Malone's Cash-Rich PE/SPAC Co. Gobbling Up High-Quality Tech Assets

Liberty Ventures (LVNTA) is a play on a high quality Liberty Media management team’s (John Malone, Greg Maffei) ability to source investment opportunities in the TMT space, monetize them in a highly tax-efficient manner, and create value through a positive NPV, tax-advantaged bond cash flow stream.

Primary opportunity – capital deployment; Liberty’s investing track record

At present, Liberty Ventures is primarily comprised of:

$3.0B in PF gross cash
An 18% stake in Expedia
A portfolio of e-commerce companies worth ~$1.2B
A portfolio of green energy investments worth $0.5B
~$1B face of tax-advantaged convertible debt instruments
$1.1B of equity-backed exchangeable debt (fully hedged)
Other equity stakes worth ~12% of SOTP

As a result of a transaction with Liberty’s TV shopping entity (QVCA) that took place in the fourth quarter of 2014, Ventures has become a cash-rich investment vehicle for Liberty management with a large deployment likely to take place.

Specifically, via intra-tracker transfers, Liberty Ventures received digital commerce assets, valued by an independent advisor at $1.5 billion, plus $1 billion in cash. In return, Liberty Interactive (QVCA) shareholders received approximately 67.67 million shares of Ventures common stock, or 0.14 of a LVNTA share for each share of LINTA held.

Since the aforementioned transaction, Liberty management has spoken to a preference for making a sizeable investment as opposed to numerous smaller ones – as recently as their 4Q14 earnings call – though management (Maffei) did not rule out the possibility of continuing to pursue tack-on acquisitions to build out their ecommerce portfolio similar to the purchase of Mercent – a retail technology company – to augment the growth of Commerce Hub, a virtual inventory platform for retailers wholly owned by Liberty. With regard to the transaction size and scale of such purchases, Liberty management indicated both would be small in nature.

Regarding Liberty’s preference for pursuing a larger deal, CEO Greg Maffei reiterated their reason for pursuing large deals on their most recent earnings call, stating that their decisions are primarily influenced by their exchangeable tax shield and desire for influence within their investments:

“…going in and buying three to five percent of something, given that we need to have a longer-term time frame internal build-up, probably doesn’t work. We need to be able to buy a meaningful stake; have that voice…”

With Liberty’s current focus on sourcing large-scale investments in the TMT universe and its consistent with past investments, it’s worth exploring, generally, what rates of return the company has produced for its shareholders own in the past.

Going back to Liberty’s inception as a publically traded company (ticker ‘L’), after adjusting for stock-splits and asset spins, the company has shown an ability to generate high single to low double digit rates of return on investment, on average.

While Liberty’s tax-advantaged bonds will be explored more thoroughly in a later section, the company’s ability to outrun a growing tax shield liability is important to consider; however, the company’s ability to generate high single to low double digit shareholder returns is significant, because at that level, Liberty believes they can create value for shareholders net of the ultimate repayment liability, based on return thresholds discussed at their Investor Day presentations.

Looking at some of the larger investments Liberty has made over time, the company typically seeks out under-leveraged TMT businesses with sustainable revenue growth and strong free cash flow conversion (SIRI, LYV, and CHTR being prime examples). A prerequisite for any investment in a business of this caliber is also an opportunity to take a large stake in company, along with a path for control when immediate control is infeasible.

Given commentary at their last public shareholder meeting around “inflated” public equity market valuations, it also seems likely that Liberty will spend considerable time scouring private markets for new investments, where Malone and Maffei should be able to leverage unique rolodexes to source opportunities.

In the past, Liberty has used margin loans as a way of drawing additional funds for investment in lieu of raising debt at a business with no significant operating company, a la Ventures. For that reason, it’s likely that the Ventures team will explore raising additional capital from a margin loan on their $2B EXPE stake, in the event that an immediate deal with Barry Diller to regain their voting control (explained more thoroughly below) to finance a larger transaction.

