Thank you for posting the 8K.
Game on.
Here is TJ's musings from yesterday in case you did not see it....
The $1 Billion Tax Bill That Isn’t: My Rebuttal on QVC
T.J. Detweiler
To: me · Fri, Aug 15 at 12:42 PM
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The $1 Billion Tax Bill That Isn’t: My Rebuttal on QVC
I got a good comment from Andrew Coye who disagrees with me on QVC.
This is really the reason why I started this blog and why I started using social media. There comes a point when you have an idea, but if you’re in your own little bubble, you don’t have fresh perspectives to test your thoughts. You’re just left in your head. So finding people who disagree with you is important.
I asked Andrew if I could use his comment for a post, and he said I could. I have to say it’s refreshing to have an honest dialogue. Social media makes people hostile. Here is his comment, and my response will come after:
TJ, thank you for putting your pen to paper and driving the conversation.
Personally, I can't square the circle.
At the end of the day all debt games are just a reordering to get the at the value of the assets. Let's quantify the asset. For simplicity let's say the QVC Inc is a $700mm OIBDA business and put a 6x multiple on it. That creates $4.2 billion of EV to be sliced and diced among the creditors and parent cos. There's also some cash, Cornerstone and miscellaneous held at various legal entities.
There was $2 billion of RCF before the latest cash draw at Inc. Let's take the premise the RCF lenders become super prime and recover 100% in the form of new debt to restructured QVC Inc. let's pretend the bondholders get haircut but end up with some new debt and most of the new equity in restructured QVC Inc.
Now let's move up to Linta. They've got debt and DTL. If I understand it, if the exchangeable are touched in any way the DTL is accelerated. So let's just leave that debt alone until it's fall 2029 maturity.
Because of the QVC Inc LME and reordering, I assume Linta will end up with much less equity in Inc. Linta will still have exchangeables with interest and DTL. It will have its bonds, maybe these are partially repaid in a separate LME using its current $200mm cash, and it has 38% of Cornerstone and some other miscellaneous VC assets and liabilities.
Whatever happens here, there is the intermediary company with lots of liabilities and less ownership of QVC Inc.
Let's move up one more level (Parent). We're now two layers removed from the LME at Inc. Its Linta sub now owns less equity in the new QVC Inc. and we've got to deal with the Preferreds and common shares. I believe it was suggested that a 1:1 conversion of Pref into Common with common owning 60% or the Parent is a scenario. The Parent has $200+ million of cash, 62% of Cornerstone and 100% of Linta. In this scenario Linta now owns less than half of QVC Inc (ie a minority).
QVCGA now owns less than half of Parent.
So even in a reasonable, clean scenario with lots and lots of haircuts and LME, QVCGA ends up with **less than half of half** of the restructured QVC Inc plus some cash and Cornerstone.
If QVC Inc is restructured and performs well then any FCF that can be upstreamed passes to Linta which needs to service its own debt and address its DTL (counting down til 2029 or punt it again somehow) before passing up any FCF from QVC Inc to the Parent.
Even with its future indirect (diluted) ownership of QVC Inc, it's unlikely that any FCF can ever move up to the Parent given the troubled entity in between (Linta).
I've yet to see anyone comprehensively lay out a plan that addresses each issue at each level. You have done a nice job explaining what might happen at QVC Inc (RCF lenders lead a restructuring) and also what might happen to the Pref (BOD vote or conversion or some other transaction).
But the picture that I see is incomplete because it doesn't address Linta and what's left (if anything) for the QVCGA Parent.
The above are round numbers and a simplified scenario to highlight the obvious liabilities and issues, not a proposal or prediction. It's very hard to see the value creation opportunity, especially for QVCGA.
Maybe it's because my imagination and analysis is bad, or maybe it's a hard problem and that's why dozens of $1,000+ per hour advisers are being brought in to analyze and prepare to negotiate.
A real solution is that QVC Inc generates more OIBDA and therefore the asset is worth a lot more. This has been the crux since I first looked at QRTEA in Nov23. Except for a short, false dawn, the customer count, revenue, OIBDA and FCF has headed in one direction - LOWER, regardless of the capitalized letter McK strategy (ATHENS, WIN, etc).
Amazon, Temu, Walmart, Sharkninja, and the decline of linear cable have been an insurmountable headwind. TikTok Shop is a good idea, better than SUNE, but it's a drop in the bucket compared to the sums of debt and asset value / cash flow required.
IMO the creditor fight is over a damp cigarbutt, and even once it's in hand, it's not clear that the Parent gets a soggy puff.
Best of luck to all involved - the complexity and unpredictability will surely create opportunities within the capital structure and by following closely we can all Learn a lot. Unfortunately, for most interested, there has already been a heavy tuition paid along the way.
-Andrew
My RebuttalObviously, if you’ve been reading my posts, you know I disagree with Andrew’s conclusion. But I appreciate the discussion.
The biggest problem with the entire argument is that it largely hinges on a 100% false premise.
The LINTA exchangeables DTL.
