Liberty Global Growth Overshadowed by Acquisition of Virgin Media

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Liberty Global (LBTYK) reported another excellent quarter with continued rapid growth in cable, broadband, and telephone subscriptions and accelerating growth in financial metrics. This news was expected. What was not expected was the company’s acquisition of Virgin Media (VMED). LBTYK is a very acquisitive company but expectations for the next big merger were focused on the fast growing German market. Instead, LBTYK bought VMED, the dominant cable company in the United Kingdom. The deal is nicely accretive to earnings an free cash for the next few years but could dilute the company’s growth rate as fast growing Germany is a smaller portion of revenues and moderately growing United Kingdom becomes one of LBTYK’s largest markets.
The growth dilution and the fact that LBTYK is partially paying with its own shares has led to an 8% pullback in its shares. I think this will prove to be temporary. Partially, my opinion is based on trust in LBTK’s excellent management. They have executed flawlessly and been excellent stewards of shareholder capital. I think they deserve the benefit of the doubt on this deal. In addition, I have long followed VMED (Northlake clients use to own it), and I think its outlook is better than many on Walll Street expect.
After digesting VMED in 2013, LBTYK will return to its aggressive share buyback program which combined with mid to upper single digit revenue and EBITDA growth will drive free cash flow share up by about 20% per year. As free cash flow approaches $10 in a few years, I think the shares can trade to $90-100, up dramatcailly form current levels around $60. The VMED acquisition may put a temporary headwind on LBTYK shares but the payoff could be huge and is worth sticking around for.
Both LBTYK and VMED reported good fourth quarter results highlighted by continued higher than expected subscriber gains. In a networked, subscriber-based business, net additions ultimately drive accelerated financial results. LBTYK is already seeing the benefits of its prior subscriber gains with the latest quarter showing 6% gains in revenue EBITDA. Both figures are up from 4-5% earlier in 2012. I see more of the same in 2013 for LBYTK. Investors are likely to come around to my bullish view as these numbers are reported and VMED continues to grow even as the UK economy faces challenges.
Liberty Global is widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Filings can be found at www.sec.gov. Liberty Global and Virgin Media are net long positions in the Entermedia Funds. Steve is the portfolio manager of the Entermedia Funds, owns a majority stake in the Funds investment management company, and has personal monies invested in the Funds.

2013 Outlooks Bullish for CBS and Discovery Communications

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CBS and Discovery Communications (DISCK) each reported mixed 4Q12 results compared to expectations but provided positive guidance for 2013. I think both stocks offer further upside with the caveat being that each company’s results are sensitive to consumer spending trends via their exposure to advertising. With worries about the consumer on the rise due to the payroll tax increase and potential budget cuts due to sequestration, the stocks may pause. Should the economy weather the austerity storm, CBS has upside to the low $50s and DISCK could reach the mid-$70s. I plan to hold both stocks in Northlake client accounts.
CBS reported 2% revenue growth and 6% EBITDA growth. Both figures were slightly below expectations. The EBITDA figure was below expectations for about 10% growth with margins at local TV and radio stations coming in a little below expectations. Despite the slight miss, management softened the blow by announcing an incremental and accelerated share repurchase for $1 billion to be completed in the first quarter. This almost doubles the already aggressive share repurchase plan. Listening to management comments on the conference call, it is not surprising that they see value in their own shares. Advertising trends, particularly at the CBs Network, remain firm, even with early season ratings struggles. Rising non-cyclical advertising streams from Showtime and retransmission consent are driving margins higher and reducing CBS’s exposure to the economy. Management also indicated that it plans to return even more cash to shareholders after the conversion of its Outdoor business to a REIT, hopefully at the start of 2014. The story here remains very positive with great management, rising margins, less cyclicality, more consistent and higher growth, and most shareholder friendly capital allocation policy in the media industry. I think 2014 EPS estimates could prove 5-10% too low, maybe more if the REIT conversion happens in its most aggressive form. Given CBS recent history, I think it is worth holding on for the bull case which would be the low $50s based on a 15 P-E in 2014.
DISCK reported among the fastest growth of all media stocks in the fourth quarter with revenue up 9%, EBITDA up 11%, EPS up 30%, and advertising up 11%. These results were widely expected. IF anything, the company could have reported a little better results but there is little to complain about. The outlook for 2013 was in line with street estimates but hard to interpret as they include about nine months of the company’s recently announced acquisitions in Europe. Continued high levels of share repurchase despite the acquisitions is good news. Strong ratings for DISCK’s stable of networks and the beginning of a new round of affiliate fee increases seems to set the stage for more industry leading growth in 2013. The primary risk I see to the story are that the stock has the highest valuation among media companies (well-earned for sure!) and the new acquisitions are a little outside of the core competency in non-fiction programming. Assuming that cable network ratings remain solid, I think the stock can hold its current P-E of 19 times as focus shifts to 2014 results later this year. This would get the shares to the mid-$70s.
CBS and Discovery Communications are widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Filings can be found at www.sec.gov. CBS and Discovery Communications are net long positions in the Entermedia Funds. Steve is the portfolio manager of the Entermedia Funds, owns a majority stake in the Funds investment management company, and has personal monies invested in the Funds.

