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Exclusive Interview: Kevin Byun on John Malone
Watch a video recording of this interview
in The Manual of Ideas Members Area at
www.manualofideas.com/protected
We had the pleasure of meeting Kevin Byun, managing partner of Denali
Investors based in New York, for a conversation about John Malone’s financial
brilliance. Kevin Byun founded Denali Investors in 2007. He has a triple major
from Rice University and an MBA from Columbia Business School. Prior to
Columbia, Kevin Byun was an investment banker with UBS.
(The following is an edited transcript of an interview and may contain errors.
The transcript has been condensed for clarity, readability, and timeliness.)
Oliver Mihaljevic, The Manual of Ideas: How did you come across John
Malone and what led you to study him?
Kevin Byun: John Malone is a very interesting guy. The first time I came across
him or looked into him more closely was when I read Greenblatt’s book, You
Can Be a Stock Market Genius. There is a very interesting case study in there.
I had done a few years in investment banking and decided that wasn’t the longer
term path for me. And so in the period after that, I had read everything I could
about investing but the special situations angle, especially what I read in
Professor Greenblatt’s book, really jumped out at me. That led me to applying to
Columbia Business School, specifically just to take his class.
And you learn about him there too, and so this is going back let’s call it eight
years was when I first actually spent more time on John Malone.
MOI: John Malone is not an unknown name in value investing circles. Give us
a sense of what attracted you the most, and what are some of the key things you
found interesting?
“If you’re talking about
finding high-quality, highmargin cash flow businesses,
that in isolation is good. But
when you combine that with
attractive tax attributes,
aggressive share buybacks,
rights offerings, creative
structures—all of those
together over the long term
have provided astounding
returns for investors.”
Byun: You have a talented owner-operator. He understands how to create and
build value. There’s also a financial and capital markets approach that allows
him to maximize that. If you’re talking about finding high-quality, high-margin
cash flow businesses, that in isolation is good. But when you combine that with
attractive tax attributes — tax deferral — if you combine that with aggressive
share buybacks, rights offerings, different creative structures, all of those
together over the long term have provided astounding returns for investors.
If you look at TCI, which is the first phase, that was a 900x return from a dollar
invested in TCI through the end of that term. More recently, over the past eight
years, the Liberty entities have compounded at 35%. There’s something special
because of the combination, this flywheel that continues to produce returns. The
components are actually quite simple. The great part about it is that nothing is
hidden, it’s just hiding in plain sight. The question or the challenge for an
investor is to do the work to see through to the opportunities that are there.
MOI: Help us break that down a bit for us. Of course, the Liberty entities as
they are today require some work to understand… how do you see the structures
and what are some of the interesting things for you?
Byun: The structure itself is quite interesting. It’s atypical. It’s not a Berkshire
[Hathaway-type structure], where you have one stock and everything goes
through that entity. In its current form, across Liberty entities, you have Liberty
Media (LMCA), Liberty Interactive (LINTA), Liberty Ventures (LVNTA), and
the international cable platform, Liberty Global (LBTYA). Of those four,
LINTA and LVNTA are trackers for Liberty Interactive. Right there, people just
stop because, what’s going on with this cable business that’s international...?
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You have QVC within Liberty Interactive. You have this hodgepodge of other
non-control assets in Liberty Ventures.
All the way down the line, everything looks different, but my contention is that
they’re actually all the same. They’re quite similar if you look at them from the
perspective of, you have these entities where you can get a sense of the NAV
today. And you can project that one or two years down the line, and you have a
higher NAV at that time because the underlying businesses are continuing to
accrue value. And you [may] have a discount. For each of those, you [may] have
50% to 80% from the intrinsic value or the NAV, so you have a 20% to 50%
discount. That’s for the core business. What that implies for the stub business,
out of the core business, is that the stub businesses that are the non-core parts of
each of those entities are probably 50% to 80% off, so that’s a pretty big sale.
MOI: You mentioned the word trackers. That’s also something where it often
starts to become confusing in these structures. Help us understand, what does a
tracker mean in the context of Liberty Media and how is it employed?
“It’s quite simple. It is, what
do you expect to get? How
long is it going to take? And
then, what’s the risk?”
Byun: With a regular common stock, you have a direct claim on the residual
assets of a business. With a tracker, that’s not the case. It’s a representation of
the holdings of a corporate entity. That’s one of the major issues people have —
what am I getting for my outlay of capital, this tracker which is not a regular
stock? The trade-off is that you can actually represent different portions of the
corporate assets much more cleanly and with much more flexibility.
With Liberty Ventures and Liberty Interactive (inside trackers for Liberty
Interactive), Liberty Ventures has exchangeable debt that is shielding or
basically accrues losses at a much more accelerated rate than the actual interest
payments. On the Liberty Interactive side, with QVC, you get a lot of cash flow
and earnings. If you were to separate those out, you wouldn’t get the tax shield.
But since they’re within one corporate entity, you have the tax benefit. So, not
only do you get the tax benefit, but also you get the value that’s been created
with Liberty Ventures being separate as a tracking stock. When we invested in
Liberty Interactive pre-spin, effectively we got the Ventures for free, and then
we bought more Ventures, and then Ventures tripled. Had it not been spun out in
one entity, we would never have gotten that opportunity via the tracker entity.
MOI: As an investor, how do you approach the relative merits of investing in
one entity versus another?
