GCI Liberty: Cheap, Tax Asset, Malone Fatigue?

GCI Liberty (GLIBA/K) is back in public markets, the leading telecommunications provider in Alaska was spun off on Tuesday (7/15) from Liberty Broadband (LBRDA/K) ahead of LBRD's merger with Charter Communications (CHTR).  

Alaska is a challenging market, it has a small population with a huge unforgiving geography, partially protecting GCI from competition (although satellite providers like Starlink are a threat and starting to take some share).  GCI is primarily a broadband business (70% of revenue) which also includes 3000 miles of undersea cable connecting Alaska to the rest of the country with the remainder mostly in wireless (GCI recently discontinued their video offering).  The business was founded 45 years ago by Ron Duncan who is still the CEO today at 72 years old.  Unlike other broadband businesses, GCI is skewed towards business revenue with the big exposure to healthcare and education in rural/remote villages, many of these places only have a couple medical professionals or teachers, everyday services are provided in single rooms using video conferencing.  However, their business has challenges, much of GCI's revenue is tied to government programs (Universal Service Fund or "USF" is mid-40% of revenue) under constant scrutiny and the Alaskan economy is tied to cyclical natural resource markets like oil and mining.  Population has declined slightly over the last few years, revenue growth at GCI is likely roughly flat to inline with inflation over time.

Below is a back of the envelope valuation of GCI:

GCI Liberty is cheap compared to peers (I pulled peer multiples from CapitalIQ, didn't verify or normalize), but that's not really what caught my attention in the spin.  Unlike other Liberty entities where John Malone has stepped back from the board or agreed to eliminate his super-voting rights in negotiated mergers, here at GCI, Malone is the Chairman and will be leading capital allocation decisions.  

To steal the line of another investor I chat with, this is like the old quote that Warren Buffett has stated he believes he could achieve a 50% annual return if he were managing a smaller sum of money.  The spin was taxable to Liberty Broadband shareholders which allowed Malone to achieve setup basis on the GCI assets, resetting the depreciation tax shield (which likely also benefits from the Trump administrations recent "BBB") the value of which will be based on the first 20 days of trading, but capped at $420MM per the merger agreement with CHTR.  That value is not included in the valuation above and significant given the ~$2B enterprise value.

In the investor day presentation, John Malone comments both on the valuation and capital allocation thoughts (attribution to BamSEC):

Shane Kleinstein Liberty Media Corporation – Head of Investor Relations

I think building on that, John, we got a question from a valuation perspective, building on what Ron had said, how do you suggest investors think about appropriate multiples or valuation for this asset partially in light of the recent Cox-Charter transaction, partially in light, while GCI has strategic advantages. It is -- the dynamics have changed since it last traded publicly. So curious reviews from a valuation standpoint.

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, I would say, if you're speaking of valuation in terms of EBITDA multiple, it should trade at a premium EBITDA multiple because it's EBITDA will be fully sheltered, it has a modest debt leverage situation, so it doesn't have a lot of downside risk. It has a declining capital intensity, and therefore, its free cash flow characteristics should be superior. Now Charter is currently is trading at or around a 7 multiple EBITDA. I would think that this business should be trading at a premium to that. And if it doesn't, we've got -- we're going to have plenty of free cash flow with which to reduce equity if that opportunity presents itself, I think, the Board will be looking at returns on the free cash flow and how to deploy it.

And given the fact that we have more than enough tax shelter to shelter our own cash flow, we'll be looking opportunistically for acquisitions or investments that provides unusually high pretax returns, but that can benefit substantially from the shelter that consolidating what GCI could provide. So it's kind of an ideal core asset, around which to build some interesting incremental assets. So we certainly look forward to that. I'm hoping that it can become the beginning of a new Liberty Media and now that Liberty Media has largely gone to a single line of business focus with its spin-offs and we will have the availability, of course, of the Liberty Media management team who work for -- who will work for this enterprise under contract, providing services ranging from financial to tax accounting and public relations chain, including you.

Later on, after commenting on leverage, he goes into possible areas he'd be interested in:

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, from my point of view, Shane, I would say 3 is a pretty nice number going up for accretive acquisitions. Sometimes you'll take it up in order to -- until you get the synergies realized from combination. We would try to stay in the 3 to 3.5 range, I would think. And if we drop below that, we might take it up in some kind of a small recap and shrink the equity. But my guess is that if we look widely enough, we're going to find lots of accretive, small but accretive acquisitions in the communications sector, looking primarily at special situations, in some cases, distress, but I think that we will find opportunities to grow the business outside of Alaska with accretive small incremental acquisitions in the -- in and around the communications industry.