If Liberty were to including additional cash from a margin loan on their EXPE stake, Ventures would have roughly $4B PF to invest in a new operating asset, given margin loans on their equity stakes held at other vehicles have typically been in the 40%+ LTV ballpark. Returns generated on larger deployments the company has made over time have been well in excess of aforementioned return hurdle targets, as well.

FCF and tax advantaged bond cash inflows

An added wrinkle of investing at the Ventures platform is a set of three convertible debt instruments each paired/hedged to equity stakes Liberty held at the time of initial issuance in 1999 – 4.0% S/CTL notes due 2029, 3.75% S/CTL notes due 2030, and 3.5% MSI notes due 2031.

In 1999 the IRS awarded Liberty preferred tax treatment on their bonds -- a taxable rate of much higher than the actual cash coupon interest rate -- effectively allowing Liberty to shield and compound the spread differential between the taxable rate (9.0 - 9.5%) and the lower, cash coupon rate (3-4%) over the lifetime of the bonds. The bonds were issued annually from 1999 through 2001 and mature annually from 2029 through 2031.

Though Liberty’s argument – they should be compensated for the difference between prevailing market rates and their bonds’ returns, due to the conversion option – was initially deemed appropriate by the IRS, Liberty has since stated the bond feature should be thought of as a one-off. Since then, Liberty has also been forced to pay a $321M settlement with the IRS for initially underpaying of taxes, which will be paid in $64M annual increments through 2018 and is incorporated in free cash flow forecasts.

Focusing on Ventures’ free cash flow, despite not having an operating business, the tracker generates cash flows for via intergroup cash transfers from the QVCA tracker. Given that Ventures lacks an operating business, it also lacks taxes to avert and therefore the entity that uses the tax shield is Liberty Interactive. For every $1 of taxes that Liberty Interactive shields, Ventures receives $1 in return via intergroup cash transfers.

Furthermore, so long as Liberty invests capital at a low single digit rate of return (see Investor Day presentations), the ultimate liability that comes due between 2029-31 is covered. Returns in excess of that hurdle rate are positive NPV. Should the company invest its cash balance alongside the inflows from QVCA, the return hurdle drops significantly and the ultimate NPV opportunity grows commensurate with cash deployment assumptions, also.

Given the bonds are exchangeable, there is risk associated with long-term value creation in the event that an all-cash takeout of the underlying equity positions (Sprint being the most important candidate, on which the 4.0% and 3.75% bonds are pegged) occurs. According to Liberty, the impact of this sort of black swan event would be in the hundreds of millions of dollars.

The other primary risk associated with Liberty’s tax shield is the risk of delaying investment and facing ever-higher hurdle rates to neutralize the tax burden as time passes. While it’s difficult to measure exactly how the hurdle rate may adjust over time without making assumptions around when Liberty will invest, and in what size, the company seems relatively unconcerned with that prospect. On their most recent earnings call, with regard to outrunning the growing tax burden, CEO Greg Maffei stated: “we’re probably people who are frankly less concerned with the time value of money [concern] than making the right bets.”

Core asset strategy – EXPE, tax-free monetization options

Beyond cash deployment and investment, it’s likely that the next most material catalyst for Ventures could be a tax-free RMT spin of the company’s stake in Expedia, Inc.

To conduct a spin of the Expedia stake, Liberty would like to first re-acquire control of their voting stake from InterActive Corp. CEO Barry Diller, and the primary hurdle to doing so has been Diller’s lack of a pressing need for cash.

Digging into Liberty’s Expedia ownership, the company currently owns a 17-18% equity interest, but has an equal share of the outstanding preferred/voting shares with Barry Diller. Though Liberty/John Malone owns the preferred stock, Barry Diller has maintained the right to vote both his and Liberty’s shares since the initial spin of the Expedia asset from within the IAC incubator.