Byun: It’s quite simple. It is, what do you expect to get? How long is it going to
take? And then, what’s the risk? That’s the basics, and you can apply those to
each one. They all have discounts. They’re all buying back stock. Some of them
have near-term catalysts, some of them have longer-term catalysts. LMCA is in
the middle of it, trying to bring back in SIRI [Sirius XM Holdings] and create a
C class. Liberty Global is right in it with Ziggo, now they’re trying to buy
another one — that’s going to be another major transaction. You have LINTA,
Liberty Interactive, and then you have Liberty Ventures, which are also
probably doing something within the next couple of months if Greg Maffei’s
timing is right — and he tends to get what he wants.
You have a scale game with Liberty Global in the cable business. They [bought]
the biggest player in the Netherlands. That takes their pro forma market cap
from $18-19 up to $27 [billion] and they’re going to continue that game. They
have a $4.5 billion buyback authorization, and most of that is left. That’s another
situation where you could say, if I look out, there’s a very interesting thesis
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about how Mike Fries is trying to accrue value. By the way, they’re looking into
spinning off the Latin America business. There’s another plank to the thesis.
“If you look at Liberty
Interactive with QVC, you
have a core business
approaching $2 billion in
EBITDA, and let’s just give it
a ten multiple. It’s an
amazing business, 22%
margin, it’s growing
internationally at a rapid
clip, there are some JVs in
there that are substantial but
aren’t consolidated.”
Liberty Media, LMCA, people are a little uncertain about the SIRI buy-in and
the C class, what does it mean? The numbers are quite simple. You have about
105 million A shares. You have ten [million] B shares. A shares have one vote,
B shares have ten votes — and then this new C class. The minority SIRI holders,
they’re going to get issued about 220 million C shares, zero votes. Existing A
and B shareholders are going to get two shares for every share, so it’s going to
be about 230 [million shares]. Add that all up, you get roughly 560 [million
shares]. You’re going to take a share that’s in the 130s and the pro forma is
going to be 45-50. Everything about it — the way it looks on paper, the ratios,
and being three or four places out to the right of the decimal place — nobody
can intuitively understand what it’s going to look like through the transaction.
But all of the same principles apply, and so you have an interesting setup.
The ones that I’m focused on — and I haven’t even gotten into the Charter stake
and what is happening there — but those two are taking literally 100% of the
attention. Nobody is really talking about LINTA, and nobody is talking about
Liberty Ventures. Based on my work, those are much more interesting, and
those have solid catalysts coming up in the next couple of months, at most up to
Q2 [2014], and those are the spinoffs themselves.
If you look at Liberty Interactive with QVC, you have a core business
approaching $2 billion in EBITDA, and let’s just give it a ten multiple. It’s an
amazing business, 22% margin, it’s growing internationally at a rapid clip, there
are some JVs in there that are substantial but aren’t consolidated. You’re at $20
billion; in that entity you have about $4 billion in net debt, so you’re at $16
billion. Isn’t it interesting that the market cap is $14 billion? You’re paying
negative for the rest of this business which has been under earning, a lot of these
businesses just being in their ramp. I haven’t counted the $2+ per share of HSNI,
the equity they own there, which will eventually be consolidated at an attractive
price. Isn’t it interesting that you have that situation coming out similarly? They
are all shades of the same thing. You have Liberty Ventures — that’s one people
have been very negative on since even before the spin and have been shorting
the stock. My view was I wouldn’t do that, but everybody has an opinion.
Again, the fundamentals: what do you think you’re going to get? How long is it
going to take? And what’s the risk? I view the [historical] discounts to NAV as
attractive. And because you have the catalysts that are going to unlock that
value, that’s even more attractive. We’re going to be able to realize the value in
a much more secure manner than you normally would. With traditional value
investing, at Point A you [may] think it’s worth Point B, but a lot of guys don’t
make it because you end up at one-half A before you end up at B. In [the
Liberty] situation, it’s a very clear line of sight to where you should end up.
Because we’ve done the work ahead of time, we’ll have a better sense of what
the discounts will be in the new pieces, and then we’ll be able to act accordingly
once those are available. That’s how I’m thinking about the opportunity set.
MOI: Let’s think about the rationale for the way Malone conducts business and
investing. The use of debt—a lot of value investors typically avoid leverage.
Malone historically has employed quite a bit of debt…
Byun: One way to think about it is having the IRS as your partner until the debt
comes due, and that’s free. They’re paying for the privilege for you to run your
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business in a much more efficient manner on all fronts, operationally, and then
via the capital structure. John Malone says it’s criminal to run a cable company
with less than 5x debt [to EBITDA], and you see why. The reason he can say
that is, it actually dovetails very nicely with the type of industries he is in. It’s a
subscriber-based, recurring revenue stream, highly reliable over time. You can
see the stream come on for each customer, you can see the benefits of scale. All
of those things come into play. When it comes to the debt component, it makes
perfect sense to run a business [on debt] that you believe has more steady
characteristics over time. You run it where you don’t have to pay taxes or have
tax leakage. It’s very simple — that having debt would be advantageous over
time. When you look to the earlier days, you’ve got guys like Gabelli and
Malone that actually get credit for advancing the concept of EBITDA. Before,
nobody really looked at it that way. Cable companies, telephone companies,
they were EPS-based, and then you had a paradigm shift: does it actually make
sense when I’m paying out taxes to the government when that should be
accruing to investors, and maybe we’ll pay taxes at a later date. That’s been a
constant. I can’t recall an interview or a conference call or any type of statement
where Malone doesn’t talk about the tax aspect. The big part of that is the debt.
MOI: Is that the key thing about debt—the effect it has on reducing taxes?
“One of the perennial battles
people have is with QVC.
That’s been the case since
the very beginning, even
when or before Barry Diller
was running it. The customer
base is older, they’re dying
off, this business has seen its
best days, and it can’t
compete with the Internet
and the Amazons. There’s
been every excuse, but it’s
just become a better and
better business.”
