It’s been an interesting week for Liberty Global Latin America (LILAK) with the stock up almost 15% after billionaire CEO John Malone bought $16.3M of the stock in the open market, his first open market purchase in any of his businesses since 2013. LILAK has been a top holding for Nitin Sacheti, portfolio manager of Papyrus Capital, since May, and he believes the stock has significant upside. Nitin shared his in-depth thesis with a complete breakdown of LILAK's complex market segments on SumZero Pro. I sat down with Nitin to answer a few high level questions about LILAK and Malone.
Luke Schiefelbein, SumZero: What does LILAK do?
Nitin Sacheti, Papyrus Capital: LILAK offers cable services (television, broadband internet and phone) along with wireless services in Chile, Puerto Rico, Panama, the Bahamas, Jamaica, Trinidad and over a dozen other smaller islands across the Caribbean. They also own the largest undersea fiber optic cable in the region.
Schiefelbein: Why did John Malone choose to buy this much LILAK, and more importantly why now? Is this a significant amount for the billionaire businessman? What do you think his plans are?
Great question. I think Malone sees what we see, a good business trading at a discounted valuation with significant organic growth and synergy upside through regional consolidation. I think he sees that the bottom is in on the stock based on recent issues being one-time and they’ve increased prices while the shareholder shift is mainly done. What’s interesting is that in the 3 days he purchased LILAK shares, he was 15-38% of the volume which is very large for a single buyer. He could still be opportunistically buying stock given LILAK’s future prospects.
Schiefelbein: So what about LILAK caught your eye as a value investor? What are LILAK's future prospects?
Sacheti: As a value investor, I love buying businesses that are (1) run by a great manager with a keen eye for profitability, (2) possess secular growth and sustainable cash flows, i.e. they are good businesses and (3) are trading at a low cash earnings per share multiples. We identified LILAK as possessing all three with near term catalysts for the market to realize the true value of the business.
(1) John Malone is arguably one of the best CEOs in history, growing Telecommunications Inc. (TCI) from 100k subscribers in 1970 to $55B in 1999 when AT&T acquired the company. In addition, his Liberty companies have delivered a higher return over the past decade than Berkshire Hathaway or the S&P 500.
(2) We believe that cable is a phenomenal business and cable combined with wireless is even better. With streaming movie services and now 4K video, consumers are demanding faster internet connections in their homes. The substitutes to cable are inferior: copper-based DSL is too slow, fiber to the home is too expensive to build, and wireless is either too expensive at fast speeds or inferior at slow speeds. This allows cable companies to continue to sell higher broadband connections to customers with very little added cost. In Latin America and the Caribbean, broadband penetration rates are low and LILAK operates the only cable network in many of their markets, allowing them to grow through higher subscriber count and increased prices. In addition to cable’s monopoly, we love quad-plays where a single company offers a triple-play cable service (home telephone, broadband and television service), plus wireless service, AKA a quad-play. While triple-play customers usually stick with their provider for 4-5 years, a quad-play subscriber usually stays for 8 years, on average. Since the cost to sign up a new triple-play vs. quad-play customer is similar, the return to LILAK on their quad-play marketing spend is significantly higher.
(3) At about 10x our 2019 cash EPS or FCF/share with 30-50% cash earnings growth, we believe LILAK has significant upside with high predictability, given the aforementioned growth/profitability through broadband and quad-play.
Schiefelbein: The stock has dropped from a recent high of $49.90 in late 2015 to $25 today. If this is such a great business, run by a great team, why has the stock halved? What is the market missing?
Sacheti: That’s a great point. We believe the stock has halved because of some recent acquisitions that the market may not understand, combined with some technical pressure and asset complexity. Their recent M&A history is important in answering this question.
