Liberty Global (Ticker LBTYA and LBTYK) is buying Virgin Media (Ticker VMED) in a stock and cash transaction. The terms are $17.50 in cash + 0.1928 LBTY/K + 0.2582 LBTY/A. The current deal spread is $1.10/share. Liberty is making an expansionary bet at a reasonable multiple of future free cash flows with potential future operational and financial engineering upside. We like LBTYK as a deleveraging security / cash machine, with an undemanding valuation, run by a well-regarded management team (goes without saying: John Malone involved).
*Through out this write up, we will refer to LBTYA as the “A” shares and LBTYK as the “K” shares.
Value / Post Merger Re-Rate (Arbitrage Spread + Share Class compress + Pro Forma Merger Re-rate)
Trade: 75-100 days (deal spread / share class compression, shares re-rate to pre-deal level)
Investment: 18 months
Headlines Merits stats:
~20% FCF accretive (ex price increases)
Re-Domiciling in the UK should have tremendous tax synergy
VMED holders will own 36% PF equity (26% of the voting)
$110mm operating synergy; $70mm capex synergy (these will prove to be low)
VMED has $23bb of tax shields (1/3 Net Operating Losses and 2/3 capital allowances)
$1.75bb of share repurchase/year
Fully Diluted Shares: 365mm (note: company has been blacked out from buying back stock until the proxy is filed)
LBTYA/LBTYK surprised the investment community by issuing shares (for the first time) as part of the consideration to pay for the VMED transaction. In addition, to the surprise of issuing shares, the arbitrage pressure has sent LBTYK shares to attractive levels.
CEO of Liberty sums up the merits of the deal well here: “Adding Virgin Media to our large and growing European operations is a natural extension of the value creation strategy we've been successfully using for over seven years. Virgin Media will add significant scale and a first-class management team in Europe's largest and most dynamic media and communications market. After the deal, roughly 80% of Liberty Global's revenue will come from just five attractive and strong countries - the UK, Germany, Belgium, Switzerland and the Netherlands."
What is the trade (if you believe the deal will close on terms)?
We believe VMED, LBTYA, and LBTYK are all attractive securities. But we believe there is an attractive risk/reward to buy VMED, short A shares and either buy K shares or attempt to set up the deal ratio long VMED vs short A and come out long K and Short A (sounds more confusing than it is…). The result is that pro-forma for the transaction close, we want to be positioned to benefit from the longer term de-leveraging Liberty story, capture some of the arbitrage spread, and also be set up for the share class spread to compress as pro-forma Liberty buys K shares as part of their $1.75bb/year share repurchase mandate. I am not going to present the various ratios, as it is up to the investment manager mandate; however, if you believe deal risk is low, this is highly scalable trade set up.
If you believe the deal carries any type of deal risk (vote, regulatory, etc), than being long LBTYK should work well as a stand-alone trade.
Straight re-rate trade and capture spread/cushion: Long VMED
Arbitrage: Long VMED / short 0.1928 K and short 0.2582 A
Arbitrage + Share Class + Re-Rate: Long VMED; Long K; Short A on ratio
Conservative Trade: Long K (if you believe there is deal risk)
Other: Share Class – Long K / Short A (although this relationship hasn’t worked in the past)
Feb 6: Deal Announced after speculation
March: Proxy filing (we believe the proxy review will be streamlined as the proxy was reviewed by regulators last year)
April: Shareholder vote
April/May: Deal Close (Liberty is guiding to a June close now)
After various regulatory due diligence, we don’t envision in a problematic or lengthy regulatory review, and should be proxy driven. European Commission will be filed, but should be a non-event as there is limited overlap or other competition issues such as content/production. “Fit and proper test” as seen in broadcast deals won’t apply.
Arbitrage spread closes as the transaction closes
Share class spread compression (long shot in the near term, but perhaps they collapse the shares)
K share repurchase (company has been straight forward they want to be aggressive with share repurchases and most likely buying more K shares than A shares). See slide 12 in the investor presentation for additional color.
Sale of the Company: this is not a near term event, but it is not far fetched for LBTYA/K to be sold to a large global TMT enterprise
De-leveraging and re-leveraging
Future Accretive Transactions
Multiple expansion: never count on it, but we see no reason why this business can’t trade for 9-10x EBITDA and be a security owned by growth investors
Risk / Reward:
Base Case (arb+share class+re-rate)
Longer Duration Upside Case
Probability weighted upside target is $88/share or 35% higher than current levels).
Currency always worth noting
Liberty is an M&A machine / roll-up
Levered equity although unlikely to be an issue
Europe risk – blah blah blah
This is not a complicated event-driven / catalyst trade, and various ways to express the bet that LBTYK will trade higher as the event path firms up and after the transaction closes. The VMED transaction has a low probability of a deal break, but if in the event the deal doesn’t close the arbitrageurs will be forced to cover their short shares and both classes of shares should bounce to pre-deal break levels – or 8-10% higher. LBTYK should be able to trade to ‘par’ over the next couple years producing a solid IRR as they shrink the float by $20bb.
*All numbers are approximations
I do not hold a position of employment, directorship, or consultancy with the issuer. I and/or others I advise hold a material investment in the issuer's securities.