Byun: At Ventures, they took down a billion [dollars] of TWX convertibles. It
was 3+% notes, very cheap as it is. They sold the equity against that so that
basically washed out to zero. They replaced it with 0.75% debt. The question
you have to ask is, if you can get that type of rate, and you can run any business,
does that make sense to do? There are a lot of potential factors. If I’m going to
take on debt, should I do it? When you have a situation like that, with this
extreme low end of interest rate availability, what they’ve been talking about for
years is that the debt is so cheap, it makes sense to take advantage of having that
debt because you’re not really paying anything against it. What we’re earning on
the equity or the business part of it — maybe you don’t expect 35% IRRs like
they had in the past eight years — whether that’s 25%, or 15%, or anything
above 0.75%, you’re going to do okay. That’s also one of the considerations.
MOI: People will get that, yet when we observe reality, many stable businesses
that take on debt end up getting into difficulty. There seems to be something
unique about Malone that has helped him avoid trouble…
Byun: One of the perennial battles people have is with QVC. That’s been the
case since the very beginning, even when or before Barry Diller was running it.
The customer base is older, they’re dying off, this business has seen its best
days, and it can’t compete with the Internet and the Amazons. There’s been
every excuse, but it’s just become a better and better business.
Whether it’s that business or what they do with SIRI — you had this very
similar short thesis: look at what’s happening with technology and the Internet,
who wants to pay extra to have SIRI texting them in their car. But post the
merger, post all the operational changes, without all of the excessive re-upping
and competition and overbidding for content, it’s changed quite dramatically.
You have a rear-view picture and then a forward picture. You see these cases
where the approach has been to take the other side of the table, but they’re also
getting in at quite attractive terms in creating the positions themselves. SIRI
was, literally, you have guys that have equity at $0.05 per share, that’s how bad
it got, and that’s when they got in. it’s worked out very, very well, but it doesn’t
always work out that way. It’s still to be determined but, for example Barnes &
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Noble, who knows how that will work out. it’s not 100%, But you see it where
they continued to evolve and progress with these attractive businesses.
At the same time, that’s not the only option they have. If you have levered
equity, the fact that it’s levered magnifies the change in that stock price by
default — that’s interesting for a value investor such as John Malone. If the
stock comes down quite a bit, then we can apply that 25%, 30%, 40% we have
available in potential buybacks and do these aggressive buybacks. For LINTA,
they just bought back $1 billion in the past year, and that’s a big chunk of their
stock. They paused until after the spinoff, but you would expect they would pick
that up again because there’s a substantial discount to the NAV, and if you look
further out, it’s only going to grow. The same could be said about each one of
those entities. The question about the debt is actually very interesting because
that is atypical as well. But when you think about how it fits into everything
else, it actually makes a great deal of sense.
MOI: Another area where John Malone has excelled, which is counterintuitive
to a lot of value investors, is acquisitions. What’s so different in the case of
Malone doing acquisitions, and how do you get comfortable with acquisitiondriven investment cases?
“In [Malone’s] early days,
that’s the model he applied
— when he bought a new
company, the first thing is,
get rid of the top layer. Pay
them out, they’re gone. Then
he can apply his framework,
which means cost-cutting,
reducing capex, all those
things that would increase
the cash flow back to the
core of the mothership.”
Byun: [John Malone] is probably much more bored these days than he was in
the early TCI days when he was doing more than an acquisition a week. Those
being the earlier days in the cable industry — quite balkanized very early in the
industry’s life cycle — so there that’s what you had to do. You had to cobble
together more and more geographies and cities to get scale and actually end up
in a position in which you’re actually left. If you don’t have the scale, you’re at
a constant disadvantage. That’s the flywheel he talks about — you need to have
that machine working.
Acquisitions are a part of that. You find an acquisition, you bring it in, you fund
it with debt. The cash flows from the acquisition pay off the debt, and the debt
shields the taxes, and so on and on. If you’re ahead of the curve, your competitor
is in a tougher competitive position, and that continues. In its modern form, it’s
really the same thing on a much bigger scale.
Actually, it’s interesting that the tail is wagging the dog, and that you have the
first act where it was the investment, a 27% stake in Charter through Liberty
Media. Now you have [Tom] Rutledge being brought over from CVC
[Cablevision], going after what is now a vacuum of power at Time Warner
Cable [TWC], working together with Comcast [CMCSA] and [Brian] Roberts to
carve up what is this nice turkey in TWC. The SIRI transaction is part of that, so
it’s all coming together. The acquisition of Charter, with Malone working more
in the background, those are all the same reasons as always.
When you think about Malone and Rutledge working together, this is what
Malone talks about in his Roman Empire approach. In his early days, that’s the
model he applied — when he bought a new company, the first thing is, get rid of
the top layer. Pay them out, they’re gone. Then he can apply his framework,
which means cost-cutting, reducing capex, all those things that would increase
the cash flow back to the core of the mothership. The targets have changed and
increased in size, but it’s very similar to what he’s always been doing.
One of the interesting parts about it is that you repeatedly see very low
premiums paid by Malone, and he’s done that with a public entity at a higher
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multiple buying out private entities at a lower multiple. In almost every case,
you’ll see a low premium and sort of a bear hug, and a creeping takeover.
He’s done that in stages [with TWC], offering very little premium to TWC
holders but offering up tax advantages, continued participation, and [talking
about] the undisturbed price before [he] came along. I don’t know how that’s
going to actually play out but it sounds like he’s gotten some support with TWC
shareholders, and that’s what’s ultimately going to drive the process.
MOI: Another feature that stands out with John Malone is the use of joint
ventures. How relevant is this to some of the entities that you are looking at?
