By Eric Jackson
10/28/08 - 11:17 AM EDT
About 10 days ago, Liberty Media (LINTA Quote - Cramer on LINTA - Stock Picks) Chairman John Malone sold $18 million worth of stock in Liberty Global (LBTYA Quote - Cramer on LBTYA - Stock Picks), a video and broadband service provider catering to Japan, Europe and Chile. Although Liberty Global's stock price is down 55% in the last month, you should follow his lead and get out now ahead of earnings, which will be announced in early November.
Malone's multiple Liberty-related entities (e.g., Liberty Communications, Liberty Global, Discovery Communications (DISCA Quote - Cramer on DISCA - Stock Picks)) have one thing in common: a love for opaque corporate structures with multiple classes of voting shares. In early 2007, before the words "CDS" and "subprime" had entered our collective lexicon, such complexity mattered little compared with high-growth businesses fueled by acquisitions. Liberty Global complied with this preference and its shares peaked at $44 in July 2007. However, there's been a slow descent since then until this month when the stock has fallen off a cliff. They traded yesterday under $13.
Malone's large stock sales this month are not unique for corporate chiefs these days. Sumner Redstone of Viacom (VIA Quote - Cramer on VIA - Stock Picks) and CBS (CBS Quote - Cramer on CBS - Stock Picks) and Aubrey McClendon of Chesapeake (CHK Quote - Cramer on CHK - Stock Picks) both had to unload large amounts of shares in the face of margin calls a few weeks ago. Malone gave no explanation for his sale, although he presumably faced similar pressures, considering that Liberty Global had spent $1.621 billion repurchasing its shares in the first six months of this year at weighted prices between $34.37 and $35.55.
That cash spent on share repurchases at triple the current market price could come back to harm Liberty Global in the coming quarters, as it only had $1.2 billion in cash at the end of June and just under $20 billion in debt.
Liberty Global is essentially a Comcast (CMCSA Quote - Cramer on CMCSA - Stock Picks)for non-U.S. markets. It delivers video and Internet via broadband instead of traditional cable. It derives no revenue from subscribers in the U.S.; its customers are principally in Japan, Western and Eastern Europe, Chile and Australia. In the first half of 2008, when the notion of emerging markets being decoupled from a flagging U.S. economy was in vogue, such a portfolio would be envious. Now, it appears all these countries are in for a longer recession than the U.S.
Aside from country recession risk, Liberty Global is exposed to currency risk. Virtually all the currencies tied to Liberty Global's customers have weakened significantly between June 30 and Sept. 30. In October, the pace has dramatically increased. Hungary's forint is down 30% this month vs. the dollar, the Chilean peso is down 22.5%, and the Aussie dollar is down 31%. These three countries counted for 16.4% of Liberty Global's total revenue last quarter.
Liberty Global does have extensive derivatives to mitigate this currency fluctuation risk. And some of its debt held in these currencies will surely benefit from the strengthening of the dollar in the past few months. However, the explanations given in the most recent 10-Q make don't make clear the extent to which the company is protected. We will probably have to wait for a more complete explanation during the company's next analysts' call. What is clear is that many companies that believed they were protected from currency risk have experienced deep pain in the last few weeks (such as Citic Pacific's $2 billion loss on a wrong bet against the Aussie dollar).
Liberty Global's assets also include stakes it owns in Sumitomo and News Corp. (NWS Quote - Cramer on NWS - Stock Picks). These investments were worth $682 million at the end of June using fair value accounting. Both companies dropped 25% in the third quarter, and more in October.
When you stack up Liberty Global vs. Comcast, Liberty Global's valuation still appears too rich. Liberty Global's trailing price-to-earnings ratio is 98, with a forward P/E of 26. That is starkly higher than Comcast's trailing P/E of 16.8 and forward P/E of 13. Liberty Global also has a much lower operating margin, return on assets, and return on equity compared to Comcast. Additionally, Liberty Global's debt-to-equity ratio stands at 3.84 vs. 0.81 for Comcast.
We have seen highly levered companies with high P/E ratios -- such as Las Vegas Sands (LVS Quote - Cramer on LVS - Stock Picks) and MGM (MGM Quote - Cramer on MGM - Stock Picks) -- punished in the last few weeks, even though they had both experienced significant sell-offs over the last eight months. (Las Vegas Sands' debt-to-equity ratio is only slightly larger than Liberty Global's.) Liberty Global needs to win back the trust of shareholders by simplifying its corporate structure and fully explaining the extent of its currency exposure in next month's analyst call. Until then, investors should follow John Malone's lead and stay away from Liberty Global.
At the time of publication, Jackson's portfolio was short Liberty Global, CBS and News Corp.
Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.
Tuesday, October 28, 2008