Though voting control is not a requirement to conducting the spin, Liberty management believes the true value of a potential Expedia SpinCo -- from a market perspective -- would lie in its takeout opportunity; i.e. the opportunity for a acquirer to effectively acquire control the Expedia business without paying for a >50% equity interest. As a result, it’s unlikely that shareholders will see the benefit of an Expedia RMT spin until Liberty acquires voting control.

Using the TripAdvisor transaction as precedent, Liberty could structure a transaction to reacquire voting control of EXPE by purchasing a small amount of Barry Diller’s common or preferred stock at a large premium to compensate him for surrendering the vote. When weighing the ultimate tax avoidance against the premium that Liberty might have to pay to Diller on a per-share basis, even a very significant premium to market represents a positive NPV transaction for Ventures. Via RMT spin, Liberty would avoid over $600M of taxes that would be surrendered from an open market sale of their equity. Assuming the amount of common stock purchased from Mr. Diller is similar to the volume we saw in the initial TRIP transaction (approx 5M shares), even a very significant premium to market wouldn’t erode even a large portion of the value shielded from a tax-free transaction. Therefore, I believe the primary question around a transaction with Mr. Diller remains a matter of “when,” not “if.”

Another option frequently discussed for monetization is a “section 355 exchange;” commonly referred to as a “cash rich split.” A 355 transaction is another form of tax-efficient monetization that involves a tax-free swap of Liberty’s stake in Expedia for 2/3 of the public market value in cash and 1/3 of the value accounted for in an operating asset. In a hypothetical transaction, based upon this would net Liberty over $1.5B in cash, tax-free, but would also leave the company with approximately $700M of value tied up in a new asset that the company would have to creatively find a way to monetize.

Expedia has a wide variety of assets that could be used to satisfy the operating asset valuation criteria, but Liberty has frequently stated that they have very little desire to conduct a 355 exchange, despite having entertained the option with Expedia management in the past. A non-core operating asset worth ~$700M with little to no tax basis would only prolong the overall monetization process for Liberty.

As previously mentioned, the sticking point in reacquiring the shares has primarily been Diller's lack of need for liquidity and, potentially, any personal attachment he may have to the Expedia asset, which came from the IACI umbrella.

Core asset strategy – e-commerce assets, M&A opportunity

Another opportunity with the Ventures portfolio remains the various e-commerce assets they control; the most valuable of which are Bodybuilding.com, Backcountry.com, and CommerceHub.

While the ecommerce business are a less material piece of the story than their EXPE stake, or their tax-advantaged bonds, the argument initially posed by critics of their transaction with Liberty Interactive that the assets are non-core or worth very little makes little sense when recognizing the collective worth of both profitable and unprofitable portfolio companies to the overall Ventures Story.

Particularly with regard to the less valuable, or unprofitable companies in the portfolio, most – if not all – have been owned by Liberty for more than five years. The reason this is significant is that an RMT spin needs to include an “active trader business,” which is essentially a business in the same sector as the SpinCo (EXPE, in this case) that’s been wholly owned for more than five years. So while CommerceHub is frequently the asset that Liberty highlights in terms of importance and potential longer-term strategic value, a business like RedEnvelope is important in terms of providing a readily available ATB asset for an eventual spin of EXPE.

Overall, each of the businesses in their portfolio offers value as either: an undervalued business that should grow organically and via tack-on acquisition, a takeout opportunity, or an active trader business to aid a tax-free spin of EXPE.

Rationalization of their investment portfolio could include a sale of assets to strategic buyers (Bodybuilding to GNC, or Backcountry to EMS/REI/etc. being the most common assumptions) in the same way the company had sold Pro Flowers/Provide Commerce to FTD, or deploying cash to build around the most promising assets (most likely CommerceHub).

Digging a bit deeper into the actual implied value of the assets vs. the reported $1.5B valuation placed on the assets by independent advisors during the transaction process, the ascribed valuation was thought to be roughly 15-17X the combined EBITDA of the overall operating asset portfolio.

