TransDigm Group (TDG)

So this is sort of a footnote to the previous post about a really great book. 
  (The Outsiders:  Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. )

In chapter one (page 34), Thorndike mentions the TransDigm Group (TDG) as a contemporary analog for Capital Cities.  TDG has grown  cash flow at 25%/year since 1993 through internal growth and acquisitions (which Thorndike calls an "exceptionally effective acquisition program").   The approach is similar to Capital Cities in that they focus on businesses with exceptional economic characteristics.

The CEO responsible for this nice record, Nick Howley, is still the Chairman and CEO and is 60 years old (as of the 2013 proxy) so the story may still be intact; maybe it's worth a look.

TDG Performance versus S&P 500 Index Since IPO

That's a 33%/year performance since 2006.  Pretty nice and consistent with the performance of other outsider CEOs.  The book says TDG grew free cash flow +25/year since 1993. 

Here are some figures for the last five years:

                                             2007             2012        CAGR
Sales   ($mn):                       593               1,700       +23.5%              
Operating income ($mn):     234                  700       +24.5%
Adjusted EPS:                     $2.01               $6.67     +27.1%
EBITDA:                            $275                $809       +24.1%

These are pretty decent growth rates and the period includes the great recession.

What would one pay for a business that grew adjusted EPS at +27%/year in the past five years?  The midpoint of the company guidance for 2013 is $6.80.  With the current stock price trading at $143/share, that's a P/E ratio of 21x.  This may not be Graham and Dodd cheap, but with historical EPS growth of +27%/year and a company goal of growing 15-20%/year (in equity value), 21x may not be expensive at all, not to mention that free cash flow is much higher than adjusted earnings.  If we use 55% of current year expected EBITDA as free cash flow (see later slide), we would get $8.93/share in free cash flow per share and a multiple of 16x free cash; not bad for a company growing so quickly.

Some of the components included (or excluded) in the "adjusted" earnings and EBITDA may be debatable, but I'm not trying to pinpoint an exact valuation here; just getting a general sense of the company.

Unlike the many outsider companies, TDG has a great investor relations website with some interesting slides (see here).

By the way, one thing we have to look at later is that current year adjusted EPS guidance is $6.80 (at midpoint) versus $6.67 in 2012. I haven't dug into this to see if the growth period for TDG is over, or if it's a short term thing (EPS was also flat in 2010, so this may be lumpier than your typical 'growth' stock).

Ownership
Management/directors own just over 10% of the shares, but Howley doesn't own much except for what he gets from options (which only vest with performance).  Howley owned just under 5% at the time of the IPO but hasn't owned much since except for the options.

Berkshire Fund VII (Private equity, not the Buffett entity!) owns 7.6%,  and Lone Pine Capital owns 6.7% (as of the 2013 proxy).  It looks like they sold some shares but still own 2.6 million shares as of the August 13F.   Lone Pine Capital is run by the highly successful Stephen Mandel, a Tiger cub (ex-Tiger Management).  Tiger cubs are known to do a lot of work (analysis) on their holdings.

Also, I noticed that Tiger Global, also a high performing Tiger cub bought some shares this year which indicates that TDG might still represent some value.  Tiger Global owned a large stake for a while but didn't own any shares (according to the 13F) earlier this year until some shares showed up on the 13F in August.  It's only 530,000 shares or so compared to their 4.5 million shares they owned back in 2008.  TDG didn't show up in the 13F as far back as late 2011, so maybe this is seller's remorse.  In any case, it's a datapoint for whatever it's worth.  Tiger cubs are generally very fundamentally based investors who focus a lot on management so it's a good sign that they are shareholders.


Anyway, let's take a look at some slides.

First I'll snip some stuff out of the 2012 Analyst Day presentation:

TDG makes and sells aftermarket products for the aerospace industry.  It is apparently a high-moat business since not just anyone can make stuff and sell it to people who put them in planes.  They are highly engineered and government approved (for safety etc...), which usually takes time and money to do.

The private equity-like business model is their dependence on acquisitions for part of their growth.  They typically pay 9-11x EBITDA and through efficiencies,  get the effective EBITDA multiple down by more than 50%.