Capex will be a bit muted in the next 12-18 months has GCI finishes its investment cycle as part of the Alaska Plan, but following that, as a minimal cash tax payer, Malone should have a lot of flexibility to make acquisitions and use GLIBA like his "50% return PA".  Read through the spinoff docs as well, there's a lot of talk about issuing Ventures Group tracking stock in the future which could be a turnoff to many.  I haven't seen much chatter about this spinoff, there seems to be a lot of John Malone fatigue in the last 5-10 years as some of their investments have underperformed (that might be generous phrasing).  He's 84 years old, but he's an admitted deal junkie:

Shane Kleinstein Liberty Media Corporation – Head of Investor Relations

Well, John, I'll turn a related but different one to you. A question came through, what's your expected involvement in GCI and Liberty. What are the areas that you particularly expect to be taking part?

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, I enjoy strategy, I enjoy strategizing with Ron. I love M&A. I love deals, and I love structure and so the opportunity to rebuild what some people regard as complexity and I regard it as high return investing is what I look forward to. And I think the combination of Ron and his knowledge of the business and his team with some of the young guys within Liberty Media's management structure, who are pretty good at turning over rocks so we'll have talent available to the organization that is several steps above what an organization that size would normally have available to it in terms of finance, tax structure and clearly IR and public relations. So I think we have a little bit of a supercharger when it comes to capabilities that you wouldn't normally find in a business of the size of GCI because of the involvement with Liberty, Liberty Media, me and the rolodexes that both Ron and I have been able to develop over this long period, I think, we're going to find some very interesting opportunities, which will have exceptional financial reward associated with them.

I think it's an interesting setup, cheap asset on its own, with the call-option on Malone's deal making capabilities in a smaller, less followed entity.

Disclosure: I own shares of GLIBA/K once again

WideOpenWest: Cable Overbuilder Rumored for Sale

Quick one today that I mentioned briefly in my Mid-Year post as a watchlist idea.

WideOpenWest (WOW) ($1.6B market cap) is a cable/broadband overbuilder primarily focused on secondary and tertiary markets in the southeast that trades for 7.5x EBITDA, while it sold assets last year for 10-11x EBITDA (here and here).  WOW is rumored to be in a late stage process to sell itself with both Morgan Stanley Infrastructure Partners and Global Infrastructure Partners reported as interested bidders (worth noting that the two asset sales were to strategic buyers, both of these firms would be financial buyers).  Fully acknowledge that we're not in the same 2021 M&A environment, but the PE bid and financing are still there for digital infrastructure like businesses.  Even a takeout at a 9.5x EBITDA multiple would equate to $24.30/share or 35% higher than today's $18.00/share price.  After the asset sales, WOW is currently under levered at 1.9x net debt/EBITDA (a PE buyer would likely lever a cable company up to 5-6x); taking WOW out at a cheapish price with a relatively small equity check due to the ability to lever it up further, this deal would likely be a home run for the buyer.

A bit more about the business, as an overbuilder, WOW is the "challenger" cable provider that enters established markets which typically already included either Comcast's (CMCSA) Xfinity brand or Charter's (CHTR) Spectrum brand (which I'm long via LBRDK).  In order to convince customers to switch from an incumbent provider, WOW has to offer some combination of faster speeds, lower prices and better customer service.  Additionally, WOW lacks the scale and purchasing power of a Comcast or Charter when it comes to negotiating with content providers, further squeezing margins in the already declining video business.  All adding up to an overbuilder like WOW having lower penetration rates (28% of homes passed), thus lower margins and generally viewed as an unfavorable business model compared to the incumbents.

However, times are changing, as more people cut the cord and move away from the broadband/video cable bundle to just seeking out a broadband internet provider, WOW's value oriented proposition starts to look pretty good, offering similar speeds at a lower price.  With a recession potentially on the horizon, WOW might also benefit from the cord cutting trend accelerating and their position as a value offering as consumers look to cut costs.  To provide some perspective, 90% of WOW's new customers are only buying broadband.  Cable valuations have come down recently, partially due to rising competition, new competition is less likely to join the fray into WOW's already competitive markets, rather fiber-to-the-home overbuilders are more likely to focus on markets where the incumbents are vulnerable to new competition.

On the downside, WOW is currently trading at only a slight discount to Charter and the struggling Altice USA (ATUS), where CHTR/ATUS have better business models as a incumbent cable providers.  So there is some deal premium baked into WOW, maybe a turn worth.  I pulled the above public comparables from TIKR, I realize each is a bit different, especially throwing DISH in there.  I don't love the idea of adding another speculative merger position to my portfolio, but this one just seems to make too much sense for a PE buyer to take private.

