A publicly-traded equity would be an ideal investment if i) it could be purchased at a huge discount to intrinsic value, ii) it related to a business that generates world-beater financial performance and enjoys numerous sustainable competitive advantages, iii) the business to which it relates offered an attractive free cash flow yield so that time would be the friend of the investment, iv) the managers and board of directors of the company were significant owners and skilled capital allocators, and v) there were a clear catalyst in the foreseeable future for price appreciation.  Liberty Media Corporation's Interactive Group Series A Common Stock ("LINTA") possesses all of these features.

 

(Figures in thousands, except per share figures)
				Low		High		Comments
	QVC			$13,150,000	-	$15,350,000		7.0% - 6.0% FY10 UFCF Yield
	eCommerce Businesses			772,000	-	1,150,000		Low: Cost; High: 3.0% Pro Forma UFCF Yield
	Value of Consolidated OpCo's			13,922,000	-	16,500,000
	Add: Cash			1,100,000	-	1,100,000
	Add: Equity Interest in IAC	$23.75		304,000	-	304,000
	Add: Equity Interest in Expedia	23.64		1,636,356	-	1,636,356
	Add: Equity Interest in HSN, Inc.	28.02		518,823	-	518,823
	Add: Equity Interest in IILG	12.46		207,384	-	207,384
	Add: Equity Interest in Tree.com	7.20		19,973	-	19,973
	Add: Other Non-Operating Assets			0	-	0
	Less: Debt			(6,095,000)	-	(6,095,000)
	Less: Preferred Stock			0	-	0
	Less: Non-Operating Liabilities1			(117,302)	-	(117,302)		Intergroup payable; put option liability
	Less: Non-Controlling Interests2			(663,000)	-	(663,000)		17.0x net income attributable to NCI
	Equity Value			$10,833,234	-	$13,411,234
	Series A Common Stock	568,101
	Series B Common Stock	29,250
	Effect of Dilutive Securities3	0						Outstanding options are out-of-the-money
	Effective Shares Outstanding	597,351
	Value per Share			$18.14	-	$22.45
	Margin of Safety - Equity	$10.50		42.1%	-	53.2%
	Margin of Safety - Enterprise			32.8%	-	43.3%

 

 

(1) Reflects an intergroup payable and put options written on 12.6 million shares of LINTA.  The put options have a weighted average exercise price of $17.27, which is below our estimate of LINTA's intrinsic value.  If Liberty Media Corporation takes delivery of the shares upon expiration (as opposed to settling with cash), we believe these options would actually be accretive to the per share intrinsic value of LINTA.

(2) 17.0x net income attributable to non-controlling interests, primarily i) QVC Japan (60% owned), ii) Backcountry.com (81.3% owned), and iii) Bodybuilding.com (82.9% owned).

(3) Exercisable options on Series A Common Stock and Series B Common Stock have weighted average exercise prices of $16.88 and $23.41, respectively.

 

 

 

At $10.50, LINTA is trading at only 58% of a conservative estimate of intrinsic value.  The majority of LINTA's value comes from its 100% ownership interest in QVC, a wonderful business.  LINTA also offers a very attractive free cash flow yield.  If one excludes the market value of Liberty Interactive Group's equity interests in non-consolidated companies, which generate returns for Liberty Interactive Group through price appreciation, not cash flow, LINTA's current price implies a 23.5% yield on 2009 levered free cash flow.  Additionally, levered free cash flow is almost certain to be higher in 2010.  The attractiveness of this robust cash generation is further enhanced by the impressive capital allocation skills of Liberty Media Corporation's management and board of directors.  Liberty Media Corporation's management team and board of directors, led by CEO Greg Maffei and Chairman John Malone, collectively have a significant ownership interest in the Company and have a strong track record of success.  Under these conditions, one does not necessarily need an identifiable catalyst for price appreciation to consider LINTA an attractive investment, but a powerful catalyst does in fact exist.  Liberty Media Corporation plans to consummate a split-off transaction in late 2010 or early 2011 that will convert LINTA from a tracking stock to a traditional, "asset-backed" security.  This transaction should be a meaningful positive catalyst for LINTA, because market participants seem to assign a heavy valuation discount to tracking stocks.  That "tracking stock discount" is part of the reason why this opportunity exists, and it should diminish materially as a result of the proposed split-off transaction.