Selling Charter and Buying Disney

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I just completed a swap of all Northlake client positions in Charter Communications (CHTR) into Walt Disney (DIS).
CHTR shares have been strong the last few days on takeover rumors. The stock had fallen sharply last week after Time Warner Cable (TWC) announced poor earnings and guidance. GHTR takeover rumors appeared before the Liberty Global (LBTYA/LBTYK) buyout of Virgin Media (VMED) but surely a big deal in cable, even if it was in Europe, helped the takeover rumor gain traction. The only article I found regarding the rumor was on deadline.com which referenced a freeze in expenses at CHTR in conjunction with a move of the company’s headquarters to Connecticut, close to the new CEO, Tom Rutledge. I like Rutledge and think he has the chops to create a lot of value at CHTR. However, I think it is way too soon for him to consider selling the company. I know that is not totally in his control but it just seems an odd thing for the Board to consider after bringing him in and launching an aggressive growth strategy with higher investment in marketing to attack CHTR’s underpenetrated markets in digital video and broadband.
Those expense increases is what worry me especially after TWC soured investor sentiment toward the group. CHTR’s increased spending is to gain new subs. If it works, the payoff long-term is significant. TWC appears to be catching up the industry on programming expenses after a year where its increase in this category sharply trailed other cable companies. If CHTR is not bought out, I fear that guidance for 2013 could disappoint the street and send the shares down to the low $70s.
Cable stocks, including CHTR, did exceptionally well in 2012 as fears about over the top and cord cutting receded, investors ignored the margin pressure from rising programming expenses, and appreciation of cable’s dominant position (and hedge) in broadband grew. In addition, cable’s entry into in business services became a material driver of growth. The TWC guidance, the re-emergence of Netflix (NFLX), the rollout of Aereo, and more focus on programming expenses could leave the group vulnerable. CHTR might be especially vulnerable given it is in investment mode.
DIS is a new buy. The company is at the beginning of a ramp in growth driven by ESPN and theme parks. ESPN, the company’s biggest single asset, is coming off a period of heavy sports rights inflation. Increased rights fees are being passed through to cable and satellite distributors via increased affiliate fees, alread negotiated with 7 of the top 10 cable and satellite companies. The benefit of the fees begins this quarter. Over the next few years, the rights fee increases will level off as the affiliate fees rise, setting up margin expansion. A new national sports networks competitor form News Corporation (NWSA) is a risk to sentiment but will not impact ESPN’s ramping profitability for several years if ever.
In theme parks, DIS is coming off a period of heavy capital investment. Visitation and per capita spending should benefit from the investment leading to growth in revenues and margin expansion at the parks. California is already seeing this benefit. Spending will pick up in Shanghai but I believe investors will cut DIS slack given the opportunity in China at the new park and to build DIS’s already strong brand in the country.
DIS also appears to be at a good spot at its film and TV studio. Film seems poised for a good run with its upcoming slate driven by the Marvel acquisition and then the Lucasfilm acquisition. TV production is in a bull market for all the major players as increased spending by cable and broadcast networks all over the world are driving business fundamentals. The value of TV in a digital world to both traditional and new broadband distributors is bullish for DIS.
Disney and Liberty Global 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. Regulatory filings can be found at www.sec.gov. Disney, News Corporation, Liberty Global, and Virgin Media are net long positions in the Entermedia Funds. Steve is sole portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the Funds. The Entermedia Funds are long long/short equity hedge funds focused on media, entertainment, communications, leisure, and related technologies.

Both Models Shift!!! Mid Cap and Growth Now in Favor.

