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11/26/2014

(LMCA/LBTYA) Malones cable strategy | Glenn Chan's Random Notes on Investing

Glenn Chan's Random Notes on Investing


DISCLAIMER: Some of the information on this site is
wrong. Always do your own research.
MAY 4, 2014 BY GLENNCHAN

(LMCA/LBTYA) Malones cable strategy


Heres how I see it.
Some people are superstars at operating a cable company while the majority of people are bad at it.
One way to figure out who the superstars are is to figure out how much money is made per home
passed. Libertys investor day presentation uses adjusted EBITDA per home passed, which is a rough
proxy for this. (I would prefer to subtract maintenance capex from adjusted EBITDA.) Each home
passed represents a potential customer. Good operators will turn a high percentage of its homes passed
into customers and sell them as many services as possible (television, premium channels, Internet, voice,
video-on-demand, etc.).
Libertys investor day presentation (PDF
(http://ir.libertymedia.com/common/download/download.cfm?companyid=ABEA4CW8ZW&fileid=696754&filekey=6cc885c2-ce93-4ad8-80799c29daaf8a1c&filename=Liberty_Media_Investor_Day_2013.pdf)) compares various cable companies:

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11/26/2014

(LMCA/LBTYA) Malones cable strategy | Glenn Chan's Random Notes on Investing

(https://glennchan.files.wordpress.com/2014/04/charter-ebitda-per-home-passed.png)
Historically, Charter had been very poorly managed while Cablevision has been well managed. Tom
Rutledge attributes Cablevisions performance on this metric to his performance as Cablevisions chief
operating officer (*not the CEO). Now that he is Charters CEO, he will try to get Charter up to
Cablevisions (old) performance level.
What the adj. EBITDA/home passed metric doesnt take into account is that there are differences in
each home passing. Charter has a mostly rural footprint. It will not face as much competition from
competing non-satellite technologies (phone lines, fibre) because rural areas cost more to build out than
urban areas.
One downside of this metric is that it does not measure return on invested capital. This metric could be
gamed by overinvesting in capex at poor rates of return.
Other important metrics of an operators skill are the penetration rates of video, Internet, and voice
services.

Turnaround/control investing
The idea is to buy into poorly managed cable networks and have a superstar manager take over. There
is a reason why Malone is obsessed with controlling the companies he owns. He knows that
management makes a huge difference in shareholder return. (He learned this lesson the hard way
when he sold Liberty to AT&T, which overpaid for assets and took on too much debt.) This is the
template for Liberty Globals roll-up strategy. Global could make an accretive deal taking over Virgin
Media because Virgin was poorly operated (e.g. very low rates of video, Internet, and phone
penetration per home passed on the cable side).
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11/26/2014

(LMCA/LBTYA) Malones cable strategy | Glenn Chan's Random Notes on Investing

As far as Charter goes, Charter was lucky enough to have Tom Rutledge become its new CEO. Malone
recognized the opportunity and bought a large stake in Charter, recognizing the turnaround that was
about to happen.
I suspect that Malone doesnt explain this game because he doesnt want other people playing it. He
doesnt want shareholders of publicly-traded cable companies to install better management teams. He
wants his competitors to operate their assets poorly so that he can swoop in, buy them at low
valuations, and turn them around for very healthy profits. As cable companies tend to be heavily
leveraged, small improvements in operations can translate into big profits. He values controlling his
companies as it allows him to protect his capital from bad management.

Capital allocation
When shares are expensive, Malone uses them as currency for acquisitions. Otherwise, he pays for
acquisitions in cash/debt.
If you were to consider John Malone a fund manager, it is clear that his track record is incredible
(especially after tax) compared to well-regarded fund managers. In a way, he is secretly one of the
greatest value investors of all time. And unlike many well-regarded fund managers, he invests in
companies within his circle of competence. He is the former CEO of a cable industry so he understands
the media industry very well and generally sticks to media-related stocks. Unlike many well-regarded
fund managers, he does not invest in industries that are very difficult to understand or very difficult to
perform due diligence on (mining, oil & gas, pharma, investment banks, etc.).

