One of the books that tops Munger's recommended reading list is Influence: The Psychology of Persuasion by Robert Cialdini, which outlines 6 weapons of influence: reciprocation, commitment and consistency, social proof, liking, authority, and scarcity. I highly recommend the book. It is interesting to see companies exploiting many of these weapons of influence although frustration to find oneself a victim to them. Understanding these weapons though can help one to have an even deeper understanding of things like network effects and how powerful such a business model can be.
The story of QVC (the main operating asset of Liberty Media Interactive) reminds me of many of these psychological biases. This article is a few months old, but it keeps coming to the forefront of my memory as I look at Liberty Media Interactive under the ticker LINTA:
The Genius of QVC
The article covers the qualitative aspects of the company very well. In summary, the business has a devoted customer base and their effectively recurring revenue, a wide moat, huge scalability, and a low cost mentality.
The company trades at for $9.5B. It has full ownership of QVC as well as a couple web properties/retailers (QVC is main driver of revenue and profits), as well as stakes in Expedia (24%), IAC (11%), Interval Leisure Group (30%) and HSN (33%). Those stakes are valued at $2.9B. That puts the value of QVC at about $6.6B. There's also $4.7B of net debt attributed to the LINTA tracking group. Since QVC is the core, and practically sole, cash generator for LINTA, I'm going to attribute the debt to QVC for this back of the envelope valuation and ignore the other niche web properties they own. This gives QVC an enterprise value of $11.3B.
The company should bring in around $1.1B in operating earnings (EBIT) - do note that this number is a very rough guestimate. They did $1B, $.95B, and $1.1B in 2009, 2008, and 2007 respectively. Depreciation should come in around $550m, while capex should be about $300m ($176m already plus about $100m more expected). John Malone is known for leveraging his companies, but I would prefer to see cash return to shareholders instead of constantly being eaten up by lenders. The company does do buybacks, but there would be a lot more without all the debt. Interest payments eat up all of that arbitrage between D&A and capex and then some. That puts QVC at a multiple of 10x EBIT/EV, not exactly cheap even though it is a great business.
Wally Weitz gives the stock a positive pitch in this article:
"Liberty has split itself into six or eight different pieces, one of which is Liberty Media Interactive (LINTA), which is basically QVC. It's going to become an independent company, getting out from under the tracker-stock confusion. QVC grew right through the recession. It's doing beautifully. It doesn't have to worry about bricks and mortar. It can change its product mix on the fly, as the presenters are showing their cookware or whatever. We think the QVC business itself, which also does business in Germany, Japan, England, and Italy now, is worth $16 or $18 a share, and it's got another $5 or $6 a share of marketable securities. That adds up to $21 to $24 a share, and the stock's currently at about $15.50. Not only do you have good assets, you have liquid assets that [founder and CEO] John Malone can do something else with."
While the spinoff of LINTA into an asset-backed company as opposed to a tracking stock will eliminate the tracking stock discount, I'm not sure there is much more value on the upside. I do not know what assumptions Weitz was using in his valuation, but my guess is that he would like to accord a very premium valuation to QVC. I would not disagree with according QVC a premium valuation. Home Shopping Network (HSNI), which is 33% owned by LINTA trades at 18x earnings and is in the same business. QVC due to its size and dominant position might receive a 20x earnings valuation. QVC has recorded about $80m in net income excluding a $394m gain on a disposition in the past 9 months which I don’t believe is indicative of the health of the business. In the last 3 months it earned $100m. I'll annualized the last quarter's earnings since it probably represents a more normalized operating environment, and venture they do about twice as much business in the 4th quarter (this is not out of the blue, they do state they do a lot more business in the 4th quarter for holidays) as any quarter for annualized earnings of $500m. Adding in the $200m different between D&A and capex puts FCF at $700m. At an implied stock market value of $6.6B, that values QVC at just under 10x FCF. This is a little cheaper but that stock trades closer to 16x FCF/EV. At the 20x earnings that Weitz might be forecasting, QVC is worth $10B.
Considering QVC worth $10B, with an additional $2.9B of equity investments gives a total value of $12.9B less net debt of $4.7B for an equity value of $8.2B or $13.6/share. This is an extremely rough estimate of value as a reminder.
I'm prone to discount stocks with debt. QVC does have robust cash flow to service the debt and it fared quite well during the depths of the recession. While I would not refute that downside appears limited, I question where the upside lies. There is certainly growth in the future, but at this price it seems like a buyer isn't getting that growth for cheap and mostly likely the upper ends of what one might consider a reasonable price.
While the company is incredibly attractive, the price seems to fall in the realm of fair value. I definitely see this stock as more of a Phil Fisher than Ben Graham style investment, but would like to see it come down more in price to receive a better margin of safety.
I hold no position in stocks mentioned in this article.
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