Here's a very long term view of their results, going back to their founding in 1993 (actually, the following two charts are from the September 2013 investor presentation as they have updated figures):

 

It's good to know that TDG continued to grow even after EBITDA margins got into the 40s in the early-to-mid 2000s.   So EBITDA margin improvement from 20% in 1993 to 47% in 2013 is not the whole story; TDG has grown substantially even since 2004 when margins hit 46%.

They operate in a growing industry, so this is not rolling up local yellow pages or anything like that:

I think there is no doubt that the aviation industry is growing over the long term:

High moat businesses:

Big Market:

Sole source means they are the only ones that can replace a part.

Kind of Berkshire-like (or outsider-like) localization:

Performance based pay:

Clearly defined objective:

...and way to achieve it:

Plenty of room for more acquisitions:

As Munger says, what you don't do is just as important (or more important) than what you do:

And of course, what's the point without free cash?

Conclusion
Well, this is just a quick first look but it is certainly pretty interesting.  It's trading at 21x current adjusted P/E and 16x free cash flow (assuming free cash is 55% of EBITDA this year), which is not a bad valuation if they continue to grow in their target range of 15-20%.

I have yet to dig into the filings, conference call transcripts and annual reports going back, but there is plenty of interesting things here to make this worth at least a closer look.  I haven't followed this company at all so I don't have a comfort level with this as much as the other companies I post about, but the fact that it came out of the outsider book and has Tiger cub shareholders (even though one of them may be on their way out) gives me more comfort than a random idea I read about on the internet.

The immediate concern, I suppose, would be to get a sense of why things are slowing so much in 2013; a year that doesn't look so bad. 

Earnings for the FY 2013 (which ended in September) should be out soon and maybe we can get some more clarity on the outlook for next year.

Other concerns are obviously how long Howley will stay on, how size may become a problem going forward etc.

As usual, if I find anything interesting to add, I will make a followup post to this.

 

A Really Great Book: The Outsiders

This is old news as this book was recommended by Warren Buffett in Berkshire Hathaway's 2012 annual report.  I knew it was going to be a great book, but it was sitting in my big pile all year until this past weekend.  Once I started reading it, I couldn't put it down.  Not surprisingly, it is a really, really good book.

I'm sure many of you have already read it, but if not, stop what you're doing right now.  Go to the library and get this, or you can order it here:  The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success (by William M. Thorndike, Jr.)

Here is the list of the unconventional CEOs (and how they did versus the S&P 500 index):

1.  Tom Murphy (Capital Cities Broadcasting):
    +19.9%/year over 29 years versus +10.1%/year for the S&P 500 index
2.  Henry Singleton (Teledyne):
    +20.3%/year over 27 years versus +8.0%/year for the S&P 500 index
3.  Bill Anders (General Dynamics)
    +23.3%/year over 17 years versus +8.9%/year for the S&P 500 index
4.  John Malone (TCI)
    +30.3%/year over 25 years (up to ATT acquisition) versus +14.3%/year for the S&P 500 index
5.  Katharine Graham (The Washington Post)
    +22.3%/year over 22 years (since IPO) versus 7.4%/year for the S&P 500 index
6.  Bill Stiritz (Ralston Purina)
    +20.0%/year over 19 years versus +14.7%/year for the S&P 500 index
7.  Dick Smith (General Cinema)
    +16.1%/year over 43 years versus +9%/year for the S&P 500 index
8.  Warren Buffett (Berkshire Hathaway)
    +20.7%/year over 46 years (through 2011) versus 9.3% for the S&P 500 index

These are amazing figures.  We financial people tend to focus on fund managers and people like Warren Buffett, but there are tremendous value creators in the business world too. 

And this lead to another thought that connects to what I always try to tell people.   If you own a business with good, rational managers, then you shouldn't worry too much about what is going on in the stock market; they will do what makes sense and increase value (without shareholders having to get in and out based on all sorts of indicators and prognostications). 

Instead of worrying about what will happen to the stock market or the economy going forward, the more rational question would be, "which companies have a lot of cash flow and can take advantage of any volatility in the market or economy going forward?  Who is going to survive and come through the other end stronger?".  If this question is taken care of, then one needn't worry about much else (except for maybe how much volatility you can stomach).

This leads to the question who the "outsiders" are today.  So far, most of the businesses that I have mentioned on this blog I would consider "outsiders".  They are very focused on shareholder value.  While the "outsiders" in the book focused on cash flow, I have tended to write about financials so the focus has been on earnings and book value per share.  But still, they tend to focus not on accounting profits and losses but on increasing intrinsic value per share.