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For the first time in many years, both of Northlake’s models changed their recommendations in the same month. For February, the Market model shifted from large cap to mid cap and the Style model shifted from value to growth. As a result of these changes, all client positions in the S&P 500 (SPY) and the Russell 100 Value (IWD) were swapped into the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF). Some clients may continue to own SPY as a core holding.
I would not read anything special into the fact that both models shifted in the same month. However, I do think it shows that the fundamental backdrop for the economy (interest rates, GDP growth, trading technical) is unusual. GDP is growing but only modestly, interest rates have begun to tick higher but remain unusually low, and the stock market continues its steady move upward but with less correlation among individual stocks, economic sectors, and industries that it has had since 2007 before the economic crisis began.
With few economic or stock market statistics registering extremes and correlations declining, the models are not giving off strong signals. This leads to greater volatility on a month to month basis in the signals.
The current shift to Mid Cap was driven primarily by technical trading indicators. The steady rally in the market, which accelerated in January, has been led by small caps, improving the small cap technical indicators, particularly those based on trend. In addition, some weakening in coincident indicators of economic growth amid general growth in the economy has set up a contrarian call to favor small caps. In essence, the market and economic indicators appear to be calling for acceleration in the economic recovery. Historically, this is a good time to own small and mid caps. The Market cap model usually works in stair step fashion with the first step away from large caps to mid caps.
The new growth signal is more a function of relative valuation between growth and value. Growth stocks have really lagged, with technology indices holding back growth. Apple is actually impacting the model as its pullback and the lagging performance in the many stocks that provide products to Apple’s supply chain, has been causing technology and growth to underperform the market and value indices. Valuations are no stretched to the point that growth stocks trade at lower price-earnings ratios than value stocks. This is an unusual occurrence as investors normally pay up for growth investments.
The value signal has been in place since the beginning of August. During this time IWD has gained over 13% against a rise of less than 7% for IWF. This large discrepancy in favor of value is a main reason why the valuation indicators shifted to growth, bringing the entire model along. Northlake’s Style model made the correct call for the last six months.
The large cap signal emanating from the Market Cap model for the last two months proved less rewarding. SPY tracks the S&P 500, the benchmark U.S. stock market index. This index rose over 5% for the past two months when large cap was favored. Nothing wrong with gaining 5% plus in 60 days! However, both mid cap and small cap indices did better with MDY up 9% and the small cap index (IWM) up almost 8%. The latest signal from Northlake’s Market Cap model was inaccurate.
MDY and IWF are widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts. SPY is held by selected clients of Northlake. Steve Birenberg is sole proprietor of Northlake Capital Management, LLC, a registered investment advisor. Regulatory filings can be found at www.sec.gov.

QUALCOMM looks good as EMC continues to struggle

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Last week two of Northlake’s stock holdings in the technology sector reported earnings. The verdict was mixed with QUALCOMM (QCOM) reporting another outstanding quarter and issuing guidance for 2013 above Wall Street expectations. EMC Corporation (EMC) reported earnings in line with recently lowered Wall Street estimates but issued slightly disappointing guidance.
As would be expected, QCOM shares responded well to the company’s earnings and guidance, rising more than 5%. Interestingly, after an initial sell-off, EMC shares firmed up. In fact, backing out a 20% drop in the shares of EMC’s 80%-owned subsidiary VMWare (VMW), the implied valuation of EMC’s 100%-owned storage businesses ended the week higher. Of course, a significant part of EMC’s valuation is VMW but it could be a positive sign for future performance of EMC stock that the shares held firmly on generally disappointing news. This is often a sign that expectations have been lowered to a beatable level and that sellers of the stock are done. In other words, EMC shares may be in strong hands with better news to come and expectations low.
I do not want to get bogged down in recapping the numbers from QCOM and EMC, so let’s focus on the big picture. Northlake’s long-term approach to individual stocks emphasizes big picture themes, similar to thematic approach used by Northlake’s Market Cap and Style models.
QCOM’s results show the company’s leading position as the most important semiconductor supplier to smartphone industry. There was worry that Apple’s recent market share losses and cautious guidance for the March quarter would negatively impact QCOM. Apple could be as much as 15-20% of QCOM’s business. However, the beauty of QCOM is that it is a critical supplier to all of the major smartphone companies, including Samsung, the current market share leader. QCOM is also expanding its addressable market with products for all mobile devices including tablets and possibly laptops and ultrabooks in the near future. The investment thesis for QCOM is simple: riding the wave of smartphone adoption and mobile internet all over the world. High end, low end, emerging markets, industrialized markets. For QCOM, its does not matter. Think Intel back in the halcyon days of the PC adoption cycle. I think the stock can reach $80 this year, up more than 20% from Friday’s close.
EMC is a little trickier. Frankly, the stock has been disappointing, trading at about the same level as when it was initially purchased for Northlake clients in the fall of 2011. EMC has a similarly strong secular growth story to QCOM as it provides products to manage the massively growing storage needs driven by the internet revolution. Cloud computing, big data, virtualization…EMC is the leader in many next generation trends. The problem for the stock has been that the bulk of the company’s revenues come from large enterprises and governments. These purchasers have been under a lot of pressure to control budgets in a slow growth economic environment amid large Federal and State budget deficits.
EMC management has done a good job and the company has been growing. Growth has lagged Wall Street estimates, however, placing a stiff headwind on the shares. I am encouraged by the action in the shares since the company reported. It is consistent with a bottoming pattern often seen in stocks. EMC’s valuation is cheap and it is not a stretch at all to see the stock return to the $30 level in 2013. I am keeping EMC on a short leash but my current position is to hold on for one more quarter expecting that guidance will have proven conservative and expectations are low setting up a positive surprise and renewed enthusiasm for the shares.
QCOM and EMC are widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts. Steve Birenberg is sole proprietor of Northlake Capital Management, LLC, a registered investment advisor. Regulatory filings can be found at www.sec.gov. QCOM is a net long position in the Entermedia Funds. Entermedia runs long/short equity hedge funds focused on media, entertainment, communications, leisure and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the Funds.