Friday, February 21, 2014

Big Boy Finance- It's Major League Time on Wall Street



It has been a very interesting two weeks in the financial markets as investors have seen groundbreaking deals which could potentially alter the competitive landscape in the media and telecommunications industries.  We have seen massive bets placed by large participants in the quest for market share and future growth.  Let's take a look at what has transpired and what the implications may for quite a few different segments.

A few days ago, Facebook's Mark Zuckerberg placed a $19 billion dollar wager by buying WhatsApp, a mobile messaging service which is growing like a weed and has accumulated nearly 500 million users.  WhatsApp has an interesting business model in that users don't pay fees for the first year of usage, and after the initial annum pay a whopping $1 a year for unlimited SMS and other services.  Facebook is betting on the continued growth of its acquisition, especially in large markets like India and Brazil.  In some Southeastern Asian countries like South Korea and Thailand, companies have created large user bases with free SMS services and then tried to make money by adding additional pay layers to the free service, with some traction.  Facebook is trying to duplicate their success of buying Instagram, especially on the strategic front.  Many view the purchase of WhatsApp as a defensive measure because it tries to address the growing naysayers that Facebook's s popularity with young users is slowly eroding.  Zuckerberg financed most of the deal by issuing Facebook stock, and used cash as an incentive to retain the WhatsApp employees.

 

Deals in Silicon Valley are done primarily with stock as a way to retain the upside potential, but with interest rates where they are, the deal strikes me as one which probably could have been done a bit differently and would wind up far more tax efficient.  Still, the main issue in the future is going to be how well Facebook can take WhatsApp and create a large and ever growing cash stream from the user base.  The purchase price is a big hurdle and some of us old fogies remember services like AOL's Instant Messenger which were going to lead to large revenue streams in the future.  Until they weren't.   Still, it is a bold bet and certainly probably made the boys and girls from Google, Yahoo, and Apple sit up nice and straight in their chairs, or penthouse suites, and take notice.

 

If that were not enough, last week saw Comcast agree to buy Time Warner Cable for nearly $160 a share, or a market value of nearly $50 billion   I certainly have been very vocal about thinking John Malone and Charter Communications would ultimately wind up with Time Warner Cable (full disclosure- at every level- company, personal, and family, all members of the Liberty Media "family" are holdings).  Many investors and the media have portrayed John Malone as 'losing' to Brian Roberts and Comcast because Charter was not able to merge with Time Warner Cable.  As is so often the case, there is far more involved with this situation than to declare a winner or a loser.  Let me offer up my thoughts as to how to potentially view what transpired, keeping in mind I am looking at it from the Liberty shareholder point of view.

 

First, the person who really recognized the value at Time Warner Cable is John Malone.  The management at Time Warner Cable, including current CEO Rob Marcus, has not invested in their own infrastructure for a number of years, and it's customer service is notorious for being, shall we be kind, substandard (atrocious could also be used as a description).  As such, Time Warner Cable has proceeded to lose cable subscribers for the last two years.



John Malone's has a fourty year track record of literally turning feces and urine to gold.  If you have been an investor in almost any of Malone's public companies you should be congratulated because chances are, he has made you money, and probably quite a lot of it.  John Malone bought nearly 30 percent of Charter from a group of private equity companies, and when he did he knew Charter has something like $7 billion dollars of tax loss carry forwards as tax assets.  In addition, Liberty Media has a 52% ownership stake in Sirius Satellite and voting control of its path forward.  Sirius also possesses something like $5 billion dollars of tax loss carry forwards, has over 25 million paying subscribers, and generates over a billion dollars a year of cash, which should also grow nicely in the future.  Liberty is trying to consolidate its ownership of Sirius by buying the rest of what is does not already own.  John Malone's attempt to merge Time Warner Cable with Charter would have taken Charter's paying subscriber base from 4 million to over 15 million in one transaction.  A new entity could then shield it's substantial income from taxes with over 10 billion dollars of tax loss assets.  Just as important, Charter does not compete with Verizon or AT&T's broadband tv services in nearly any area of the country.  Charter has a clear path to growth for a long time, especially after spending this year upgrading their systems to a digital platform.  Even now, Charter is an appealing company for any cable company which is cash generative and looking for additional scale to better negotiate with content owners like ESPN, Discovery, Fox, and others.  Charter has a relatively small subscriber base of 4 million, so if it merges or acquires customers of 3-4 million, the growth in subscribers is potentially very dramatic.  Adding 11 million paying customers would have been transformational, and potentially a big home run for Charter and Liberty Media, call it a asymmetric payoff.  So what happened and why did Malone "fail"?