“[Malone] has found a
flywheel that continues to
produce. He’s willing to take
the logical steps that most of
his competitors or most other
executives won’t take
because there is some
perverse incentive that’s
preventing them from doing
it.”
Byun: [John Malone’s use of joint ventures has] been a big part of how he’s
created value. That’s basically the original Liberty Media — all the content, the
programming... He’s been involved for a very long time with JVs, in partial
ownerships, and increasing those ownerships. It’s a very cheap way for him to
participate earlier in the development of many name-brand content channels.
One of the more recent cases worth mentioning is the JV at QVC in China. They
have ~270 million homes, but 64 million of those are in China [in the JV].
That’s not consolidated, so that’s a big chunk of their business. In typical
opaque GAAP financial ways, that is not brought to the surface.
That is quite similar to the 1991 split-off of the original Liberty Media. All those
valuable stakes, a lot of them through JVs, and marked at cost. It looked terrible
from a GAAP perspective. It looked like it was losing money. So why would
anybody doing a quick check want to invest in the original Liberty Media with
all these JVs and everything that looks opaque? The truth of the matter is that
once you look past that, you can get a better sense of what is underlying, what
businesses are there — there’s a lot of value. That is just another way he
approaches not disclosing full value but having it there and then unlocking it.
MOI: If we look at the various aspects you talked about, help us understand
what’s allowed John Malone to be brilliant at it where others have failed?
Byun: He has found a flywheel that continues to produce. He’s willing to take
the logical steps that most of his competitors or most other executives won’t
take because there is some perverse incentive that’s preventing them from doing
it. With Malone, it’s the opposite — he’s looking to build value through
valuable franchises over time and then maximize that [value] per share. There’s
something to be said about somebody in the early days in an industry in which
everybody is EPS-based — and that’s where the competition lies — EPS growth
or paying dividends. For [Malone] to say, that’s actually worse for investors
over the long term, and to have the bandwidth and the continuity to be able to do
that, that’s a very unique yet very attractive situation. The outcome, even in the
early stages when TCI as an entity under his control had a 900x return over his
tenure, all the other competitors were an order of magnitude less. Over time,
there’s something to be said about that — those drivers that most people tend to
ignore he puts to full use.
If you look at the profile of a lot of executives, having come up through one silo
— whether it’s operations, legal, sales, or whatever — they have that mindset,
and it could be a struggle to impart upon them how beneficial it would be to do
buybacks or do a Dutch tender. It’s something they’re very fearful of. Or you
have these two beautiful businesses, but one of them is dragging down the
profitability of the entire entity. If you were to separate that out, you could triple
your stock. Wouldn’t that be great? But they don’t think about it that way either.
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[At Liberty] you have [someone who has] been very comfortable with that for a
very long time. Malone had already done seven spinoffs before the original
Liberty Media. We’re talking about somebody that over a very long period of
time has applied and refined these basic principles. It’s not a binary situation, or
one where you just continue to hammer away with these tools. They actually
think about the framework quite logically. If you ask them, what are you going
to do with these entities, the right answer is, we don’t know because it will
depend on what happens. It will depend on where the stock trades, and what
happens to the businesses, and what opportunities come up. That’s the right way
to think about investing overall as well.
MOI: What are some of the key lessons for you as a value investor? What
advice do you have based on your work and conclusions?
“Bill Erbey with Ocwen
Financial [OCN] — he
started off with the one entity,
and he’s done five spinoffs.
There are five entities, and
some of them have very
valuable franchises within
them.”
Byun: It’s not just John Malone or Greg Maffei. If you look to similar patterns
— albeit different methods, tactics, and industries — you can look to a Ted
Turner and think about how he put together his empire, or Rupert Murdoch.
You have recently some very interesting things going on with Masayoshi Son
who controls Softbank [SFTBY], and how he’s involved with Sprint [S] and TMobile [TMUS]. He’s also an incredible entrepreneur and owner-operator.
A person like Bill Erbey with Ocwen Financial [OCN] — he started off with the
one entity, and he’s done five spinoffs. There are five entities, and some of them
have very valuable franchises within them.
All of these individuals have similar core drivers in terms of how they think
about investing, about their business, and how they apply it. It’s very helpful to
look to and learn from these guys. I’m bringing up these [particular] guys just
because they’re coming to mind in terms of how they apply their approach and
have built massive value for themselves and their investors.
MOI: Is there anything you do differently as a result of studying Malone, in
terms of generating ideas, assessing them, or putting together the portfolio?
Byun: That’s a very good question because I’m only looking for five to fifteen
ideas in the portfolio, so it’s fairly concentrated. You don’t need that many good
ideas. That’s always been the case. It’s been reinforced because you may look at
a hundred ideas but only one idea [may be] worth making a significant position.
Let’s just call it “early bird”, “second mouse” — all these guys work incredibly
hard (the early bird), and they get the worm. But I also find that they are very
good at being the second mouse in terms of going into what looks like broken
situations or industries. They have done the work to not be the first mouse, and
[they] pick up on these incredible opportunities which are just left for dead.
When I think about how that applies to my investing — one of the mistakes I
made early on was a spinoff in the fourth quarter of 2008. It was an insurance
company that had spun off an asset management company. In a month, we had
made 2.5x our money, so I thought that’s great, we are going to move on to find
the next ideas. The spinoff from that business has now become a thirty-bagger
over five, six years.
Thinking about the timeframes, thinking about what can happen to a business in
the longer term, but yet still have the flexibility to invest in anything — that’s
what these guys have applied, and it makes sense for me as well.
MOI: Thank you very much for sharing your time and insights.