 

 

(As of March, 31 2010)
	Liberty Interactive			Liberty Starz			Liberty Capital
	Entity	% Own.		Entity	% Own.		Entity	% Own.
	Backcountry.com, Inc.	81.3%		Liberty Sports Interactive, Inc.	100.0%		AOL, Inc. (NYSE: AOL)	3.0%
	Bodybuilding.com	82.9%		Starz Entertainment, LLC	100.0%		Atlanta National League Baseball Club, Inc.	100.0%
	Borba, LLC	25.0%					CenturyLink, Inc. (NYSE: CTL)	2.0%
	BUYSEASON, Inc.	100.0%					Current Group, LLC	8.0%
	Expedia, Inc. (NASDAQ: EXPE)	24.0%					Hallmark Entertainment Investments Co.	11.0%
	HSN, Inc. (NASDAQ: HSNI)	33.0%					Jingle Networks, Inc.	9.0%
	IAC/InteractiveCorp (NASDAQ: IACI)	11.0%					Kroenke Arean Company, LLC	6.5%
	Interval Leisure Group, Inc. (NASDAQ: IILG)	29.0%					Leisure Arts, Inc.	100.0%
	LOCKERZ	65.0%					Live Nation (NYSE: LYV)	14.0%
	Provide Commerce, Inc.	100.0%					MacNeil/Lehrer Productions	67.0%
	QVC, Inc.	100.0%					Mobile Streams (LSE: MOS)	16.0%
	The Right Start	100.0%					Motorola, Inc. (NYSE: MOT)	2.0%
	Tree.com (NASDAQ: TREE)	25.0%					Overture Films, LLC	100.0%
							priceline.com, Inc. (NASDAQ: PCLN)	1.0%
							SIRIUS XM (NASDAQ: SIRI)	40.0%
							Sprint Nextel Corporation (NYSE: S)	2.0%
							Starz Media, LLC	100.0%
							Time Warner Cable, Inc. (NYSE: TWC)	2.0%
							Time Warner, Inc. (NYSE: TWX)	3.0%
							TruePosition, Inc.	100.0%
							Viacom, Inc.(NYSE: VIA)	1.0%
							WFRV and WJMN Television Station, Inc.	100.0%
							Zoombak, LLC	100.0%

Liberty Media Corporation ("Liberty" or the "Company") is a holding company that owns interests in subsidiaries and other companies engaged in the video and on-line commerce, media, communications and entertainment industries.  Liberty's equity is comprised of three publicly-traded tracking stocks that are intended to track the performance of three groups of the Company's assets and liabilities, Liberty Interactive Group ("Liberty Interactive"), Liberty Starz Group ("Liberty Starz"), and Liberty Capital Group ("Liberty Capital").

A tracking stock is a type of common stock that the issuing company intends to reflect or "track" the economic performance of a particular business or "group," rather than the economic performance of the company as a whole.  While each of Liberty's tracking stock groups has separate collections of businesses, assets and liabilities attributed to it, no group is a separate legal entity, and therefore no group can own assets, issue securities or enter into legally binding agreements.  Holders of tracking stocks have no direct claim to the group's stock or assets and are not represented by separate boards of directors.  Instead, holders of tracking stock are stockholders of the parent corporation, with a single board of directors and subject to all of the risks and liabilities of the parent corporation.

Market participants seem to assign a hefty valuation discount to tracking stocks.  Sell-side estimates of tracking stock discounts generally range from 15.0% to 30.0%.  There several potential reasons for tracking stocks to trade at a discounted valuation relative to traditional, "asset-backed" equities.  First, tracking stocks do not have a direct legal claim to the assets that are attributed to them.  The degree to which this disadvantage relative to traditional, "asset-backed" equities should merit a valuation discount should be highly related to the character of the board of directors and the management team.  Second, a tracking stock structure is irrelevant from the perspective of creditors, and therefore a given tracking stock group effectively guarantees the liabilities of all of the other tracking stock groups of its parent.  This liability should result in a lower valuation.  Finally, tracking stocks are quite uncommon.  Liberty is the only company of which we are aware that has a tracking stock structure.  The unfamiliarity of market participants with tracking stock likely contributes to the valuation discounts that tracking stocks receive.

 

 

 

Liberty's 100% ownership interest in QVC accounts for the vast majority of the value of Liberty Interactive.  QVC markets and sells a wide variety of consumer products in the U.S. (67.6% of revenue), Germany (12.8%), Japan (11.8%), and the United Kingdom (7.8%) primarily through live televised shopping programs and via the Internet (25.1% of revenue).  QVC classifies its merchandise into four groups: home (47% of revenue), apparel (13%), accessories (24%) and jewelry (16%).  QVC's products are often endorsed by celebrities, designers and other well-known personalities who often join QVC's hosts to personally promote their products.