 

Malone had two large problems in trying to make this one happen.  First, he came to a gun fight with a knife.  What I mean is while Charter is just starting to generate larger amounts of cash and has significant tax assets, it was trying to acquire a company three times its size.  Comcast is nearly ten times the size of Charter in terms of revenue and  five times it's size based on cash flow.  In reality, the only reason Charter could even entertain thoughts of buying Time Warner Cable is because John Malone led the charge and saw the potential in a possible deal.  Once he did he made a very bold bet and tried to make it happen.  In fact, he did so for nearly a year and was turned down three times by the Time Warner Cable management, an entrenched group if ever there was one.  Malone is not someone who is easily dissuaded and eventually Charter nominated their own board to potentially replace the existing one.  My own personal opinion is he was probably gaining traction with many of the institutions who owned large blocks of Time Warner Cable stock, and Comcast was very aware of the situation.  It is reported Charter and Comcast were negotiating about how to potentially split up the subscriber base and eventually disagreed about what Comcast should get.  Also, and this is crucial, Comcast disagreed with Charter about how to structure the deal and wanted it to be all equity, which is how it wound up.  John Malone is not going to do a deal which is not tax efficient, and this probably was a big source of the disagreement as well.  Another key point is also the price as TWC's stock is up over 65% during the last year, and probably a great deal of it was based on speculation a deal would get done with Charter.  In the end, Malone did not have the firepower to compete with Comcast, and very few companies would.  Still, once Comcast recognized Charter could realistically wind up with TWC, they essentially paid full price.  So now we turn to the implications of the deal and what might take place in the future.

All across the media landscape, including content providers, cable companies, telecommunications carriers, and social media enterprises, the purchase of Time Warner Cable by Comcast is very important.  If the deal gets approved by all government agencies, Comcast would provide over 30% of all U.S. homes their internet access, a massive market position.  New court rulings have thrown out net neutrality provisions, but the FCC has now indicated they are looking at new ones which better reflect market reality.  Comcast has indicated it will abide by the existing net neutrality rulings and maintain them once the transaction is approved.  Comcast is saying they won't raise prices on content providers for quite some time.  If you are one, like Netflix, Google or Facebook, you have to be very wary of this deal because already Comcast is starting to charge more for preferred access to their networks- the "dumb pipes" if you will.  You can see the content owners are going to lobby very hard to get, at the very least, their pound of flesh in terms of concessions by Comcast, and if possible, a way to deny the deal.  I suspect the transaction will be approved, but not after plenty of political grandstanding, especially by those with a very liberal slant.  You already see this from the comments of Senator Al Franken, and one can only imagine what Elizabeth Warren or Ed Markey is going to come up with.  Still, Comcast has plenty of lobbying experience and is very tight with the current administration, so odds are it will probably get done.

 

As for Liberty and Mr. Malone, the great thing about them is you never know what they are going to do, but you know they are trying to find ways to "create value" in every possible manner.   In fact, what made me a bit uncomfortable about this situation is it was not really a Malone kind of deal.  Usually, you just wake up and something is announced, it is done.  With the Time Warner Cable situation, it took way too long and there were too many rumors.  You know the old saying- loose lips sink ships.  I would bet Malone will continue to try to expand Charter and to try and to use those tax losses.  He will also try and buy the rest of Sirius and get that done.  You know, 10 billion dollars of tax shields is quite a lot.  Come to think of it, maybe the owners of Cox Communications might think they are attractive.  Malone has been partners with Cox and the Newhouse family for a long time in the ownership of Discovery.  Many investors find investing in Liberty Media too troublesome and too confusing.  Still, I'll take my chances with Malone, Maffei, Charter, and Liberty's path forward versus what Comcast has to offer any day of the week.  Five years from now, it will be interesting to see which group created greater shareholder returns.

Thanks for reading the blog post and have a great weekend.  

Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.

