Description

Liberty Latin America and Caribbean

Lilac is a fast growing cable asset in Latin America and the Caribbean which could potentially double in the next 4 years.

Background:

Lilac was spun off as a tracking stock from Liberty Global earlier this year. Liberty Global management wanted to execute a roll up of cable assets in Latin America as they had previously done in Europe. By spinning off their Latin American assets as a tracking stock, this would give the management focus as well as a currency with which to potentially execute acquisitions. The tracker was initially focused on assets that they owned in Chile and Puerto Rico. A couple of weeks ago, Lilac announced the acquisition of Cable & Wireless, a combination of cable and mobile assets in the Caribbean. This sets the foundation for a potential roll up of cable and complementary mobile assets in the Caribbean and North Latin American region. On a standalone basis assuming no incremental M&A, the company can earn close to $6 in FCF / share in 2020 leading to a more than double in the stock price.

Business Description:

The 3 main profit drivers of the company are the former Cable & Wireless assets, including Columbus Communications (60% of EBITDA), the Chile assets (30% of EBITDA), and the Puerto Rican assets (10% of EBITDA). Please note that EBITDA contribution percentages stated are on a proportionate basis.

Cable & Wireless (60% of EBITDA)

Historically, cable & wireless was a mobile operator which also had a B2B and consumer presence driven by a primarily copper infrastructure with their geographical presence driven by a presence in the Caribbean as well as Panama. In November of last year, Cable & Wireless decided to acquire Columbus Networks, a Caribbean cable operator owned by Canadian entrepreneurs and John Malone. Cable & Wireless paid 12.3x EBITDA for Columbus before any synergies for a cable asset which was growing EBITDA at 15% a year with a presence in predominantly Caribbean countries such as Trinidad, Jamaica, and Barbados. What was interesting about the combination is this would effectively give the combined entity a quad play in many of the countries in which they competed. It is very valuable to be able to have a mobile and fixed infrastructure presence as it reduces churn and creates an incremental, potentially low cost position. When you think about a mobile only player (such as Digicel in the Caribbean) trying to compete against a fixed-mobile operator, the mobile only player should have structurally higher costs as they have to depend on expensive spectrum to transmit data whereas the combined hybrid player can use a fixed infrastructure presence to offload bits via Wifi at a much lower cost. In markets where the combined Cable & Wireless did not have a fixed infrastructure presence, they have started to selectively deploy the cable infrastructure in these markets being able to leverage the competitive video product that Columbus networks had in the form of their Flow brand. This gives them access to a variety of video programming at much lower cost than they could have obtained themselves (given the scale of Columbus Networks). Cable & Wireless has continued the differentiation of their video product through exclusive rights to key sports content such as the Premier League and additional sports and high definition content. When you compare cable assets in the Caribbean region to the US or Europe there are a couple of key factors that make the Caribbean substantially more attractive: you have substantially lower penetration of services (around 40% penetration in the Caribbean) providing for a much higher and longer growth runway and the competitive landscape is much more benign especially with broadband given the very limited fiber overbuild. In addition, compared to the US, you don’t have the cost inflation issues and given broadband adoption is at a much earlier stage of adoption, a potential OTT threat is more distant. In addition to the consumer platform, the combination of Cable & Wireless and Columbus Networks strengthened the B2B firepower of the combined entity. Given the increased reach of the combined entity into the region as well as critical subsea fiber and backhaul, this combination creates a more compelling telco supplier for enterprises with multiple offices in multiple regions. While Cable & Wireless had identified $125 million in synergies from a Columbus Networks combination, Liberty Global believes it can harvest additional synergies both from the Columbus Networks integration as well as from the combination of Lilac with CWC. Given Liberty Global’s track record in harvesting synergies in previous acquisitions, the subscale nature of Lilac, and the vast scale of Liberty Global, there should be some level of incremental synergy from items such as the rationalization of overlapping corporate costs and increased purchasing power leading to lower costs. Financially, the combined Cable and Wireless and Columbus have historically grown revenue high single digits and EBITDA low double digits (not including any synergies).