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Exclusive Interview: Kevin Byun on John Malone
Watch a video recording of this interview
in The Manual of Ideas Members Area at
www.manualofideas.com/protected
We had the pleasure of meeting Kevin Byun, managing partner of Denali
Investors based in New York, for a conversation about John Malone’s financial
brilliance. Kevin Byun founded Denali Investors in 2007. He has a triple major
from Rice University and an MBA from Columbia Business School. Prior to
Columbia, Kevin Byun was an investment banker with UBS.
(The following is an edited transcript of an interview and may contain errors.
The transcript has been condensed for clarity, readability, and timeliness.)
Oliver Mihaljevic, The Manual of Ideas: How did you come across John
Malone and what led you to study him?
Kevin Byun: John Malone is a very interesting guy. The first time I came across
him or looked into him more closely was when I read Greenblatt’s book, You
Can Be a Stock Market Genius. There is a very interesting case study in there.
I had done a few years in investment banking and decided that wasn’t the longer
term path for me. And so in the period after that, I had read everything I could
about investing but the special situations angle, especially what I read in
Professor Greenblatt’s book, really jumped out at me. That led me to applying to
Columbia Business School, specifically just to take his class.
And you learn about him there too, and so this is going back let’s call it eight
years was when I first actually spent more time on John Malone.
MOI: John Malone is not an unknown name in value investing circles. Give us
a sense of what attracted you the most, and what are some of the key things you
found interesting?
“If you’re talking about
finding high-quality, highmargin cash flow businesses,
that in isolation is good. But
when you combine that with
attractive tax attributes,
aggressive share buybacks,
rights offerings, creative
structures—all of those
together over the long term
have provided astounding
returns for investors.”
Byun: You have a talented owner-operator. He understands how to create and
build value. There’s also a financial and capital markets approach that allows
him to maximize that. If you’re talking about finding high-quality, high-margin
cash flow businesses, that in isolation is good. But when you combine that with
attractive tax attributes — tax deferral — if you combine that with aggressive
share buybacks, rights offerings, different creative structures, all of those
together over the long term have provided astounding returns for investors.
If you look at TCI, which is the first phase, that was a 900x return from a dollar
invested in TCI through the end of that term. More recently, over the past eight
years, the Liberty entities have compounded at 35%. There’s something special
because of the combination, this flywheel that continues to produce returns. The
components are actually quite simple. The great part about it is that nothing is
hidden, it’s just hiding in plain sight. The question or the challenge for an
investor is to do the work to see through to the opportunities that are there.
MOI: Help us break that down a bit for us. Of course, the Liberty entities as
they are today require some work to understand… how do you see the structures
and what are some of the interesting things for you?
Byun: The structure itself is quite interesting. It’s atypical. It’s not a Berkshire
[Hathaway-type structure], where you have one stock and everything goes
through that entity. In its current form, across Liberty entities, you have Liberty
Media (LMCA), Liberty Interactive (LINTA), Liberty Ventures (LVNTA), and
the international cable platform, Liberty Global (LBTYA). Of those four,
LINTA and LVNTA are trackers for Liberty Interactive. Right there, people just
stop because, what’s going on with this cable business that’s international...?
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You have QVC within Liberty Interactive. You have this hodgepodge of other
non-control assets in Liberty Ventures.
All the way down the line, everything looks different, but my contention is that
they’re actually all the same. They’re quite similar if you look at them from the
perspective of, you have these entities where you can get a sense of the NAV
today. And you can project that one or two years down the line, and you have a
higher NAV at that time because the underlying businesses are continuing to
accrue value. And you [may] have a discount. For each of those, you [may] have
50% to 80% from the intrinsic value or the NAV, so you have a 20% to 50%
discount. That’s for the core business. What that implies for the stub business,
out of the core business, is that the stub businesses that are the non-core parts of
each of those entities are probably 50% to 80% off, so that’s a pretty big sale.
MOI: You mentioned the word trackers. That’s also something where it often
starts to become confusing in these structures. Help us understand, what does a
tracker mean in the context of Liberty Media and how is it employed?
“It’s quite simple. It is, what
do you expect to get? How
long is it going to take? And
then, what’s the risk?”
Byun: With a regular common stock, you have a direct claim on the residual
assets of a business. With a tracker, that’s not the case. It’s a representation of
the holdings of a corporate entity. That’s one of the major issues people have —
what am I getting for my outlay of capital, this tracker which is not a regular
stock? The trade-off is that you can actually represent different portions of the
corporate assets much more cleanly and with much more flexibility.
With Liberty Ventures and Liberty Interactive (inside trackers for Liberty
Interactive), Liberty Ventures has exchangeable debt that is shielding or
basically accrues losses at a much more accelerated rate than the actual interest
payments. On the Liberty Interactive side, with QVC, you get a lot of cash flow
and earnings. If you were to separate those out, you wouldn’t get the tax shield.
But since they’re within one corporate entity, you have the tax benefit. So, not
only do you get the tax benefit, but also you get the value that’s been created
with Liberty Ventures being separate as a tracking stock. When we invested in
Liberty Interactive pre-spin, effectively we got the Ventures for free, and then
we bought more Ventures, and then Ventures tripled. Had it not been spun out in
one entity, we would never have gotten that opportunity via the tracker entity.
MOI: As an investor, how do you approach the relative merits of investing in
one entity versus another?
Byun: It’s quite simple. It is, what do you expect to get? How long is it going to
take? And then, what’s the risk? That’s the basics, and you can apply those to
each one. They all have discounts. They’re all buying back stock. Some of them
have near-term catalysts, some of them have longer-term catalysts. LMCA is in
the middle of it, trying to bring back in SIRI [Sirius XM Holdings] and create a
C class. Liberty Global is right in it with Ziggo, now they’re trying to buy
another one — that’s going to be another major transaction. You have LINTA,
Liberty Interactive, and then you have Liberty Ventures, which are also
probably doing something within the next couple of months if Greg Maffei’s
timing is right — and he tends to get what he wants.