Wednesday, February 12, 2014

Yellen, Obama's Phone and Pen, and Shark Tank-

 
Janet Yellen is now the head of the Federal Reserve, and  on Tuesday she gave an update to House Financial Services Committee on the state of the U.S economy.  The Fed "Head" indicated the current policy of slowing down the purchase of fixed income securities remains in place ("Tapering" for those who don't pay attention to Fed speak).  According to her testimony, it is apparent the priority is reducing unemployment closer to "full" employment, which simply means they want far more people out looking for, and actually obtaining, jobs.  As part of the Fed's dual mandate, the other main objective is to control inflation.  With the big "I" submerged at an annual rate below 2%, the Fed clearly believes they have inflationary forces under control.  Many skeptics believe deflation is the major problem the country faces, with still stubborn low labor force participation and factory capacity utilization rates.   The most recent jobs report indicated progress on both fronts, as the two categories were at their highest levels in quite some time.  Obviously, the equity markets liked what Mrs. Yellen had to say, as low interest rates for as far as the eye can see remain a soothing balm for long skittish investors. 
 
President Obama's recent quotes about having "a pen and a phone" are certainly suggestive of the realization by our nation's "leader" he is legislatively frozen, and probably acknowledgement of the potential loss of the Senate during the November elections.  As such, the comment speaks to what he can accomplish on his own through Presidential directives.  Looking at it differently, an objective observer might ponder the serious question of unilateral decision making in a country which was founded on the idea of a government based on a series of checks and balances.  Consequently, when you see how the Affordable Care Act has now been modified in quite a few ways since it has been implemented, one gets back to the principle of checks and balances and whether of not our "leader", along with his partisan pal Senate Majority Leader Harry Reid, have any recognition their policies might not be working.  Opponents of Mr. Obama might say that instead of having a pen and a phone, a brain would be more useful.

 

The Olympics started last week in Russia, and Mr. Putin's face was never more evident as he proudly unveiled the Winter Games in the new facilities that many companies in Russia ponied up hundreds of millions of dollars for in the hope of being reimbursed.  Nyet, and in reality, the country will probably face a situation where many of these monuments won't get near the kind of usage they thought when originally conceived.  Enjoy the games, Vlad, you will be paying for them for quite some time.

 

Over the last few months, the market has corrected some and the sector which has seen the largest beating would be in the social networking space, where Twitter and LinkedIn had some of the froth taken out of their stock prices. Certainly, there are other companies which still enjoy stratospheric valuations, like Tesla and Amazon.  Another interesting tidbit is Google overtook Exxon in market capitalization last week.  I took a look at both companies and on nearly every financial metric, Exxon has larger numbers, but in the crucial statistic of free cash flow, Google is relatively close.  What this speaks to is the difference in the kinds of business each company has in terms of capital efficiency.  If you add in the fact Google is growing much quicker, it is not out of the realm to see why Google overtook Exxon.  It does not mean I agree with it, or it is a permanent situation either. 

 

The television show Shark Tank is now prominently featured on Tuesday night on CNBC.  If you have not seen it, four prominent investors, including Dallas Mavericks owner Mark Cuban, listen and evaluate pitches by entrepreneurs in search of funding to potentially grow their start up companies.  One striking thing about the show, or at least my impression of it, was many of the presentations were from business owners who really do not show up fully prepared.   The other aspect which really bothered me was how disrespectful, mean, and arrogant the venture capitalists are towards their potential partners.  Yes, they are asking for an investment, which requires serious analysis.  However, nobody deserves to be made fun of and it seems the venture capitalists find it their job to be as insulting as they can.   The show can be viewed to see what other interesting ideas people have and how they might be applied to your business, but the negativity of the "Sharks" makes it very painful to watch. 

 

In traveling around the world on vacation, it was nice to see the various attitudes which come across when in different locations.  For example, in London, the airport was bustling and manners were prim and proper.  The Brits do everything they can to be pleasant, or at least those who I encountered did, and it was much appreciated.  In Africa, the laid back attitude of the locales was very prominent, and you certainly could make the case a more professional approach might be considered.  Interestingly enough, the first Burger King in the country opened while we were there, and the lines were two hours long.  If you ponder the idea people actually lined up for the Whopper, well, not much more needs to be said. 



Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.

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