Thorndike mentions Transdigm as a "contemporary analog for Capital Cities" and mentions Exxon Mobile as a current example of a company similar to the above list (emphasis on rational capital allocation with a 20% return hurdle).

If you asked Buffett right now which company he feels fits the bill of an outsider, he would probably tell you IBM (well, and all of the other companies he owns).   Analysts sounded pretty upset in the recent conference call and the stock took a dive.  Are the analysts too impatient? Will IBM pull through?  If IBM's problems are short term as management claims, then IBM can be a great buy today.  We have to keep in mind that analysts are under tremendous pressure.  If they like a stock and recommend it to clients, they take a lot of heat if the company doesn't perform.   When analysts are frustrated, it may be a good time to buy the stock.

Eight Years in the Making
This book took eight years to write.  They spent one year studying each CEO in detail (the author with the help of Harvard Business School students).    One semester was devoted to researching financial details of the companies (and peers) including financial reports, books, magazine articles and videos and the other was spent interviewing  analysts, employees, investors, bankers etc.

So think about that.  Eight years of hard, detailed work summed up in a single book for $27.00 (list price, which nobody pays anymore).  That's a bargain.

Anyway, I don't really do book reviews here too much but I felt compelled to write this post since this book really is that good.  This belongs on every investor's bookshelf, right next to The Intelligent Investor (The Intelligent Investor will tell you how to think about the markets, and maybe this book will tell you how to think about businesses).  I feel it's really important to understand how value is created at the business level.  The more people understand how business works and how good ones can create value, the less they will worry about the stock market or the stock price.  If people can really think about the stock they own as part of a business, then I think they will tend to do better.

Some Other Books
OK, so some other books I just finished reading:

Cable Cowboy: John Malone and the Rise of the Modern Cable Business
This books is just what it says; a business biography of John Malone and the cable business.  It's very timely to read now with the recent Charter Communications deal.  We know something is brewing here, and Malone is getting back into the business that got him started.  It's also a good read because Malone is one of the "outsiders" from the above book.  This book goes into much more detail, obviously, than the single chapter in the "Outsider" book.

Anyway, from reading this you will see how immensely rational Malone is.  It's a fun read too.  

King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone
This was also a pretty good read.  I don't have any problem with the private equity industry.  I know they are not very popular (and Buffett / Munger often takes shots at them too), but I've never really had a problem.  

Anyway, this is not just the history of Blackstone and Schwarzman, but does cover the history of the industry so it was very interesting.

Schwarzman has some issues, I suppose, with his tremendous ego and things like that, but what you realize is just how good Schwarzman really is.  You may not like the guy and may not ever want to work for him, but he is really good. 

I've spent time looking at Blackstone over the past few years and I always thought that.  Go look at the Blackstone investor presentations at their website.  They are really well done.  The earnings slides are really good too.  And when you listen to the conference calls, Schwarzman is there taking questions and answering them.  If I recall correctly, they didn't just shut down the call after an hour.

Some may say that's just Schwarzman loving the sound of his own voice or whatever, but who cares.  He is there answering questions.  It's actually a good thing for investors (and the public) when the CEO likes to talk; we can learn a lot from listening (even if you are not a Blackstone or private equity fund investor).

So anyway, I am really impressed with Schwarzman and Blackstone but don't own any stock.  Why?  I was going to make a post about that (and still might eventually), but the short answer is that I just think they are getting too big for my taste.

I know that is a common criticism and Schwarzman addresses it in the presentations; they have continued to do well despite their size. Too, they grow by adding strategies and products so it's not like their private equity business is ever expanding.

A lot of the growth is from new business lines, like real estate and hedge funds (or fund of funds).  

But still, when you look at the presentations of the big, listed private equity firms, their AUMs are just exploding to the upside.  It makes you wonder how they will make high returns with so much capital sloshing around in the industry (even if they are across different strategies).

I do understand that allocations to alternative investments are rising for a reason, and this may not be a fad but a permanent reallocation similar to what happened when institutions shifted allocations into equities decades ago (the reallocation to equities was permanent and not a one-time event).

But still, when I see the trajectory of the AUM trends in ALL of these alternative managers, it makes me nervous. 