OpCo FCF will not be hindered by the DTL as suggested. The idea that there’s going to be this midco that soaks up all FCF for the IRS is factually untrue.
I’ll leave you all in suspense on the DTL and save it for the end—it’s a little complicated, but it’s fun.
Anyway…
On the Business in GeneralAndrew and I obviously disagree on the future prospects of the business irrespective of the debt overhang. And I don’t think there is anything I can do to convince Andrew here.
At the end of the day, I don’t believe the declines will go on forever. QVC hit a perfect storm of 1) a fire obliterating their largest distribution facility, 2) a severe post-COVID discretionary retail recession that is still being felt, 3) an eyeball-drawing election that affects QVC but not other retailers, and 4) tariffs.
All of these things make sense to me. People call them excuses, but I wouldn’t want to deal with any of these problems in business. Two of them affect QVC only, and the other two affect all of discretionary retail, and there’s plenty of evidence of it across the industry. I view these things as temporary. What hasn’t changed is that QVC still has a strong cohort of super users that give QVC staying power over the long run. The temporary challenges will pass. Best customers still spend more every year, including this year. And retention is up on existing customers.
In the interest of length, I’ll save the detail on QVC’s bright future for another post. This blog could probably use a break from complex capital structure discussions.
Moving on…
Bondholders and P Holders Are PanickedBondholders and preferred holders agree with Andrew, not me. If they view this as a damp cigar butt, they think their prospects are bad. There’s a reason the bond prices are so depressed. They’re not expecting to get par. And given recent history and other precedents with other LMEs, and given all of the conflicts of interest involved, and given the liquidity that QVC has (not to mention ample untapped incremental liquidity allowed in the credit agreement), everything points to a haircut across the board for bondholders and preferred holders. I think Andrew and I agree here for the most part that something is going to happen. The question is what will it be?
Let’s go piece by piece in the capital stack:
QVC BondsQVC bondholders think their paper sucks, and they’re senior secured. If there’s a tender at 50–60 cents on the dollar paired with consent solicitations that strip them of certain rights, if they don’t take the deal, they’re stuck with even crappier paper than before, and it will be illiquid paper they can’t get out of. A lot of bondholders can’t get an exit. This is their only exit option, and it’s at a premium to the market. And that doesn’t consider any distressed debt shops that are happy with anything because they were able to buy at much lower prices weeks ago. QVC has the cash to make this happen, and I think they will.
That said, the ‘27s and ‘28s may probably be left alone, since there isn’t much principal left anyway.
LINTA BondsWhat applies to QVC applies to vanilla LINTA bondholders too. What are they going to do here? Their paper is terrible and unsecured and subordinated to debt of an OpCo they believe is a melting ice cube. They will be happy to take something here. If they thought these bonds would get paid a ton more than the market price, they’d be buying them hand over fist. I don’t see why these can’t get retired for 30–40 cents on the dollar. There’s enough cash on hand at LINTA to retire half the bonds at this price with cash left over for the exchangeables. If the banks will fund more, then great.
From the bondholders’ perspective, it makes no sense to hold out for more if you think the business sucks and you’re subordinated and you’re worried about a $1 billion tax liability.
And yes, like I said before, I know the tax liability is a mirage—but it doesn’t matter what I think. What’s important is what the bondholders think. And that is what affects their judgment right now.
ExchangeablesThe exchangeables are in the worst spot.
I've written about Contingent-Payment Debt Instruments (CPDIs) already, but the exchangeable bondholders (unless they’re tax-exempt) currently hold an asset that’s practically worthless, if not less than worthless. The exchangeable feature means nothing, and you get massively negative carry before you get redeemed in 2029 or 2030. No one in their right mind (if they’re a taxpayer) is touching these. Whoever owns them is stuck with them.
The tax expense they have to pay by owning these bonds is greater than their current market price. Taxable bondholders, therefore, hilariously benefit by just getting out of the bond altogether for any price. There is precedent with CPDIs for tax indemnification agreements that mean QVC would effectively get paid (net of tax) to unload some of these. Some semblance of that may happen. Either way, after tendering for 50% of the vanilla bonds, there is enough LINTA cash remaining to tender for these too and—in fact—it may cost nothing to do so.
But…
It doesn’t make sense to get rid of all of these bonds because the tax savings to QVC are greater than the cash cost. These bonds are cash-positive for QVC, but a little under half of the bonds don’t get the benefit due to interest-deduction limitations. I think only a fraction of these should be touched to reduce the principal due at maturity while maintaining the full tax benefits in the interim.
Preferred HoldersThe preferreds are selling for 5 cents on the dollar. Do any of you honestly think that P holders are going to hold out for $1 billion? This price reflects panic. They’ll take anything at this point. The HoldCo has $260 million of unencumbered cash. They could offer 20 cents on the dollar with consent solicitations, and the preferred is gone. I’d be shocked if they didn’t take that kind of offer. And only half of the outstanding preferred shares has to consent to make it happen.