Unusual buyback strategy


Malone understands that he can make arbitrage profits if his companys shares are constantly
significantly overvalued or undervalued. I think Malone has an incredibly unusual style in that he tries
to keep his shares undervalued. Suppose he had done the opposite and kept his shares overvalued. He
would use the overvalued shares to constantly roll up other cable assets. Integrating other cable
companies would eat up a lot of managements time. As well, the resulting company would become
quite massive and eventually size would be an anchor on performance. The opposite is a little more
attractive. By keeping his shares undervalued, he is able to shrink the amount of capital he is
managing so that size isnt an anchor on performance.
The financial statements of Malones companies are highly unusual in that they use some fairly obscure
and arcane accounting. His use of tracking stocks is highly unconventional and makes his stocks
harder to understand. I believe that these are weapons that Malone uses against his investors
(institutional and retail) to trick them into selling shares at too low a price.
Historically, Malones companies have often been able to buy back huge amounts of shares over very
long periods of time. It is rare for his companies to be overvalued.
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(LMCA/LBTYA) Malones cable strategy | Glenn Chan's Random Notes on Investing

Economies of scale
When a cable company accounts for a very large percent of a programmers revenue, suddenly the
cable giant has an unusual amount of leverage over the programmer. If they fight over pricing, the
programmer will be hurt a lot more than the cable giant. Negotiations become a little unfair.
However, government regulators would likely step in and prevent companies from having this type of
power.
I think that economies of scale somewhat distract investors from the overall game that Malone is
playing. Scale is a legitimate explanation for Malones wheeling and dealing but I dont think that it is
the real reason behind most of his deals. If scale was extremely important, he would not be constantly
buying back shares rather than growing his cable empires scale. As well, Cablevision has performed
quite well (when Rutledge was the COO) versus its much larger competitors Time Warner and
Comcast. Scale is not as important as good management.
In my opinion, the reason Malone talks a lot about scale is because his merger deals require shareholder
approval of the company being taken over. Malone needs to convince the shareholders of the acquired
company that his deal is good for them. Typical reasons in favour of a merger would be synergies
and economies of scale. If shareholders were smarter, perhaps they would stop trading directly against
Malone (and his #1 salesman George Maffei) and find better managers for their cable assets. I would
not want to trade against a self-made billionaire.

Tax efficiency
Malone hires really good tax lawyers who find legal ways of reducing taxes. His tax reduction
strategies generally take advantage of:
1. Tax deferral strategies. By deferring taxes as much as possible, Malone essentially acquires interestfree loans from the IRS. Often these strategies are confusingly described as tax-free (e.g. a taxfree spinoff should really be called a tax-deferred spinoff).
2. Tax breaks that politicians introduce. Because politicians intentionally introduced these tax breaks,
tax strategies surrounding them usually arent questionable or risky. However, tax breaks are often
ruthlessly exploited after they are introduced. The IRS often implements new rules to counteract all
of the borderline fraud that tries to exploit tax breaks. So, there is still some risk to particular tax
strategies. There are areas that are grey. I believe that Liberty Ventures is taking advantage of tax
equity (http://www.woodlawnassociates.com/tax-equity-101/) related to tax subsidies for green
energy.

The big picture


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11/26/2014

(LMCA/LBTYA) Malones cable strategy | Glenn Chan's Random Notes on Investing

I think that the most important part of Malones strategy is recognizing the important of good
management. A huge amount of value is created by installing good management teams into poorlymanaged companies. This is intertwined with his obsession with control and understanding what he is
investing in.
The second most important part of his strategy is buying low and selling high.
The other aspects of his strategy (tax, buybacks, economies of scale, etc.) are just icing on the cake.
*Disclosure: Long LMCA and no position in LBTYA. I may initiate a position in LBTYA in the future.
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