Anyway, again, maybe that's a topic for another post.  But for now, I just wanted to say that I enjoyed this book.  I think there is something to learn from these guys for any serious investor.

Liberty Media Investor Day 2013

So Liberty Media (LMCA) had their investor day last week.  I wasn't there but the investor day webcast is available with a slide presentation at the LMCA website.   

There was some fun stuff in the beginning (with a disturbing slide of Greg Maffei doing some sort of dance) and then Maffei (LMCA), Meyer (Sirius XM), Rutledge (Charter) and Rapino (Live Nation) did presentations on their businesses.

Anyway, I will cut and paste a whole bunch of stuff from the presentation as it's easier to do that than to type stuff up myself.

This will be sort of a summary, but not a complete summary.  This is sort of a note to myself so I will add thoughts along the way.  Maybe it will be helpful for people who don't want to sit down for two hours to listen to the webcast. 

Those interested in LMCA should at least go look at the slides (much of them are here, but many more in the original presentation) and if you have time, listen to the presentations.  They are really well done, and the Q&A afterwards is very interesting. 

John Malone is one of the legendary people in business and he is always worth listening to.  You can learn a lot about many things by listening to him.  Just like you learn a lot about banking by listening to Jamie Dimon and learn a lot about everything from listening to Buffett, you learn a lot about cable, media / entertainment from listening to Malone.

Anyway, here is one of the 'fun' section slides from the presentation:

Non-New Yorkers might not recognize the buildings in this photo, but that's the Time Warner Center in New York City.  Maffei was talking about a fictional radio station on Sirius XM (called Malone's Melodies).  The tune playing is "Time Is On My Side", so you know they really want to do this deal.

News

LMCA did a series of deals to raise some cash (that was used to pay down margin debt).  LMCA continues to repurchase shares.  As we'll see later, they have already bought back more than half the shares in the recent past.  The repurchase of 5.2% of LMCA from Comcast in a tax-free exchange was priced at $132/share.  LMCA still has $327 million in repurchase authorization after this deal (details of this deal are in the presentation slides).
The sale of SIRI shares back to SIRI also comes tax efficiently as this was some of the high basis stock that LMCA owns and effectively gets dividend treatment for tax purposes.   

The convertible bond deal is a tax efficient way to lock in some low funding rates for the long term (10 years).

As a result, LMCA has been able to pay down much of the margin debt they took on when they bought Charter.  Maffei used the term "reload the gun" to describe what these transactions did.  Those words should excite people who are looking for LMCA to do more deals.   Well, maybe they are getting ready for Time Warner Cable.

LMCA is very shareholder friendly (we already knew that), but this chart is incredible.  They've bought back more than half of their shares since 2008, and they still have plenty of liquidity (borrowing capacity, high basis SIRI shares etc...).

Stock Price Performance

LMCA share price performance has been amazing too, and recent performance is not just a recovery from the crisis lows.  The CAGR is +36%/year since 2006, so that includes the crisis.

Sirius XM (SIRI)
Jim Meyer made a presentation about SIRI which I thought was very interesting.  He addresses some of the questions that critics raise.

Of course, LMCA bought SIRI as a distressed situation and did very well with it, but Malone sees a lot more growth ahead for SIRI.

One of the issues is competition from internet radio, like Pandora and music services like Spotify.  Meyer points out that SIRI is not a music company.  SIRI does music, talk and sports:

Also, with respect to competition from internet streaming services, Meyer points out that the big competitor out there is still terrestrial radio:

The following charts show the superior earnings model versus the competition:

Growth
The following charts show subscriber, revenue and EBITDA growth:

Increasing Margins

Meyer said that SIRI can safely get to 40%+ EBITDA margins at maturity.  He said this is doable due to the scalability of the business.

But at the end of the day, what's really important is free cash:

and free cash per share:

He said he is asked what he values more; subscriber growth, revenue or EBITDA?  He said "yes" to all but free cash flow per share growth is most important.

Growth is linked to new auto sales, obviously, and here's the trend and forecast (auto industry forecast).  SIRI has been increasing share in new auto sales. 

What's interesting is that even if new auto sales flatten out, SIRI can still grow subscribers because every new auto sale is a potential new subscriber (assuming the new car buyer didn't have it before; otherwise I suppose a driver just replaces a car so subscriber count won't change).