LILAK originally operated in just Chile and Puerto Rico but acquired Cable & Wireless Communications Ltd (CWC) in November, 2015 which operated in all of their other markets. Given the high purchase price of CWC, LILAK would have normally had to issue equity to fund the deal. Instead, Liberty Global PLC (LBTYA), LILAK’s sister company which sells cable services in Europe, backstopped the deal. LILAK essentially issued equity to LBTYA for LBTYA’s cash to fund the deal. This allowed Malone to not dilute himself by issuing equity to the public since he maintains a large ownership position in LBTYA. In mid-2016, LBTYA announced that they would distribute the LILAK shares they owned from the CWC deal to LBTYA shareholders. This essentially meant that shareholders in a $35B company (LBTYA) would receive shares in a much smaller $5B company (LILAK) that were worth 1/8 of their LBTYA position...a blip on their radar.
Soon after this distribution, LILAK missed Q3 2016 earnings estimates and guided down Q4 2016 due to a number of one-time issues that all hit at once (a hurricane related charge and two accounting changes, along with a price step down in the Bahamas). LILAK financials are also very difficult to analyze given operations in so many different markets (some partially owned), along with differing fiscal year ends.
To summarize, a guide down and earnings miss from one time events, in a disparate set of developing island nation operations with extremely complex financials, in a stock where 2/3 of the shareholders did not actually buy the stock themselves but were given shares as part of a financing deal, it’s no wonder LILAK halved.
Schiefelbein: What will catalyze the market to realize the value of your thesis?
Sacheti: I think there are two main things that need to happen:
(1) The shareholder base must shift from those who were given a piece to those people who want to own LILAK for its merits. I believe this has almost fully happened when I look at how much the stock has turned over in the past 6 months as investors understand the quality of the LILAK business/manage and dirt-cheap valuation.
(2) Investors must understand that the price step down in the Bahamas is one-time and that LILAK has pricing power across its markets. LILAK reduced prices in the Bahamas due to a new entrant in mobile. We have analyzed current pricing over time in the Bahamas and across all of LILAK’s other markets and have concluded that Bahamas pricing is comparable to its competitor, while LILAK has been able to raise prices in many of its other markets. We believe that this will show up in the next 1-3 quarterly earnings announcements. LILAK’s main competitor in the Caribbean, Digicel is also bordering on insolvency and is raising prices to stave off bankruptcy risk.
Combining (1) and (2), as investors begin to see cash flow growth over the next several quarters, they will understand just how cheap LILAK trades on 2019 cash EPS and its runway for growth over time. John Malone’s insider purchase should also solidify that the bottom is in on the stock and the fundamentals are very good.
Schiefelbein: What is your price target and how much upside is there?
Sacheti: This is the sort of business I want to own for 5+ years and let management grow its value through smart moves. We believe the company will earn $2.40 in cash EPS in 2019 and $3.40 in 2020. At 13x our 2020 cash EPS, we have a one-year price target of $45, offering 80% upside. After the stock hits this price, we believe it should continue to grow earnings at 30%, thus, at a constant 13x multiple, it could give us a 30% annual return, thereafter. What’s also important to note is that in order achieve our estimated 44% cash EPS growth from 2019 to 2020, revenue must only grow at 5% given the high incremental profitability in the business...not an aggressive assumption.
Schiefelbein: What are the key metrics people should pay attention to?
Sacheti: The macroeconomic situation in the Caribbean is important, though I’d argue that as shown in Puerto Rico and Alaska, despite a recession, people are still upgrading their broadband to the fastest speeds and cutting out other luxuries. Liberty management has also said they believe Latin America is a fragmented telecom market and can drive synergies through acquisitions so, any deals announced likely signify added upside given management skill.
Schiefelbein: What are the key risks to owning LILAK?
Sacheti: Latin America and the Caribbean are largely developing economies, which are poorer and more cyclical than the US or Europe and have a weaker rule of law. Fluctuations in GDP growth mean less disposable income for residents to spend. Also, while mobile voice revenue is a small percentage of overall LILAK revenues, this is being disintermediated by Facetime and Whatsapp as emerging market subscribers transition to smartphones on LTE networks (it’s cheaper to make a call on Whatsapp on data than pay for voice minutes). If LILAK cannot transition to sell more data services to consumers to offset voice declines, this is a risk. However, the transition has been seamless for wireless operators in developed markets as consumers spend more on data as speeds improve.