Liberties Still Shining and Charter Plots Growth

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Last week saw the final three holdings in Northlake’s individual stock portfolio report their latest quarterly earnings. The news was good across the board, rounding out an excellent earnings season for Northlake’s portfolio that has been well received by investors.
Liberty Global continues to grow its subscriber base in Europe at a rapid clip. Good cost management is allowing modest growth in operating cash flow despite the added expense of bringing new subscribers aboard. Importantly, several quarters of better than expected sub growth means that financial results will accelerate later this year and in 2013 as the new subs begin paying for their services and subscriber acquisition costs decrease. Just as in the U.S., cable TV, broadband, and telephony services in Europe are proving resilient to economic pressures. This is especially the case in Germany where Liberty Global made timely acquisitions right as German households were finally beginning to spend significant money for cable TV and broadband. It is an odd quirk but Germany has always significantly trailed other wealthy nations in the use of higher end cable TV packages and high speed broadband. Liberty Global is riding the wave now as household penetration accelerates. I see upside to $65-70 for the shares in the next 12 months.
Liberty Media (LMCA), unrelated to Liberty Global, except for having John Malone as its controlling shareholder, also continues to make good progress. LMCA is an asset value story composed of three big pieces. Sirius XM Satellite Radio represents over half of the asset value. The Starz Encore pay TV business is about 25% and the balance is a portfolio of publicly traded securities, a few private investments, and cash reserves. LMCA trades at a 20% discount to its asset value which has been growing steadily thanks mostly to Sirius. Over the past six months, LMCA has taken increasing steps to unlock and increase the value. When it reported earnings, LMCA announced it would spin-off Starz, further simplifying the remaining LMCA and setting up an end game for its investment in Sirius. Subsequently, LMCA has increased its stake in Sirius and now has a direct path to taking control. It is not clear exactly what the next steps will be but driving the value of Sirius higher, closing the gap to net asset value, and massively buying back its own stock could create value of $150 or more in LMCA.
Charter Communications reported very slightly weaker than expected results but the big news was the decision by its new, highly regarded CEO to accelerate the company’s transition to an all-digital network. This will lift capital spending for the next six to eighteen months but seems certain to accelerate growth as Charter’s penetration of its more rural and mid-size markets is quite low. The opportunity is especially large in high speed internet. The shares initially traded lower as the story for cable companies is falling capital spending, growing free cash flow, and rising share repurchases and dividends. Confidence in the CEO and the realization that Charter is merely delaying the inevitable explosion in free cash flow and likely increasing the free cash flow capability turned the shares around quickly. I think another 20% upside remains with share repurchases and dividends kicking in during 2014 making Charter shares a solid long-term holding.
Disclosure: Liberty Global, Liberty Media, and Charter Communications are widely held by Northlake Capital Management LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a long only registered investment adviser. Regulatory filings can be found at SEC.gov. Liberty Global, Liberty Media, and Charter Communications are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, communications and related technologies. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in the funds’ investment management company and has personal monies invested in the funds.

CBS Shines, Discovery Good Enough

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This week was a big one for media earnings. Besides Northlake holdings CBS and Discovery Communications, we heard from Viacom, Time Warner, Scripps Interactive, and Comcast Against a cautiously optimistic backdrop, the results came through inline to slightly better than expected with CBS leading the way again. The outlook for the rst of the year suggest modest growth in the September quarter, held back by market share losses to NBC’s Olympics telecast, which is a huge ratings winner. Management teams were very confident across the board on a pickup in the December quarter as higher pricing on upfront ad sales kicks in and political spending tightens inventory and firms up spot pricing. Overall, the national TV ad market has weathered the first half economic slowdown well. Media stocks have further upside after above average performance so far this year as investors respond to higher estimates, increased predictably, and continued aggressive capital allocation leading to large share buybacks and dividend increases. In addition, there is no sign that cord cutting is a problem or that internet video is changing the basic economics of TV. That could change but for now with near-term business momentum and reduced secular fears, media stocks have room for higher valuation on stable to rising 2012 and 2013 earnings estimates.
CBS has been a leader among media stocks since the bottom in the summer of 2009. The most recent quarter presented some very challenging comparisons but once again the company came through. Operating margins again surprised to the upside as the company adds extremely profitable retransmission, digital rights, and syndication revenue. Revenue trends were flattish as expected but a big second half pickup is clearly coming with strength expected to continue into 2013 as long as the economy holds. CBS has transformed itself into a content driven company with much less reliance on advertising. The street has been consistently behind setting up a series of positive surprises. Earnings estimates may finally be catching up but the stock still trades at a discount to its cable network peers. Closing the gap can get the stock to the $40s.
Discovery Communications reported growth toward the top end of the industry for the June quarter but was a touch more cautious on the September quarter than some of its peers. Discovery skews female and faces a somewhat greater challenge for ratings and ad spending from the Olympics. Ratings at a TLC and Discovery Channel have been a little soft as well. None of this would be a problem except that Discovery shares trade one of the highest multiples in the industry. The premium is well deserved given industry leading margins, historic growth rates, and international exposure that should drive above average future growth. A lull in the share gains cold be at hand but if the December quarter accelerates, as management firmly believes it will, upside remains. 2013 looks good as well with new affiliate fee opportunities and dramatically reduced losses at start-up networks, especially OWN.
Disclosure: CBS and Discover Communications 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. Regulatory filings can be found at www.sec.gov. CBS, Discovery Communications, and Comcast are net long positions in the Entermedia Funds. Entermedia is along/short equity hedge fund focused on media, entertainment, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds.

Switching to Value

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After twelve months favoring growth, Northlake’s Style model shifted to value for August. As a result, all client positions in the Russell 1000 Growth (IWF) have been sold and the proceeds reinvested in the Russell 1000 Value (IWD). The Market Cap model is still recommending Mid Cap, so all client positions in the S&P 400 Mid Cap (MDY) will be held for at least another month.
The shift toward value has been underway for several months as several of the Style model’s underlying indicators moved from a growth signal to a value signal. As is usually the case, the initial power of a new signal is not too strong. The models are designed to move gradually, capturing big trends, and avoiding a lot of back and forth. The key changes in the model that led to the new value are signal are (1) improved valuation for value stocks, and (2) better performance by value stocks.
The models often shift as the economic and stock market cycles change, In this case, I think it is more of a relative value call. Value has lagged growth as the economy has been stuck in slow growth mode. However, the economy is still growing despite awful headlines. Value stocks need a little help of the economy. Presently, a little help is all they are getting but with value stocks looking relatively cheaper that is enough to shift the signal.
The prior growth signal, in place beginning in August 2011, worked pretty well. Over the past year, IWF gained 5.16%, ahead of a 3.99% gain for IWD. A little over 1% might not seem like much but in a low return environment that is not bad.
There is nothing unusual in the reiterated mid cap signal. It is a little weaker and not far from changing to large cap. Large cap is usually favored when the economy slows as smaller companies need the tailwind of stronger economic growth. Investors appear to recognize this as over the past few months small caps have really struggled, including a decline of 1.5% last month when mid cap was unchanged and large caps were up over 1%.
Disclosure: IWD and MDY 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. Regulatory filings can be found at www. sec.gov.