From Virgin Media and England to Liberty Global and Germany

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All Northlake client positions in Virgin Media (VMED) have been swapped into Liberty Global (LBTYK). Both companies are leaders in supplying cable TV, telephony, and internet. VMED operates solely in England, while LBTYK operates throughout Northern and Central Europe with a major focus on Germany. I think both stocks have similar upside of 20-30%. However, VMED faces a more competitive and mature market in England, while LBTYK faces less competition and lower penetrated markets, particularly in Germany.
It is an oddity but Germany has been slow to develop its cable TV and high speed internet service. What business has existed there is highly fragmented among service providers due to the regulatory structure put in place by the German government. In the past few years, LBTYK has made two large acquisitions to become the leading cable and broadband provider in Germany. These moves have proved timely as German households are accelerating their move to digital TV and high speed internet. Business trends are also accelerating and LBTYK is poised to see faster growth in 2012 than during the past few years.
LBTYK has grown well despite the crisis in Europe. Thus far, the negative economic impact of the crisis has been largely contained to Southern Europe. LBTYK’s markets including Germany, Switzerland, Belgium, and the Netherlands have faced much less impact. I think the taint of the European crisis has held back LBTYK shares providing incremental upside should the recent easing in the crisis be sustained.
A final bullish element to the LBTYK story is the capital allocation program. Management aggressively repurchases shares using the significant free cash flow inherent in the cable and broadband business. With networks mostly built out and upgraded, capital spending as a percentage of growing revenues is falling providing double digit free cash flow growth to finance share repurchases. VMED also buys back a lot of stock but competition is requiring an uptick in capital spending this year and the long-term spending needs could be higher.
Please note that while Liberty Media (LMCA) and LBTYK share common controlling shareholders and Board members, the two companies are completely separate and do not compete with one another. The same shareholder focused approach to managing the business exists at both companies and is a major part of the investment thesis.
Disclosure: LBTYK and LMCA are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an Illinois-registered investment advisor. Filings can be found at the SEC’s website. LBTYK, LMCA, and VMED are net long positions in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, communications, and related technologies.

Media Stock Earnings on the Mark

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During the seocnd half of February, most major media stocks reported December quarter results and gave a look ahead to early 2012 business trends. In general, the results and outlook were good. This was definitely the case at CBS, Discovery Communications, Charter Communications, and Liberty Media, each of which is held in most Northlake client portfolios.
The big picture for media is dominated by two themes. First, after an unexpected and abrupt slowdown in national TV advertising demand around Thanksgiving, business has picked back up. Visibility is low but the first half of 2012 presently look like a return to moderate growth with networks producing good ratings set up for double digit gains. Second, despite constant headlines, there is little sign of cord cutting or cord shaving in the cable and satellite TV industry. The total number of households receiving multichannel TV is growing again despite worries about Netflix and other online video viewing. Stabilization of multichannel video subscribers is positive for cable and satellite and providers and the networks they carry on their systems. Charter Communications gets a boost from improved sentiment toward cable stocks as a result of better subscriber trends.
Here is a brief, closer look at each of the Northlake holdings latest earnings reports.
CBS had another good quarter driven by continued expansion of profit margins. Advertising trends were a bit below expectations driven by the late year slowdown. However, management was extremely confident in a 2012 pickup with good reason given CBS excellent ratings performance this season. CBS is diversifying away from advertising as it adds more subscription revenue. Good rating performance is also keeping programming expenditures in check. 2012 is setting up well for CBS and the stock still has 20% upside even after the huge gains since mid-2009.
Discovery Communications led the industry with 17% advertising growth as almost all of its large networks including Discovery Channel Investigation ID, Animal Planet, and TLC have positive ratings growth. Management indicated trends were continuing in 2012. Discovery is another stock that has made a giant move since 2009. The company remains best positioned of TV network owners due to its international growth profile as non-fiction programming translates well overseas. The stock is nearing my initial target and could be a candidate for a trim in the days ahead.
Charter Communications reported solid results driven by growth in broadband internet subscribers. Cable TV subs continue to stabilize removing a primary risk to the Charter story. New CEO Tom Rutledge, a cable industry star, participated in his first conference call with the company in late February. He sounded optimistic and outlined opportunities to sustain modest operating income growth and keep the free cash glowing at a double digit pace. Charter is a free cash flow story as it pays down debt to benefit shareholders.
Liberty Media is an asset play. The stock trades at ab 20-30% discount to the value of the assets it owns. By far the largest asset is a 40% stake in Sirius XM Satellite Radio. The primary issue at Liberty now is that its standstill agreement with Sirius expires this week allowing Liberty to increase its stake. It is very difficult what will happen next but Liberty will be a much stronger position to undertake a transaction that closes the gap between its stock the value of its assets. Management has a multi-decade of doing just that leaving Liberty shareholders with plenty of upside.
Disclosure: CBS, Liberty Media, Charter Communications, and Discovery Communications are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. All four stocks are also long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in the Funds’ investment management company, and has personal monies invested in the Funds.

Small Caps and Growth Still in Vogue

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There are no changes to Northlake’s models for March. The Market Cap model is recommending small caps for the second consecutive month. The Style model continues to favor growth, as it has since August 2011. With no changes this month, Northlake client assets invested in the models will continue to own the Russell 2000 (IWM)) and Russell 1000 Growth (IWF).
As mentioned in last month’s update, when the models shift off long running signals, there is often several months of volatility in the recommendations. The Market Cap model did stay on small cap for a second month. However, the indicators underlying the model show a weaker small cap signal. The bond momentum and trend indicators each shifted away from a small cap reading. Bond momentum measures the recent trend in interest rates. Although rates have not gone up over the last several months, the steady downtrend in rates has ceased. Small caps perform best is falling interest rate environments, so the indicator shifted away. The trend indicator is now in neutral mode after favoring small caps last month. This indicator measures very recent relative performance of small stocks vs. large stocks. As discussed further below, small caps lagged February’s rally so this indicator is no in neutral mode. Based on the current condition of the Market Cap model indicators, the model could very well shift back to mid caps next month.
The Style model saw a strengthening of its growth signal for March driven mostly by a shift in trend indicator that reflects the recent strong performance of growth stocks. The growth signal is very likely to remain in place for at least another month or two given the currently strong reading in favor of growth stocks. With technology stocks back in a leadership role for the market, a growth signal is a comfortable place to be.
Last month, the models put in a mixed performance. The new small cap signal trailed the market the S&P 500 by a little over 1%. Fortunately, this was offset by above average performance for the growth signal. On a year to date basis, both models are running comfortably ahead of the S&P 500.