Andrew used a 1-to-1 conversion since that’s been mentioned on social media. I don’t see that happening. There’s no need. The P holders have no way of selling. The Board has no requirement to pay. Whatever board seats they could get would still be minority representation. And Section 17 of the Certificate of Designations says that any right the preferred holders have may be waived with 50% consent—a rare and onerous clause. And there is plenty of unencumbered cash to coerce that kind of consent.
To conclude this section:
At every level of the capital stack, nobody believes they’re going to receive anything close to their original fixed claim. Otherwise the prices of those instruments would be higher. Haircut risk is already priced in everywhere. And QVC has enough cash to entice and coerce bondholders and preferred holders to take an offer. Diluting the common shareholders would make way more sense if there wasn’t so much liquidity. But there isliquidity. I think we’re all anchoring to dilution because nearly every time we see distressed scenarios, there is no liquidity left over—so the only compensation that can be given in that case is equity. But QVC is a special situation where the general expectation doesn’t apply. I’ve never heard of a distressed company with this much cash at their disposal to make deals. Most of the time, the tap has already dried up.
As a result, the residual claimant stands to benefit the most in this case, and that is why I own QVCGA.
But that’s all a moot point if there’s $1 billion in tax liabilities sitting between me and the QVC Queens who love shopping at QVC.
Am I screwed?
The DTL MirageThe biggest mistake the market has been making is that QVC has a $1 billion tax hit for CODI with the exchangeables—that if they touch them at all, they’re screwed. Andrew’s argument hinges on this being the choke point in the capital stack. Once I dismantle that idea, you can see how the rest of his chain falls apart.
When they took on those exchangeables 25 years ago, they had a long-range plan to deal with the tax. This isn’t a new development. And everybody seems to simultaneously admit that they don’t understand them while claiming with certainty they are going to get hit with a $1 billion tax when they retire them.
But if you don’t understand them, how can you be so sure?
Just starting with the absolute basics, they have $700 million in DTAs related to tax credits, NOLs, and carryforwards as it stands today.
With just a cursory look at the notes in the 10-K, you will see that they can retire over half of the exchangeables today with no tax consequence. And you don’t have to be a tax expert to figure that out—it’s right there in the 10-K:
And if your initial thought is “there’s a valuation allowance,” you don’t understand how tax accounting works. The valuation allowance generally doesn’t credit planned future actions that will generate taxable income from LMEs—it’s a conservative measure tied to operations. They’re not going to generate enough taxable income from operations alone to utilize the DTAs. Retiring the exchangeables early is not what the VA is meant to capture.
You might say, “Well fine, it’s still a $300 million tax hit.”
But that isn’t true either, and it’s a little more complicated, but it’s fun—so here goes…
Of the $700 million in DTAs that are usable, $100 million are foreign tax credits. These are very valuable.
These foreign tax credits get created with a 21% tax rate, but when they claim the credit, they’ll only have a 10.5% rate under GILTI. These foreign tax credits are growing too.
The long-term strategy goes like this: retire enough exchangeable bonds that will create a tax liability of ~$600 million in the U.S. You don’t need to do this all at once—you do it over time. There are 2025 NOLs expiring. The foreign tax credits will not be touched when you retire these—you’ll be using the NOLs and interest carryforwards here to offset the tax. All that’s left is ~$400 million.
You take the bonds that are leftover, and at some point you make QVC Global Corporate Holdings, LLC the co-obligor on those bonds and you retire these bonds with that entity.
QVC Global is a disregarded entity for U.S. tax purposes, and it is a subsidiary of a Luxembourg entity (the country is important). The Luxembourg entity will claim the income for tax purposes—but Luxembourg doesn’t tax CODI. And because this is foreign income, QVC now has a way to utilize its foreign tax credits.
This cancellation of debt income will be recognized as Global Intangible Low-Taxed Income. And this GILTI is taxed at 10.5%—meaning that $400 million of the DTL is overstated on QVC’s books because it’s calculated at a 21% rate.
So in reality, when they retire these bonds to use up the foreign tax credit, it’s actually ~$200 million in tax liability—not $400 million. And with ~$100 million in foreign tax credits, they’re only left with ~$100 million in tax.
And I know they’re going to do this because 1) I’m familiar with this tax strategy and 2) they’ve done it in the past (e.g., 2020 with the MSI exchangeables).
But there’s more.
This assumes they retire all of the bonds today. They’re not going to do that.
Remember what I said earlier. These FTCs are growing. They’re generating more foreign tax credits every year.
By 2029 and 2030, they’ll have close to enough FTCs to offset nearly the whole DTL tied to CODI on the exchangeables as of today.
What about future DTLs on the exchangeables?
Moving forward, the DTL grows every year. Is that a concern? No! The DTL grows dollar-for-dollar with current cash savings. It’s an interest-free loan, so even if they just put the current tax savings in Treasuries, they’ll be fine.
So yeah, I’m not worried about the DTL. I can understand why the market doesn’t understand this stuff. But the market is mistaken. The DTL is not a problem.
Based on everything above, even if Andrew’s “half of half” scenario plays out—which is far worse than what I think will happen—at the current price, QVCGA is still extremely attractive.
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