You have a scale game with Liberty Global in the cable business. They [bought]
the biggest player in the Netherlands. That takes their pro forma market cap
from $18-19 up to $27 [billion] and they’re going to continue that game. They
have a $4.5 billion buyback authorization, and most of that is left. That’s another
situation where you could say, if I look out, there’s a very interesting thesis
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about how Mike Fries is trying to accrue value. By the way, they’re looking into
spinning off the Latin America business. There’s another plank to the thesis.
“If you look at Liberty
Interactive with QVC, you
have a core business
approaching $2 billion in
EBITDA, and let’s just give it
a ten multiple. It’s an
amazing business, 22%
margin, it’s growing
internationally at a rapid
clip, there are some JVs in
there that are substantial but
aren’t consolidated.”
Liberty Media, LMCA, people are a little uncertain about the SIRI buy-in and
the C class, what does it mean? The numbers are quite simple. You have about
105 million A shares. You have ten [million] B shares. A shares have one vote,
B shares have ten votes — and then this new C class. The minority SIRI holders,
they’re going to get issued about 220 million C shares, zero votes. Existing A
and B shareholders are going to get two shares for every share, so it’s going to
be about 230 [million shares]. Add that all up, you get roughly 560 [million
shares]. You’re going to take a share that’s in the 130s and the pro forma is
going to be 45-50. Everything about it — the way it looks on paper, the ratios,
and being three or four places out to the right of the decimal place — nobody
can intuitively understand what it’s going to look like through the transaction.
But all of the same principles apply, and so you have an interesting setup.
The ones that I’m focused on — and I haven’t even gotten into the Charter stake
and what is happening there — but those two are taking literally 100% of the
attention. Nobody is really talking about LINTA, and nobody is talking about
Liberty Ventures. Based on my work, those are much more interesting, and
those have solid catalysts coming up in the next couple of months, at most up to
Q2 [2014], and those are the spinoffs themselves.
If you look at Liberty Interactive with QVC, you have a core business
approaching $2 billion in EBITDA, and let’s just give it a ten multiple. It’s an
amazing business, 22% margin, it’s growing internationally at a rapid clip, there
are some JVs in there that are substantial but aren’t consolidated. You’re at $20
billion; in that entity you have about $4 billion in net debt, so you’re at $16
billion. Isn’t it interesting that the market cap is $14 billion? You’re paying
negative for the rest of this business which has been under earning, a lot of these
businesses just being in their ramp. I haven’t counted the $2+ per share of HSNI,
the equity they own there, which will eventually be consolidated at an attractive
price. Isn’t it interesting that you have that situation coming out similarly? They
are all shades of the same thing. You have Liberty Ventures — that’s one people
have been very negative on since even before the spin and have been shorting
the stock. My view was I wouldn’t do that, but everybody has an opinion.
Again, the fundamentals: what do you think you’re going to get? How long is it
going to take? And what’s the risk? I view the [historical] discounts to NAV as
attractive. And because you have the catalysts that are going to unlock that
value, that’s even more attractive. We’re going to be able to realize the value in
a much more secure manner than you normally would. With traditional value
investing, at Point A you [may] think it’s worth Point B, but a lot of guys don’t
make it because you end up at one-half A before you end up at B. In [the
Liberty] situation, it’s a very clear line of sight to where you should end up.
Because we’ve done the work ahead of time, we’ll have a better sense of what
the discounts will be in the new pieces, and then we’ll be able to act accordingly
once those are available. That’s how I’m thinking about the opportunity set.
MOI: Let’s think about the rationale for the way Malone conducts business and
investing. The use of debt—a lot of value investors typically avoid leverage.
Malone historically has employed quite a bit of debt…
Byun: One way to think about it is having the IRS as your partner until the debt
comes due, and that’s free. They’re paying for the privilege for you to run your
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Value-oriented Equity Investment Ideas for Sophisticated Investors
business in a much more efficient manner on all fronts, operationally, and then
via the capital structure. John Malone says it’s criminal to run a cable company
with less than 5x debt [to EBITDA], and you see why. The reason he can say
that is, it actually dovetails very nicely with the type of industries he is in. It’s a
subscriber-based, recurring revenue stream, highly reliable over time. You can
see the stream come on for each customer, you can see the benefits of scale. All
of those things come into play. When it comes to the debt component, it makes
perfect sense to run a business [on debt] that you believe has more steady
characteristics over time. You run it where you don’t have to pay taxes or have
tax leakage. It’s very simple — that having debt would be advantageous over
time. When you look to the earlier days, you’ve got guys like Gabelli and
Malone that actually get credit for advancing the concept of EBITDA. Before,
nobody really looked at it that way. Cable companies, telephone companies,
they were EPS-based, and then you had a paradigm shift: does it actually make
sense when I’m paying out taxes to the government when that should be
accruing to investors, and maybe we’ll pay taxes at a later date. That’s been a
constant. I can’t recall an interview or a conference call or any type of statement
where Malone doesn’t talk about the tax aspect. The big part of that is the debt.
MOI: Is that the key thing about debt—the effect it has on reducing taxes?
“One of the perennial battles
people have is with QVC.
That’s been the case since
the very beginning, even
when or before Barry Diller
was running it. The customer
base is older, they’re dying
off, this business has seen its
best days, and it can’t
compete with the Internet
and the Amazons. There’s
been every excuse, but it’s
just become a better and
better business.”