Anyway, SIRI did some work on this and shows the growth potential based on projected new car sales:

Meyer said that they are very comfortable that they will reach more than 100 million enabled vehicles by 2018 (enabled vehicles is not the same as number of subscribers, but shows the potential).

Their balance sheet looks much better now than before at 2.7x leverage (versus 3.5x target):

The other big growth area is used cars.  The used car market is 3x larger than the new car market and this area has a lot of potential.  Also, connected vehicle services (telematics) is another area of growth potential that Meyer talked about. 

As Malone mentioned in the Q&A later, he sees a lot more growth to come at SIRI.

Charter Communications (CHTR) 
Tom Rutledge did a presentation on CHTR.  This is actually a pretty exciting situation, I think.  There is a lot more on the topic in the Q&A where Malone talks a lot about the history of cable and what he sees happening there going forward.

One of the reasons why I got interested in CHTR and LMCA (I have owned LMCA and DISCA in the past but haven't followed them too much recently until early this year) again is because I thought that the industry was coming to some big inflection point.  For many years, cable companies just kept growing by adding subscribers.  They were making so much money and growing so much that they didn't really care what they paid for content as the subscribers paid for them.  That's why I was always a fan of content; I've owned Disney and CBS in the past for that reason.  I figured content providers will always get paid regardless of what happens in the distribution world.  For all I care, the phone, cable and satellite companies can fight it out and destroy each other, but they will all still have to pay high fees to ESPN.  So as a Disney shareholder, I was indifferent to what happened in the pipe wars.  Who cares who won.  They will all just have to pay more to get more content to compete even more.

Then cable got saturated (well, it has been saturated for a while) and stopped growing and then phone companies came in with video offerings, and of course satellite companies continued to take share away from cable.  So, all of a sudden, with distributors unable to grow (due to saturation), and prices of content continuing to go up and customer cable bills rising, new alternatives pop up, like Netflix, Hulu, Youtube or whatever else.

Distribution companies start wondering why they are paying so much money to content providers when the same content can sometimes be viewed elsewhere for free.

In any case, I don't really understand the media business that much, but all of this stuff was the impression I was getting.  The industry seemed really ripe for a change.  Business as usual just wasn't going to work anymore.

And then LMCA takes a big stake in CHTR.  So for me, this deal coincided with my feeling that something is happening in the industry, or at least something is about to happen.  At first, I wasn't sure how the industry can change.  I thought, like everybody else, that cable was under pressure from phone companies and satellite providers, and increasingly from over-the-top TV.  I did understand that their ownership of the last mile into people's homes was a big asset but it wasn't really clear to me how the cable companies with their video package (which Malone himself said will be obsolete in five years or less) will compete with the over-the-top guys like Netflix.

Now I think I understand this a lot better what can happen.

Anyway, let's get back to the CHTR presentation where Rutledge explains why CHTR is such a great opportunity.

CHTR History
Rutledge started by explaining the history of CHTR.  It was founded by Paul Allen.  They assembled a big system by paying very high prices and spent a lot of money creating a state-of-the-art network.  Because of the high prices they paid and poor management, they went bankrupt.  They then had to cut cost where they shouldn't have leading to poor service etc.  As a result of this, CHTR has the lowest product penetration.

So a lot of the growth story here is just bringing things back up to where they should be in terms of product penetration.  Here is a slide that shows the potential for CHTR:



Also, FiOS competes in only 4% of CHTR's markets.  As for satellite competition, CHTR's edge is that they have two-way connectivity versus one-way for satellite.

Malone said a while ago in an interview that he thinks CHTR can get competitive high speed internet at a much lower cost than others (fiber optics etc.).  Here is a slide that shows how this can happen:

This is the other story for CHTR.  By going all digital, they free up a lot of broadband on their cables that will allow them to increase speed / capacity for high speed internet and other things.

Rutledge says that capex is high now due to spending related to going all digital, but once that is done capital intensity of the business should go down.  Along with increasing revenues, this should boost EBITDA going forward.

There are a lot more details in the presentation, but the CHTR story is pretty simple; reversing the years of undermanagement to boost revenues, going all digital, decreasing capex needs going forward and operating leverage from that.

Live Nation (LYV)
Frankly, Live Nation has never been on my radar.   I always thought of the concert industry has one that makes money from the occasional Rolling Stones fairwell tours, Kiss reunion tours and things like that.  I think for many years (not that I follow this stuff) the highest grossing concert tours tended to be these old, boomer-generation rock bands.  So Michael Rapino's presentation was an eye-opener for me.