Chile (30% of EBITDA)

Liberty Global has had their Chilean asset for over a decade. The network is a complete hybrid fiber coaxial network which can attain broadband speeds comparable to high speed cable networks in the US and Europe (if you look at the top marketed speeds on their web site, they advertise speeds of 120Mb/s). Similar to the Caribbean, you have similar dynamics in terms of low penetration of broadband in the country as well as extremely benign competitive dynamics given extremely limited fiber overbuild as well as a geographic density of homes more similar to the US than Europe making it more difficult for an overbuilder. Liberty Global is about to deploy their Horizon box in Chile which offers an advanced user interface making it more easy to access features such as on-demand and search. VTR has been growing top line and EBITDA mid to high single digits driven by increased broadband and video subs as well as increased pricing.

Puerto Rico (10% of EBITDA)

Lilac owns 60% of Puerto Rico while the private equity firm Searchlight owns the other 40%. This has similar dynamics to the other two regions described in terms of benign competitive dynamics with Claro (America Movil) as the only DSL based competitor on broadband with additional competition from satellite players Dish and DirecTV in terms of video. Recently, this entity acquired Choice Networks in Puerto Rico completing cable consolidation in Puerto Rico and at an attractive multiple of 6.1x EBITDA including synergies. This asset has been growing high single digits helped by underlying organic growth as well as synergies from the Choice acquisition.

Financial Model

Liberty Global believes that the pro forma entity can grow EBITDA low double digits. In light of the historic growth rate of the assets, the opportunity to increase penetration and pricing (especially on broadband and pay-TV given the very low penetration in the region), the opportunity to scale the very limited B2B business in Latin America and supercharge the B2B business in the Caribbean given the increased scale and presence, as well as the opportunity to realize additional synergies, it seems that this growth could potentially be conservative. However, given the current price of the stock, it seems that even using this potentially conservative guidance can potentially yield material growth in the stock price over time.

At $5.79 FCF / share in 2020, assuming a 15x multiple gets you to a $87 stock or roughly a 24% compounded growth rate in the stock from here. The $5.79 estimate could be conservative due to incremental synergies from the Cable & Wireless transaction, more M&A in the region that is more accretive than simply buying back shares (especially due to synergies), and assuming deleverage to 3.7x Debt / EBITDA is potentially conservative given the leveragability of the assets. I don’t think this potential return has gone unnoticed. If you look at the structure of the Cable & Wireless deal John Malone and his partners seem apt to receive Lilac shares while incentivizing others not to take Lilac. If free float shareholders want Lilac stock under their recommended alternative, they get the shares at a price of $45 while Malone and his partners get the stock at a market price. In addition, instead of issuing cheap Lilac stock to acquire the whole enterprise, Liberty Global heavily used its own shares which gave the entity a 67% inter-group interest in Lilac. However, if you look at the valuation at which this was done, it is favorable to Lilac. The terms of the inter-group interest were dictated by a 95 day VWAP on the Lilac shares and a 5 day VWAP on the Liberty Global shares. Given that the Lilac shares 95 day VWAP is roughly $42 this is much more beneficial than the $37 at which the stock currently trades. It seems that Mike Fries may have been trying to limit the potential dilution to the Lilac tracker given the price. Given the limited issuance of Lilac shares, the limited trading volume of the shares, and the attractive price at which they are trading, Malone and his partners have successfully been able to substantially increase their stake in Lilac in a tax-efficient and dilution efficient fashion. Catalysts to further compounding in Lilac shares include a hard spin of the tracker in asset form as well as additional M&A. In my view both are highly likely to occur over the next couple of years.

The major risks are adverse regulation and continued depreciation of the Chilean currency. In terms of regulation, to some extent you are diversified in the Caribbean given multiple regulatory regimes governing assets in the region. Chile has historically been favorable regulatory wise and will likely continue to be one of the most investor friendly countries in Latin America. Puerto Rico is regulated in a very similar fashion to the US.

Catalyst

Catalysts to further compounding in Lilac shares include a hard spin of the tracker in asset form as well as additional M&A. In my view both are highly likely to occur over the next couple of years. Growth in free cash flow per share over time.