QVC's shopping program is telecast live 24 hours a day to approximately 98 million homes in the United States.  QVC Shopping Channel reaches approximately 23 million households in the United Kingdom and the Republic of Ireland and is broadcast 24 hours a day with 17 hours of live programming.  QVC's shopping network in Germany reaches approximately 38 million households throughout Germany and Austria and is broadcast live 24 hours a day.  QVC Japan, QVC's joint venture with Mitsui & Co. (60% QVC / 40% Mitsui) reaches approximately 23 million households and is broadcast live 24 hours a day.

QVC has numerous sustainable competitive advantages, phenomenal financial performance, and material growth opportunities.  It is the type of business that one could be very comfortable owning if the stock market were to shut down for 5 years.  Simply put, QVC is a great business.

QVC's sustainable competitive advantages arise from the combination of the unique nature of the television shopping network business model and factors specific to QVC.  The television shopping network business model has several sustainable competitive advantages relative to other retail business models:

Powerful Selling Techniques - A television program is a much more controllable and robust medium for selling than either a traditional retail store or an e-commerce website.  As a result, television shopping networks can much more effectively implement individual selling techniques and implement more of those techniques simultaneously than other types of retailers can.  Some examples of these techniques include:

• Scarcity - A person will desire something more when he or she perceives that it is scarce. This effect is further enhanced if the object is increasingly scarce, and even more so if it is increasingly scarce because of social demand

Television shopping networks exploit this to great effect.  Most of the items featured on television shopping networks are represented to be available in a specific quantity or for a limited period of time at a given price.  The host will often repeatedly announce that only a certain amount of the item is left and a graphic counting down the number of available items or the amount of time available to purchase the item will often be displayed.  Viewers are well aware that the decreasing availability of the item is due to demand from other viewers.  This triggers a significant psychological desire to purchase the product.

• Social Proof - One of the means the human brain uses to determine a course of action is to find out what other similarly situated people are doing. This is known as social proof. People will weigh social proof particularly heavily in situations where uncertainty is present.

Social proof is used in television shopping programs in three primary ways.  First, television shopping programs frequently air live phone conversations between the host and a viewer who owns a given product and has a favorable opinion on it.  Second, announcements or graphics related to the diminishing quantities of a given product act as social proof by demonstrating that other viewers are purchasing the product en masse.  Finally, the hosts are generally selected based on being similar in some respects to the typical viewer.  As a result, a host's favorable comments about a given product can act as a social proof.  Combining these forms of social proof with the enhanced uncertainty created by a scarcity-influenced purchasing decision creates a powerful effect.

• Liking - People are much more likely to purchase something if they like the person who is selling it. Television shopping networks get their viewers to like the program hosts. Some viewers even refer to the hosts as their "friends." Many viewers watch television shopping networks because they are lonely and the hosts provide them a sense of companionship. Although somewhat sad, you don't have to watch a television shopping network for too long before a woman calls in and happens to mention that her husband recently passed away. In our experience, this happens much more frequently than could be explained by chance. We believe this is a reflection of the success television shopping networks have achieved in getting their viewers to consider the hosts friends and companions.

So how do television shopping networks get their viewers to like their hosts?  First, they choose hosts that are on the attractive side of similar-looking to their core viewer.  People are more likely to like other people who are attractive and similar-looking to themselves.  Second, over time the hosts become familiar to the viewers.  Familiarity subconsciously enhances liking.

Television shopping networks also use celebrities to sell merchandise to take advantage of liking.  If viewers like a certain celebrity who is selling merchandise on a given network, the viewers are more likely to purchase that merchandise.  While other types of retailers can exploit the same phenomenon by offering celebrity-endorsed products, television shopping networks can offer a much richer "interaction" with a celebrity to a much greater number of customers by having a celebrity appear on a program than a traditional retailer ever could by having a celebrity appear at a single store.

• Repetition - Television shopping networks tend to have subtly repetitive sales pitches. A host will demonstrate a product one way using certain language and then will basically convey the same message several more times with slightly different demonstrations and language. Research has shown that repetition done in this way delivers two benefits. First, the viewer has an experience more similar to a direct product experience than a visual advertisement. Second, the viewers perceived value of the product increases as she internalizes all the different ways the product could be used.

• Demonstration - Television shopping networks can more effectively demonstrate most products than any other form of retail. While physical retailers can hold in-store demonstrations that are similar to the product demonstrations conducted by television shopping networks, such demonstrations reach a far, far smaller number of customers and are therefore much less cost effective.