Byun: At Ventures, they took down a billion [dollars] of TWX convertibles. It
was 3+% notes, very cheap as it is. They sold the equity against that so that
basically washed out to zero. They replaced it with 0.75% debt. The question
you have to ask is, if you can get that type of rate, and you can run any business,
does that make sense to do? There are a lot of potential factors. If I’m going to
take on debt, should I do it? When you have a situation like that, with this
extreme low end of interest rate availability, what they’ve been talking about for
years is that the debt is so cheap, it makes sense to take advantage of having that
debt because you’re not really paying anything against it. What we’re earning on
the equity or the business part of it — maybe you don’t expect 35% IRRs like
they had in the past eight years — whether that’s 25%, or 15%, or anything
above 0.75%, you’re going to do okay. That’s also one of the considerations.
MOI: People will get that, yet when we observe reality, many stable businesses
that take on debt end up getting into difficulty. There seems to be something
unique about Malone that has helped him avoid trouble…
Byun: One of the perennial battles people have is with QVC. That’s been the
case since the very beginning, even when or before Barry Diller was running it.
The customer base is older, they’re dying off, this business has seen its best
days, and it can’t compete with the Internet and the Amazons. There’s been
every excuse, but it’s just become a better and better business.
Whether it’s that business or what they do with SIRI — you had this very
similar short thesis: look at what’s happening with technology and the Internet,
who wants to pay extra to have SIRI texting them in their car. But post the
merger, post all the operational changes, without all of the excessive re-upping
and competition and overbidding for content, it’s changed quite dramatically.
You have a rear-view picture and then a forward picture. You see these cases
where the approach has been to take the other side of the table, but they’re also
getting in at quite attractive terms in creating the positions themselves. SIRI
was, literally, you have guys that have equity at $0.05 per share, that’s how bad
it got, and that’s when they got in. it’s worked out very, very well, but it doesn’t
always work out that way. It’s still to be determined but, for example Barnes &
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Noble, who knows how that will work out. it’s not 100%, But you see it where
they continued to evolve and progress with these attractive businesses.
At the same time, that’s not the only option they have. If you have levered
equity, the fact that it’s levered magnifies the change in that stock price by
default — that’s interesting for a value investor such as John Malone. If the
stock comes down quite a bit, then we can apply that 25%, 30%, 40% we have
available in potential buybacks and do these aggressive buybacks. For LINTA,
they just bought back $1 billion in the past year, and that’s a big chunk of their
stock. They paused until after the spinoff, but you would expect they would pick
that up again because there’s a substantial discount to the NAV, and if you look
further out, it’s only going to grow. The same could be said about each one of
those entities. The question about the debt is actually very interesting because
that is atypical as well. But when you think about how it fits into everything
else, it actually makes a great deal of sense.
MOI: Another area where John Malone has excelled, which is counterintuitive
to a lot of value investors, is acquisitions. What’s so different in the case of
Malone doing acquisitions, and how do you get comfortable with acquisitiondriven investment cases?
“In [Malone’s] early days,
that’s the model he applied
— when he bought a new
company, the first thing is,
get rid of the top layer. Pay
them out, they’re gone. Then
he can apply his framework,
which means cost-cutting,
reducing capex, all those
things that would increase
the cash flow back to the
core of the mothership.”
Byun: [John Malone] is probably much more bored these days than he was in
the early TCI days when he was doing more than an acquisition a week. Those
being the earlier days in the cable industry — quite balkanized very early in the
industry’s life cycle — so there that’s what you had to do. You had to cobble
together more and more geographies and cities to get scale and actually end up
in a position in which you’re actually left. If you don’t have the scale, you’re at
a constant disadvantage. That’s the flywheel he talks about — you need to have
that machine working.
Acquisitions are a part of that. You find an acquisition, you bring it in, you fund
it with debt. The cash flows from the acquisition pay off the debt, and the debt
shields the taxes, and so on and on. If you’re ahead of the curve, your competitor
is in a tougher competitive position, and that continues. In its modern form, it’s
really the same thing on a much bigger scale.
Actually, it’s interesting that the tail is wagging the dog, and that you have the
first act where it was the investment, a 27% stake in Charter through Liberty
Media. Now you have [Tom] Rutledge being brought over from CVC
[Cablevision], going after what is now a vacuum of power at Time Warner
Cable [TWC], working together with Comcast [CMCSA] and [Brian] Roberts to
carve up what is this nice turkey in TWC. The SIRI transaction is part of that, so
it’s all coming together. The acquisition of Charter, with Malone working more
in the background, those are all the same reasons as always.
When you think about Malone and Rutledge working together, this is what
Malone talks about in his Roman Empire approach. In his early days, that’s the
model he applied — when he bought a new company, the first thing is, get rid of
the top layer. Pay them out, they’re gone. Then he can apply his framework,
which means cost-cutting, reducing capex, all those things that would increase
the cash flow back to the core of the mothership. The targets have changed and
increased in size, but it’s very similar to what he’s always been doing.
One of the interesting parts about it is that you repeatedly see very low
premiums paid by Malone, and he’s done that with a public entity at a higher
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multiple buying out private entities at a lower multiple. In almost every case,
you’ll see a low premium and sort of a bear hug, and a creeping takeover.
He’s done that in stages [with TWC], offering very little premium to TWC
holders but offering up tax advantages, continued participation, and [talking
about] the undisturbed price before [he] came along. I don’t know how that’s
going to actually play out but it sounds like he’s gotten some support with TWC
shareholders, and that’s what’s ultimately going to drive the process.
MOI: Another feature that stands out with John Malone is the use of joint
ventures. How relevant is this to some of the entities that you are looking at?
