The following note provides a high-level view of how we find investment ideas. It should not be construed as investment advice. Please refer to Important Disclosure Information at the end of this note.
John Malone is arguably one of the great capital allocators of our time. To learn more, I highly recommend reading The Outsiders by William Thorndike
So when a member of the Liberty group (i.e., a Malone company) announces a transaction, we pay attention.
Not that long ago, Liberty Global, which is primarily a European cable company, created a tracking stock, Liberty Latin American and Caribbean Group or LILAC, to track the underlying value of its small yet rapidly growing Chile and Puerto Rico-based cable business.
Investors in Liberty Global had a choice. They could own the parent company which was a pure Europe-based cable company or they could own LILAC.
The thesis on LILAC, as presented by management, was relatively straightforward. LILAC would be a horizontal acquisition platform to consolidate the fragmented LatAm cable industry. If management were able to deliver, then LILAC shares could be worth more in a few years.
So what happened?
Right out of the gate LILAC shares began trading poorly. Many reasons were cited for this poor performance:
- Typical spinoff dynamics: Indiscriminate selling by large shareholders who were unable or unwilling to own a small "speculative" growth company.
- Unattractive cable footprint: Puerto Rico, which is bankrupt, and Chile, a commodity dependent economy.
- Concerns with LILAC's ability to fund its acquisition plans: LILAC isn’t generating much after-tax cash flow and the LatAm debt markets are not as deep or liquid as the US market, so access to capital for acquisitions could be hard to come by.
So we were left with an orphan stock that no one wanted to own.
Then recently, Liberty Global announced the acquisition of Cable & Wireless Communications (CWC) a Caribbean cable company which is also a Malone company. As is typical with Malone deals, the transaction wasn't straightforward. Confused market participants voted with their feet leading to indiscriminate selling of both Liberty Global and LILAC shares.
The way the deal is structured, Liberty Global, the European parent business, and not LILAC, the Latin American business, would be buying CWC.
Liberty Global shareholders perceived the deal as a re-entry of the European parent company into LatAm - not what they expected. LILAC shareholders were just plain confused.
Riding Malone's Coattails
As we sharpen our pencils, we find a lot to like about the deal.
- The deal structure appears to signal to the market that "big brother" will be there to underwrite LILAC's acquisition funding needs in LatAm, removing one market concern.
- The combined company will have some scale and much needed cash flows, removing another concern.
- The combined company will diversify away from Puerto Rico and Chile.
- While not obvious, the transaction terms favor Malone owning more LILAC shares while other market participants have an incentive to own less LILAC shares.
- Finally, if management is able to deliver on their target of double digits cash flow growth over the medium term, then LILAC shares could be worth much more in a few years.
Today, market participants don't fully appreciate the deal. Perhaps over time they will?
Important Disclosure Information
At the time this report was submitted for publication, the principals and clients of Burr Capital LLC owned securities issued by LiLAC (Ticker: LILAK), Liberty Global (LILAK), Liberty Media (LMCK), Liberty Ventures (LVNTA).
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