Jul 12, 2010
John Malone and Starz Entertainment
John Malone is renown as one of the best dealmakers in media and entertainment. He recently gave an interview with some of his thoughts on the industry:
WSJ: What are the big risks and opportunities for cable operators right now?
Mr. Malone: Cable has come through technologically in great shape relative to its competitors. The telcos, unless they’re willing to spend a massive amount of capital—like [Verizon Communications Inc.'s] Fios has—have run out of steam in terms of the speed of their Internet capabilities. The real issue I think for cable right now, at least in the U.S., is regulatory.
WSJ: Does Liberty want to invest more in cable?
Mr. Malone: We’ll undoubtedly hold our position [in Time Warner Cable]. And we may choose to increase it if we think cable’s undervalued. That would be a good way to play cable. Just own some more Time Warner Cable.That would be the only way I could see us playing in cable networks domestically. Internationally, of course, Liberty Global is always in the hunt and has a pretty good pipeline of potential acquisitions. Hopefully we will find some good M&A opportunities, but outside the U.S., in cable.
WSJ: What do you mean?
Mr. Malone: It is entirely feasible that government may choose to open these networks up. They could come in, for instance, and tell cable operators they can’t bundle broadband with video, with telephone, that they’ve got to sell them all a la carte and they can’t do any deep discounting, no exclusionary deals and so on.
And [as they review the Comcast-NBC deal] they can set the pattern that they would later enforce on the industry at large through rule-making.
For investors looking to partner up with Malone, there are a few options. Liberty Media Capital (NASDAQ:) operates as Malone’s hedge fund. Valuing LCAPA takes some work. The company invests in public and private businesses, which adds complexity. You really want to try to look at it from the perspective of net asset value (NAV) but the problem is that some businesses are extremely difficult to value. This is particularly evident in the company’s ownership of the Atlanta Braves and certain debt/mezzanine investments. Ultimately, I think that this creates opportunity for investors, especially when the markets turn volatile.
Some of Malone’s other holdings are more straightforward to value. Take Starz (NASDAQ:). Starz is a premium movie channel that is available to most cable and satellite subscribers. I like this company because it is almost like a tollbooth. Starz basically licenses content from movie studios and then sells it to the cable companies. There’s really no risk of content production costs. A subscriber might elect to go with a plan that gives them HBO, Showtime, and Starz because they are already pre-bundled.
I would value Starz using an EV/EBIT multiple. The company has about $1B in cash with virtually no debt. That brings enterprise value (market cap + debt – cash) down to $1.75B. Using the TTM EBIT figure, we get $330M. That gives us an EV/EBIT of about 5x. To me, that is pretty cheap. Yes, media companies face a good amount of competition, but the tollbooth like nature of the business means it is worth at least 7.5 to 9 times. With the current price around $53, it should fetch a per share valuation of $80 to $95 per share, or a gain of 51% to 80%.
Liberty appears to think the business is undervalued as well:
Share Repurchases
From January 30, 2010 through April 30, 2010, Liberty repurchased 539,970 shares of Series A Liberty Starz common stock at an average cost per share of $47.40 for total cash consideration of $25.6 million. Since the introduction of Liberty Starz on November 19, 2009 through April 30, 2010, Liberty has repurchased 1.1 million shares at an average cost per share of $48.06 for total cash consideration of $53.3 million. These repurchases represent 2.1% of the shares outstanding. Liberty has approximately $446.7 million remaining under its Liberty Starz stock repurchase authorization.
So what might be causing the company to remain undervalued?
1. Starz is a tracking stock, which makes analyzing its financials a bit more complicated. I don’t think many investors are used to dealing with tracking stocks so they might just ignore the company.
2. There seems to be an overall bearish sentiment towards media stocks. Investors might be critical of Starz because as we transition towards consuming more television over the internet, the barriers to entry come down. Starz aggregates content that is created by studios like Disney and some analysts have questioned whether the internet will “cut out the middlemen”. Instead of watching Disney movies on Starz, we will watch them via Disney.com or a video site made in partnership with content creators (such as Hulu.com). So far this has happened with TV programming but not films. Plus, Starz retains the digital airing rights for the content that they license. That is what allows you to watch Starz on Netflix. Over the longer term, I do think there is potential for their business model to be eroded by direct connections to the content creator. I think it will be important to monitor how successful the premium Hulu Plus service is in order to gauge that potential.
3. Investors might be nervous about investing in a business that is so controlled by John Malone. So far though, Malone has been really savvy in the media business and I don’t expect that to cease any time soon. The greater risk might be increased inter-group lending where Starz uses cashflow to provide loans to other Liberty Media units. I think that is probably the greater risk but that it is still pretty limited. The appointment of Chris Albrecht, who used to run HBO indicates that Liberty is serious about making Starz into a competitive pay TV network.
I think that if you are interested in examining the businesses within Malone’s empire, Starz is a good place to start. The business model and structure is simpler than others and the current valuation is pretty attractive.