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May 09, 2014

Liberty Global Growth Acceleration Beginning

Liberty Global (LBTYK) reported improved March quarter earnings after several expected but slower growth quarters. What LBTYK calls rebased revenue grew 2.3% just slightly below estimates of 3%. The upside surprise came in operating cash flow which saw rebased growth of 6%, well ahead of consensus for 4%. An investment cycle, cost related to several large acquisitions, and a few markets with increased competition had slowed revenue and operating cash flow growth to the low single digits. As management has promised, these headwinds are about to give way and become tailwinds. The big pickup was expected in 2H14 so the March quarter surprise was welcome. I do not expect the June quarter to be quite as strong but the new trend is clear and visibility has dramatically increased.

The stock has responded bouncing 8% and recouping almost the entire 10% 2014 decline. One headwind remains: the company is awaiting regulatory approval of its acquisition of the leading cable company in the Netherlands. During this period, LBTYK will be unable to buyback stock, a major part of the investment thesis. This is widely known, however, and during the March quarter, the company accelerated its share buyback into the weakness in the stock giving great confidence that once the acquisition is approved the buyback will comeback at even stronger levels.

Following a series of acquisitions in Germany, England, and the Netherlands, and the subsequent investment cycle to upgrade in those markets and others to enhance the speed and quality of the company’s cable systems and set top boxes, LBTYK should enter a period beginning in 2015 where capital spending drops significantly as a percent of sales. Capex peaked at 23.4% of revenue in 2Q13. In the most recent quarter, capex was 20.1% of sales. This allowed free cash flow to grow 47% in the March quarter. LBTYK should see capex fall into the upper teens as a percent of swales over the next few years. Coupled with mid-single digit revenue growth, margin expansion as acquisition synergies kick in, and continued massive share repurchase, free cash flow per share could explode.

Bullish analysts, with whom I agree, think that free cash flow could be near $7 per share in 2017. Today, LBTYK trades at about a 7% free cash yield. If the company made $7 in free cash flow per share in 2017 and the stock held the same free cash flow yield, the target would be $100 against current prices in the low $40s. There is always something happening at LBTYK on the acquisition front and broadband is a competitive business with tough foes in all countries. It may not be a straight line but the upside along with one of the highest quality management teams I know makes LBTYK a uniquely good investment opportunity.

LBTYK is 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. Northlake’s regulatory filings can be found at www.sec.gov. LBTYK is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Posted by Steve Birenberg at May 9, 2014 12:12 PM in LBTYK