“[Malone] has found a
flywheel that continues to
produce. He’s willing to take
the logical steps that most of
his competitors or most other
executives won’t take
because there is some
perverse incentive that’s
preventing them from doing
it.”
Byun: [John Malone’s use of joint ventures has] been a big part of how he’s
created value. That’s basically the original Liberty Media — all the content, the
programming... He’s been involved for a very long time with JVs, in partial
ownerships, and increasing those ownerships. It’s a very cheap way for him to
participate earlier in the development of many name-brand content channels.
One of the more recent cases worth mentioning is the JV at QVC in China. They
have ~270 million homes, but 64 million of those are in China [in the JV].
That’s not consolidated, so that’s a big chunk of their business. In typical
opaque GAAP financial ways, that is not brought to the surface.
That is quite similar to the 1991 split-off of the original Liberty Media. All those
valuable stakes, a lot of them through JVs, and marked at cost. It looked terrible
from a GAAP perspective. It looked like it was losing money. So why would
anybody doing a quick check want to invest in the original Liberty Media with
all these JVs and everything that looks opaque? The truth of the matter is that
once you look past that, you can get a better sense of what is underlying, what
businesses are there — there’s a lot of value. That is just another way he
approaches not disclosing full value but having it there and then unlocking it.
MOI: If we look at the various aspects you talked about, help us understand
what’s allowed John Malone to be brilliant at it where others have failed?
Byun: He has found a flywheel that continues to produce. He’s willing to take
the logical steps that most of his competitors or most other executives won’t
take because there is some perverse incentive that’s preventing them from doing
it. With Malone, it’s the opposite — he’s looking to build value through
valuable franchises over time and then maximize that [value] per share. There’s
something to be said about somebody in the early days in an industry in which
everybody is EPS-based — and that’s where the competition lies — EPS growth
or paying dividends. For [Malone] to say, that’s actually worse for investors
over the long term, and to have the bandwidth and the continuity to be able to do
that, that’s a very unique yet very attractive situation. The outcome, even in the
early stages when TCI as an entity under his control had a 900x return over his
tenure, all the other competitors were an order of magnitude less. Over time,
there’s something to be said about that — those drivers that most people tend to
ignore he puts to full use.
If you look at the profile of a lot of executives, having come up through one silo
— whether it’s operations, legal, sales, or whatever — they have that mindset,
and it could be a struggle to impart upon them how beneficial it would be to do
buybacks or do a Dutch tender. It’s something they’re very fearful of. Or you
have these two beautiful businesses, but one of them is dragging down the
profitability of the entire entity. If you were to separate that out, you could triple
your stock. Wouldn’t that be great? But they don’t think about it that way either.
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[At Liberty] you have [someone who has] been very comfortable with that for a
very long time. Malone had already done seven spinoffs before the original
Liberty Media. We’re talking about somebody that over a very long period of
time has applied and refined these basic principles. It’s not a binary situation, or
one where you just continue to hammer away with these tools. They actually
think about the framework quite logically. If you ask them, what are you going
to do with these entities, the right answer is, we don’t know because it will
depend on what happens. It will depend on where the stock trades, and what
happens to the businesses, and what opportunities come up. That’s the right way
to think about investing overall as well.
MOI: What are some of the key lessons for you as a value investor? What
advice do you have based on your work and conclusions?
“Bill Erbey with Ocwen
Financial [OCN] — he
started off with the one entity,
and he’s done five spinoffs.
There are five entities, and
some of them have very
valuable franchises within
them.”
Byun: It’s not just John Malone or Greg Maffei. If you look to similar patterns
— albeit different methods, tactics, and industries — you can look to a Ted
Turner and think about how he put together his empire, or Rupert Murdoch.
You have recently some very interesting things going on with Masayoshi Son
who controls Softbank [SFTBY], and how he’s involved with Sprint [S] and TMobile [TMUS]. He’s also an incredible entrepreneur and owner-operator.
A person like Bill Erbey with Ocwen Financial [OCN] — he started off with the
one entity, and he’s done five spinoffs. There are five entities, and some of them
have very valuable franchises within them.
All of these individuals have similar core drivers in terms of how they think
about investing, about their business, and how they apply it. It’s very helpful to
look to and learn from these guys. I’m bringing up these [particular] guys just
because they’re coming to mind in terms of how they apply their approach and
have built massive value for themselves and their investors.
MOI: Is there anything you do differently as a result of studying Malone, in
terms of generating ideas, assessing them, or putting together the portfolio?
Byun: That’s a very good question because I’m only looking for five to fifteen
ideas in the portfolio, so it’s fairly concentrated. You don’t need that many good
ideas. That’s always been the case. It’s been reinforced because you may look at
a hundred ideas but only one idea [may be] worth making a significant position.
Let’s just call it “early bird”, “second mouse” — all these guys work incredibly
hard (the early bird), and they get the worm. But I also find that they are very
good at being the second mouse in terms of going into what looks like broken
situations or industries. They have done the work to not be the first mouse, and
[they] pick up on these incredible opportunities which are just left for dead.
When I think about how that applies to my investing — one of the mistakes I
made early on was a spinoff in the fourth quarter of 2008. It was an insurance
company that had spun off an asset management company. In a month, we had
made 2.5x our money, so I thought that’s great, we are going to move on to find
the next ideas. The spinoff from that business has now become a thirty-bagger
over five, six years.
Thinking about the timeframes, thinking about what can happen to a business in
the longer term, but yet still have the flexibility to invest in anything — that’s
what these guys have applied, and it makes sense for me as well.
MOI: Thank you very much for sharing your time and insights.
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