Growth
First of all, I was wrong about the concert industry.  Who knew it was a growth business?  I don't go to concerts anymore, so I guess there would have been no way for me to know anyway.  But here it is:

And look at 2013 growth by region:

...and for ignorant people like me who think only U2 or the Stones can sell tickets, check this out:

I don't know if I should be proud or embarrassed to say that I have no idea who these people are.  OK, I know Fleetwood Mac, Depeche Mode, Kid Rock and Beyonce.  Not bad, I guess...

So why is it growing so much?  What's different now than before?  This is an interesting thing that Rapino said.  He explained that concerts these days are driven by fan demand.  In the past, concerts have been driven largely by record labels. It was the record distribution model that included concerts as promotional events to sell records. 

Now concert demand is driven by fans, and how this is done is very interesting:  It is done through social media like Youtube, Facebook etc.

Check out this slide:

So we see that only 17% of the Rihanna concerts take place in the world excluding North America and Western Europe, but 56% of her fans on Facebook and 40% on Youtube are from this area. 

If you ever wonder who benefits or makes money from Youtube or Facebook, well, now we can think about LYV.

The live concert business is not a particularly high margin business.  So that may be another reason why I wasn't too interested in LYV before, but the LYV business model is actually to use the live concert business to drive the other high margin businesses:

They are also increasing business through mobile (another question people keep asking; how people make money off of mobile), and their secondary ticket sales business looks pretty interesting.  There is a bunch of stuff in the presentation that you should look at if you're interested.

But the bottom line is that all of this is leading to some interesting growth:

 

Anyway, I've never looked at LYV in detail so I don't know where all the above numbers lead in terms of valuation, but there seems to be no doubt that it is growing at a decent rate and there seems to be some more growth opportunities in the future.

So that's it on the business presentations. 

And then there was what many may consider the most interesting part of the day.

Q&A Session
Malone and Maffei took questions from investors and there were some interesting discussions on various topics.  Anyway, these are from my messy notes so not word-for-word or anything.

Why continue to keep owning SIRI? Why not spin it off?
They like SIRI.  LMCA has no big free cash generating assets.  SIRI is the only big one.  It's ability to generate capital for LMCA to use is interesting.

SIRI is also a work in progress.  They feel they can still help SIRI. 

Maffei mentioned that historically, LMCA has spun off assets when the value of an asset was not recognized by the market, or when a business has reached an apogee.  They think neither is the case at SIRI.  The value of SIRI is well recognized inside of LMCA now and there is much more they can do there.  There is still "a lot of upside".

Malone says CHTR will require capital (Time Warner?).  SIRI will give them the financial flexibility to "chase a few more rabbits".

Malone also said that there are still some synergies in the music business that hasn't been exploited (and LMCA can help SIRI with that).

Is there more tension between programmers and distributors now?  Relationship more complex, more aggression than in the past?  Is this a reason for consolidating?
Malone said that programmers and distributors have had good relations for years.  It was all about who could create economic value.   The over-the-top phenomena is creating unusual tension.  TV everywhere would create value for everyone.   Distributors and content providers still have huge monetization systems to defend.  They will eventually realize that.  Consolidation will make it easier.  Fewer rational players works better than more, but is is not the primary reason to consolidate.

Dilution at CHTR in case of Time Warner deal
LMCA would like to keep interest above 25% for future flexibility.  LMCA would purchase more CHTR to keep interest above that level to offset dilution, for governmental reasons.  He explained later that the Investment Company Act makes a 25%-owned asset a good asset, and one under 25% a bad asset.  I think he meant that under 25%, the ICA would deem it a passive investor interest or an investment security so would make LMCA an investment company, whereas owning more than 25% would make it an operating subsidiary (so wouldn't make LMCA an investment company).

Competition to Cable
Malone feels that the long term competitive position of cable is good.  Increasing digitization of video will free up bandwidth,and increase speed and capacity of internet delivery.  Cable has a marginal cost advantage (a tremendous advantage) for base network.

He mentioned that DT (Deutsch Telecom) put in a volume cap.  DT provided content is not included in the volume cap but non-DT content is.  The regulators are currently digesting this so don't know what will happen.