Disclosure: I own shares of WOW

GCI Liberty: Stock-for-Stock Deal with Liberty Broadband

How can you be an event-driven investor and not own a couple positions in the Malone universe?  There are people with smarter takes than me on the Liberty complex and cable (Andrew Walker for one), but with the news coming out last week that GCI Liberty (GLIBA) and Liberty Broadband (LBRDA/K) are in talks to merge, it seems timely to take a look at the transaction and what Liberty Broadband might look like after the deal closes.  The talks are only preliminary and not final, but it's safe to say that a transaction is a near certainty to take place as it's long been thought a GLIBA/LBRDA combination which pools together Liberty's investment in Charter Communications (CHTR) would make an eventual consolidation with CHTR simpler.

Quick and incomplete origin stories:

• GCI Liberty is the result of a 2018 deal between Liberty Interactive's Liberty Ventures (old LVNTA) tracking stock merging with General Communications ("GCI", old GNCMA), the largest provider of cable/telecom to Alaska, eliminating the tracking stock structure and creating an asset backed stock with GCI as an operating subsidiary.  As a result, GCI Liberty holds about 70% of its assets in LVNTA's historical investments in CHTR, one as the result of TimeWarner Cable's (TWC) merger with CHTR and then through an investment in Liberty Broadband which in turn funded the cash portion of the acquisition of TWC by CHTR.  GCI Liberty also contains a legacy home-run investment in Lending Tree (TREE), the financial services online marketplace.
• Liberty Broadband also traces its roots similarly, it was a 2014 spinoff of Liberty Media (old LMCA) which held LMCA's stakes in CHTR and TWC, the TWC stake was then folded into CHTR as a result of the above mentioned CHTR/TWC deal, leaving Liberty Broadband as substantially just a pass-thru to CHTR (they have a tiny active trade business to keep the spin tax free).

Creating an NAV for both companies is a fairly straight-forward exercise (saying that, I probably made some mistakes - feel free to point them out - so do your own home work).

The main variable input for GLIBA is how you want to value GCI, the operating subsidiary, I've chosen to use a 9x multiple (essentially the multiple LVNTA paid for it) on TTM EBITDA.  It traded well below that prior to the acquisition, but with the eventual path being a CHTR acquisition, there's some synergies that could be added and thus it seems as fair of a multiple as any to me.  Then there's the exchangeable debt, much of GLIBA's direct Charter investment is pledged to exchangeable bonds that either directly reside on GLIBA's balance sheet or some legacy exchangeables that are at GLIBA's former sister tracker, Qurate Retail Group (QTREA), and GLIBA is responsible for the in-the-money exposure since all the CHTR shares moved over to GLIBA in the hard split.  An exchangeable bond is sort of like a convertible bond, but instead of having the option to convert into the issuers stock (would be GLIBA here as an example), the bondholder has the option to receive shares in another reference security (CHTR in this case, which is in the money at a $370 strike price, thus the liability increases as CHTR's stock continues to perform).  As a result, almost all of GLIBA's CHTR exposure is in LBRDK and featured a "double discount", as shown below, LBRDK trades at a discount to its investment in CHTR and GLIBA traded at a discount to its primary investment in LBRDK.

Liberty Broadband is simpler, as mentioned, it is essentially a pass-thru for CHTR that trades at a mid-teens discount to CHTR.

What might the proforma company look like?

The proposed exchange ratio is 0.58 shares of LBRDK (the non-voting LBRD shares) for every share of GLIBA (so GLIBA share holders go from Class A to Class C, not that it really matters), by combining the two, Liberty Broadband is effectively able to buyback the LBRDK shares GLIBA owns and share the benefit of closing that second layer of discount between the two shareholder groups in a stock-for-stock merger.  GCI Liberty shareholders naturally receive most of that benefit, GLIBA goes from having a ~$83 NAV per share to a ~$90 NAV per share (on the GLIBA sharecount), Liberty Broadband shareholders get a smaller benefit moving from ~$155 to ~$157.

Other thoughts:

• Obviously I'm missing any analysis on CHTR, others have covered it in great detail, they're the second largest cable provider in the U.S., financially they utilize Malone's levered equity strategy: levered 4.5x and use FCF to buy back stock in order to maintain that leverage.
• No thoughts on the ultimate timing of a CHTR takeout, but I sleep pretty well knowing that's the eventual path, Malone has a history of consolidating these investment HoldCo's back into the operating company (Direct TV and Expedia are good examples).  As a result of LBRDK's ~25% ownership stake, Liberty gets 3 seats on the board, appointed the current management team, seems likely that their influence will result in the closing of the discount in a tax efficient manner.
• GLIBP is a big beneficiary to the combination, the preferred shareholders gain a whole lot more equity cushion below them and keep the elevated 7% dividend rate.

Disclosure: I own shares of GLIBA