% discount rate and a 20x terminal
EBITDA multiple after ten years, our DCF analysis indicates that each
interactive digital network that Liberty Digital launches could be worth $2.0
billion. We assume Liberty Digital enjoys 50% of the value of each channel,
with its channel partner(s) receiving the remainder. This could prove
conservative as Liberty Digital could develop many of these interactive
channels itself, thereby retaining the bulk of the economic value. Our
12-month price target of $42 assumes that the Company launches two channels in
fiscal 2001 (excluding GSN) and another two per year thereafter. We also
assume that the Company's investment portfolio can grow in value at 20% per
annum.
Our ten year, single channel DCF analysis assumes three different household
penetration levels and purchase rates depending upon whether the channel is
received via digital satellite, cable with a DCT-2000 or equivalent box or
with an advanced DCT-5000 solution. We look for total channel penetration
from the three sources to average nine to ten million households during the
first year and grow to 60 million over a ten-year period. We believe this is
reasonable given that AT&T alone is expected to have roughly three million
digital subscribers by the close of 2000 and satellite is already up to 10
million digital subscribers.
We assume average commerce revenues per household beginning at $5 per annum
for satellite homes, $7 for DCT-2000 homes and $20 for DCT-5000 homes. We
believe that these numbers are reasonable when compared to HSN and QVC, which
are currently averaging more than $30 per household and offer no on-screen
back channel for interactivity. Also, we have not included any revenue
streams from other potential sources such as advertising or pay-per-view
options.
On the cost side of the equation, we look for a gross margin of 35% after
accounting for product costs and a 5% revenue share with the MSOs. Again we
believe our assumptions to be reasonable as HSN currently sees gross margins
around 38%. We look for a channel to begin with just eight hours of
programming per day (run on a 24-hour loop) and grow to 16 hours with an
initial average cost of $20,000 per hour. We look for just $20 million of
initial start-up capital expenditures and low capital investment requirements
thereafter.
In our model, a channel reaches profitability late in its third year and
ultimately grows EBITDA margins up to 21% on $2.9 billion of annual sales in
year ten. A 20% margin assumption is comparable to current Home Shopping
Network levels. We use a 20% discount rate and a 20x multiple on year 11
EBITDA to arrive at a value of roughly $2 billion per interactive channel.
Assuming the channel economics are split 50-50 with a partner or partners, the
value that accrues to Liberty Digital would be more than $4 per share per
channel.
Investment Risks
Rollout of advanced set top boxes. The deployment of Liberty Digital's
interactive television channels requires cable companies to roll out advanced
digital set top boxes (DCT-5000). While cable companies have been notoriously
slow to deploy new technologies, we believe that current competitive
pressures could compel MSOs to deliver services capable of competing with DTH,
DSL and other broadband applications. Even if the MSOs continue to drag
their heels, we believe that interactive broadband television could be a
reality in most homes by 2004 whether the platform is cable, satellite or
wireless. We also note that the Company's channels will be more friendly to
hand-held wireless devices than most traditional Web sites. This offers the
Company a potential second source of distribution.
No operating model for a while. For now, Liberty Digital has no operating
model. Operating cash flow is limited to the approximately $25 million
generated by DMX. As a result, there are no near-term benchmarks other than
cable network announcements.
Distribution issues. The wording of the AT&T distribution agreement is
somewhat vague. It grants Liberty Digital the right to "negotiate for
carriage" on one 6Mhz channel. Thus, we do not know exactly what the Company
will have to pay for this carriage. Obviously, the sooner it can gain
carriage on non-AT&T systems, the more leverage the Company may have in these
negotiations. It is important to realize that Liberty Media and therefore
AT&T own over 90% of the Company's stock and hold more than 99% of the votes.
Dependence on management. The Company's key advantage in operations, in our
view, is the programming experience of its management and the media power
which Liberty Media and AT&T bring to the table. Should the Company lose any
of its senior members, especially CEO Lee Masters, it could encounter
difficulties developing its channels.
Liquidity. Liberty Media holds 90% of the outstanding shares in the company.
The Company's float is limited making the stock less liquid and more volatile
than a typical company with a $6 billion market capitalization. |