Malone mentioned that eventually terrestrial carriers will have to price traffic based on volume.  The current model is unsustainable as revenue and pricing won't reflect capital pressures of the providers.

Over-the-top content can be bundled with broadband and when that starts to happen, cable can clawback share from satellite.  Cable market share will grow because of services bundled.  (Somewhere he said that cable will get at or equal to fiberoptics in terms of speed).

Intrinsic Value versus Price of the Parts
Someone asked him how he viewed the prices of LMCA holdings versus intrinsic value.

Malone said that he has always been a leveraged free cash flow investor, so he discounts the free cash flow at whatever interest rate they can fund at.  If you lengthen the maturity and fund at current levels, he says that the "multiples look low to me".

Importance of Content?  Does CHTR need more content?  Comcast bought NBC
Malone said that the control of content is an important determinant of market share.  He then went on to explain the evolution of the cable business.

Cable in the early days was highly balkanized.  There was no ubiquity and they didn't compete with each other.  Back then, the opportunity for cooperation, scale and uqiquity was obvious.

TCI did one acquisition a week for ten years.

As an industry, they got together to cooperate.  They organized joint ventures.  For example, in technology they created the MPEG video compression, coaxial cable architecture etc...  In content, they created Discovery, BET, Telemundo etc...  The industry created 23 or 24 programming vehicles that the cable industry collectively invested in.

Ted Turner was an entrepreneur that got the support of the industry.  TCI was a founding investor in Fox News.

The industry solved the balkanization and scale problem by joint effort.  Malone says it can be done again.  Hulu can be syndicated, or something created from scratch.

He mentioned Comcast, as big as it is, can't buy national level content.  It's not big enough. You have to be pretty big to get content for TV everywhere.

So this cable industry inability to buy or create content has benefitted Netflix. They buy nationally, distribute ubiquitously and their local distribution is incrementally free.  This is not a situation that can persist indefinitely.

Cable industry is in the need of organizational development.

HBO transformed the cable industry and "made us all rich".  If there is an equivalent to that, of course they would be more enthusiastic in investing in the business.  M&A and industry cooperation go hand-in-hand. 

(At some point the Microsoft purchase of Comcast shares was mentioned, and Maffei was actually at Microsoft at the time and did the deal; so we know he knows the business)

Investment opportunities?  Which Liberty entity is the cheapest?
Malone said international (non-U.S.) is where the opportunity is now.  He said don't put all your eggs in the U.S. basket.  There are some rabbits outside of the U.S., but obviously he can't say what looks good.

Mobility?
75% of mobility is is wifi (and rising). The implication is that mobile traffic will end up on cable (wifi -> cable connection) and not cellular network.

With over-the-top and TV everywhere why do consumers need aggregation interface and pay economic rent?
Netflix, Hulu and other streaming models offer content without economic rent.
Malone said that the answer to that is that they don't need it.
Why did HBO come into existence?  Why didn't Hollywood sell directly to cable operators?  They couldn't work together.  This created opportunity for HBO to get scale.  Once they had scale, they didn't need all the studios so changed pricing power.

Over the top guys will get content through scale; original and unique content.  Netflix has enough scale to get exclusion and original content.

Netflix
Netflix started as a library of old content.  They built a business on low distribution cost (almost free); heavily subsidized U.S. Postal Service.  Netflix migrated to streaming service.  They have gained scale and ubiquity of presence.   The cable industry has been very slow and that gave a window of opportunity to the over-the-top guys.

With network neutrality (free incremental distribution cost) and scale, they have "quite a good business".

A year ago NFLX was written off by many, but it's good that NFLX survived.  If it was bought by someone with deep pockets it would've been more dangerous;  someone with infinite capacity to underwrite their strategy of buying exclusive content.

NFLX has scale and uniqueness to do well now   (but as he said before, this is not sustainable).

So that's about it.

My Thoughts
I do like LMCA and CHTR; I find them very interesting situations (SIRI and LYV don't look too bad either).  As far as valuation is concerned, it seems like most of LMCA value is driven by the large listed holdings.  The multiples look high, particularly on the big SIRI position, but the growth rates are pretty high too.   If they keep growing subscribers and their margins get up to over 40% (EBITDA margins) as they say, it can be pretty interesting.

On the other hand, for an entity like LMCA at this point in time, I tend to think the bigger question is what LMCA does with the liquidity offered by SIRI over time.