What this portfolio includes, which I believe should be broken out, is Liberty’s equity stake in FTD, which was distributed to as a result of FTD’s purchase of LVNTA’s ProFlowers/ProvideCommerce asset. Given FTD is a publically traded company, it is easier and more accurate to value at market.

Subtracting the public market value of FTD (~$350M) from the $1.5B ascribed valuation of the e-commerce asset portfolio and we are left with an ascribed valuation of roughly $1.150B, or 12.8X 2014 EBITDA (disclosed on their 4Q14 earnings call), for the remaining companies. Given that these assets are growing faster and provide greater strategic value to Ventures than FTD, it appears fair to value in line with the low end of the PF valuation ascribed by the independent advisors (15-17x), if not above that.

Non-core assets – equity stakes and green investments

Our value of non-core assets and green energy investments is based upon recently reported values from Liberty’s earnings reports and Investor Day presentations.

While Liberty has highlighted the excellent ROIC of their green investment portfolio (wind farm, clean coal plant, etc.), these investments appear difficult to source and represent a lower portion of overall SOTP value relative to the aforementioned core assets.

Precedent for a NAV discount to narrow

Historically, Liberty tracking stocks have traded at very large discounts to net asset value. The best example of which over the last ~5 years has been the Liberty Media (LMCA) tracking stock, in which the company took a ~40% stake in Sirius via preferred stock and loans to the company.

Once Liberty announced their stake in the company and subsequently moved to obtain a controlling interest in the company via open market purchases, the outsized discount on the company (in the 30% ballpark at times) narrowed to a more reasonable 5-15% tracking stock discount. Likewise, when Liberty announced their investment in Charter, not only did the value of their stake double over a very short time period as investors piggy-backed Liberty’s cable trade (also benefitting LMCA shareholders via mark-ups to reflect CHTR fair value) the discount on the LMCA shares also narrowed to 0-5% vs. NAV.

Assuming Liberty Ventures is able to deploys some/all of their cash balance in the future, or can structure a transaction to monetize their EXPE stake tax-efficiently, we should see the discount narrow to at least the higher end of a traditional tracking stock SOTP discount near 15%.

Management Team

John Malone and Greg Maffei, who currently serve as Chairman of Liberty Media and CEO of Liberty Media, respectively, run Liberty Ventures, along with Chris Shean, who serves as Chief Financial Officer. Together, the Ventures management team – which also oversees other Liberty entities LMCA and QVCA – have sourced and rationalized significant investments in Sirius XM, Charter Communications, Live Nation, Expedia, TripAdvisor, and more.

With regard to Liberty Ventures, both Malone and Maffei have significant equity positions in the company and neither have reduced their ownership since the spin off of Ventures from Liberty Interactive in 2011. At present, Mr. Malone owns 1.1M shares of LVNTA, while Mr. Maffei owns 1.0M.

To-date, John Malone has spent 25 years running Liberty Media and its tracking stocks, while Greg Maffei has served as CEO for the last 10 years. Mr. Shean has been an employee of Liberty Media since 2000.

Under the tenure of Malone and Maffei, Ventures has roughly quadrupled from its split-adjusted initial price of $11.06 and should continue to create value for shareholders going forward as the investment/monetization thesis plays out.

Other Considerations

Valuation: A 15% discount to NAV equates to a share price of $43, while a 5% discount equates to a share price of $48. At parity to NAV, Ventures is worth $50.

Potential Catalysts: Deployment of cash in new investments or around existing stakes; Tax-efficient monetization of their EXPE position; Raising cash via margin loan of their EXPE stake to finance larger-scale investments; rationalization of e-commerce assets via M&A

Potential Risks: Dilution of the tax-advantaged cash flow stream due to M&A (A Sprint takeout, most likely); Inefficient investment of their growing cash balance; negative events at Expedia impacting the value of their holdings