I would tend not to look at it like, "what is SIRI actually worth and how much per LMCA share is that?".  My question would be more like, as LMCA liquidates SIRI over time (via SIRI buybacks and maybe other transactions), what do they invest in next?

LMCA is obviously holding SIRI for the cash generation ability so more interesting to me is what they invest in with the cash from SIRI rather than what SIRI is worth.

This is not to say that it doesn't matter what SIRI is worth.   Malone said that SIRI gives them the flexibility to "chase a few more rabbits".  I'm sort of more interested in the "rabbits" than satellite radio.

Still, it's good to know that Malone thinks there is still a lot of upside there even as they use SIRI as a source of liquidity. 

The Market is Fairly Valued!

So this valuation thing has been nagging at me all weekend so I just decided to take a quick look at something.  Since the S&P 500 index is too big and unwieldy and I don't have access to data, I just decided to take a look at the Dow.  Last time I looked at margins (to see if margins are too high and unsustainable), I picked a bunch of big, blue chip names that popped into my head.  

This time, I wanted to be more objective and not do that.   So I figured why not look at the Dow Jones Industrial Average components?  It's not a great index as it's price weighted (which is ridiculous), but it has been highly correlated to the S&P 500 index over long periods of time anyway.

So I just googled Dow P/E ratio and up popped this page from the Wall Street Journal:

I almost fell out of my chair.  14x P/E for the Dow 30?!  No way.  I suspected this had to do with the price-weighting of the Dow (again, how ridiculous and arbitrary!) so I punched in some numbers on the spreadsheet and sure enough, if you just add up the prices of the component stocks and divide by the sum of the EPS, you get a P/E ratio of around 14x. 

But nobody is going to buy that as representative of a broad market index valuation. 

So I calculated the simple average of the P/E ratios of each component stock.  I used the last twelve months EPS of each component stock as listed in the recent Barron's.

Last Twelve Months, Current and Next Year P/E Ratios

Sure enough, if you calculate a simple average of each P/E ratio, it comes out to 18.5x; a bit on the high side and certainly not cheap.

Just out of curiousity, I typed in the current year analyst estimates for each component stock (from Yahoo Finance).  We all know analyst estimates can be wildy inaccurate.  But since we are already almost done with the current year, I figure the December 2013 year-end estimate can't be all that bad.

Using current year estimates, the P/E ratio of the Dow 30 (using a simple average) comes to 15.11x.  That's totally reasonable and I would consider that 'fair' for sure.   The Dow is not expensive at all.  Sure, 3Q and 4Q can come in lower than recent estimates but since 1Q and 2Q is already in the can, it can't change this figure too much unless we have a disastrous 3Q and 4Q.

The last column on the spreadsheet is certainly questionable.  It's the analyst estimate for December 2014 year earnings.  Earnings estimates for a year that hasn't started yet can be off by a lot depending on how the year develops. 

But that figure, for what it's worth, comes in at 13.74x earnings. 

Conclusion
I just took a quick look at the inside of an index to see where the overvaluation might be.  The macro charts seem to show expensive stocks and above trend earnings but for me the problem is that it just doesn't feel like it.  Other than a few pockets of mania, I just don't get the sense that people are rushing into stocks.   The economy too is slow growing so it doesn't feel like corporate earnings are above trend (I know they are, but it just doesn't feel like a corporate earnings bubble).  I know interest rates are low so that boosts corporate profits as it lowers interest expense, but it feels more like corporations are suffering from low rates as they are flush with liquidity.

Yes, the Fed pump priming (and others around the world) and fiscal deficit is highly stimulative, so earnings probably are higher than they would otherwise be.

So it's a little strange to me.  People seem to hate stocks (rushing into alternative assets), and yet valuations are a little bubbly.

Having done this exercise, I can see how the market can be considered fairly valued.  If you look down the list at each component stock, each one seems to me more or less reasonable.  Not cheap, but not expensive either, except for maybe Nike, Home Depot and Visa.

Is this a picture of mania in the stock market?  To me not at all.  Coca-Cola at 40-50x P/E was indicative of something, but I don't see that sort of thing in the above table.

Sure, maybe corporate earnings come down.  But if it comes down from current year estimate levels, the market may not be as wildy overvalued as some charts seem to indicate.

I just throw this out there as a thought, not an answer.