• Authority - People are more likely to be influenced by someone they perceive as an authority figure. Television shopping networks exploit this by having an "expert" join the host in demonstrating a given product and answer any questions that the host may pose.

 

Lower Cost Structure - The television shopping network business model allows for a much lower cost structure than a traditional retailer.  If a television shopping network is effective at monetizing the households it reaches, its operating costs (e.g. payments for television carriage, production costs, corporate overhead, etc.) can be substantially lower than those of a traditional retailer and comparable to those of an internet retailer.

 

(Figures in thousands)
		FISCAL YEAR 2009
		QVC5	HSN6	Macy's	Bed Bath & Beyond	Nordstrom7	J.C. Penney	Amazon.com
	Revenue	$7,374,000	$2,007,897	$23,489,000	$7,828,793	$8,258,000	$17,556,000	$24,509,000
	Cost of Goods Sold	4,755,000	1,329,180	13,973,000	4,620,674	5,328,000	10,646,000	18,978,000
	Gross Profit	2,619,000	678,717	9,516,000	3,208,119	2,930,000	6,910,000	5,531,000
	Operating Expenses	1,150,000	520,846	8,062,000	2,227,432	2,109,000	5,916,000	4,402,000
	EBIT	1,469,000	157,871	1,454,000	980,687	821,000	994,000	1,129,000
	Add: Depreciation & Amortization	78,000	29,228	1,210,000	184,232	313,000	495,000	378,000
	EBITDA	$1,547,000	$187,099	$2,664,000	$1,164,919	$1,134,000	$1,489,000	$1,507,000
	Margins
	Gross Profit	35.5%	33.8%	40.5%	41.0%	35.5%	39.4%	22.6%
	Operating Expenses	15.6%	25.9%	34.3%	28.5%	25.5%	33.7%	18.0%
	EBIT	19.9%	7.9%	6.2%	12.5%	9.9%	5.7%	4.6%
	EBITDA	21.0%	9.3%	11.3%	14.9%	13.7%	8.5%	6.1%

(5) Excludes estimated amortization of intangible assets

(6) Excludes Cornerstone

(7) Excludes credit operations

An effective television shopping network can also have a lower cost of merchandise than other types of retailers.  Not only can a successful television shopping network like QVC sell huge volumes of a given item in a short period of time, it also effectively provides valuable advertising for the products featured in its programs.  As a result, vendors are willing to sell merchandise to television shopping networks at their lowest prices and also offer other benefits, such as return privileges.

Greater Flexibility/Responsiveness - Television shopping networks receive real-time feedback regarding the effectiveness of their merchandising, selling techniques and programming.  A television shopping network will know almost instantly whether a given item is meeting sales productivity goals.  It generally takes other forms of retail several weeks to get the same level of feedback.  As a result, a television shopping network can be much more flexible and analytical than other types of retailers in its approach to merchandising, selling techniques and inventory management.

More Entertaining - Women enjoy shopping, and television shopping programs provide them with a uniquely entertaining and seemingly social shopping experience.  No other type of retailer can easily match the entertainment qualities of a television shopping program in the eyes of the viewers of these programs.

 

In addition to the advantages QVC derives from the television shopping network business model, QVC also has unique sustainable competitive advantages, including:

Scale - QVC is the largest and most productive television shopping network in the U.S.  Its significant scale advantage primarily comes from more effective conversion of households that receive its programming. 

(Figures in thousands, except per household, per active customer and ASP figures)
			FISCAL YEAR 2009
			QVC	HSN	ShopNBC
	Gross Units Shipped		112,500	38,800	5,600
	Revenue		$4,948,000	$2,008,000	$528,000
	Full-Time Equivalent Households		94,800	94,000	75,600
	Revenue per FTE Household		$52.19	$21.36	$6.98
	Average Selling Price		$48.00	$59.00	$108.00
	Active Customer Base		7,400	4,500	1,022
	Gross Units per Active Customer		15.2	8.6	5.5
(Source: ValueVision Media presentation dated July 26, 2010)

QVC's superior scale and productivity relative to its television shopping network peers provide several advantages.  First, QVC is the most attractive television shopping network from a vendor's perspective, because QVC can achieve the highest volumes.  That means QVC gets better terms and/or pricing from vendors than the other television shopping networks do and has a stronger chance to secure any exclusive products or celebrity relationships.  Having better merchandise at better prices contributes to QVC's superior sales productivity, which further strengthens its merchandising advantage in a beneficial self-reinforcing cycle. 

Second, QVC's higher productivity makes it a more attractive partner for the distributors of its programming.  Generally, QVC's programming distributors (e.g. cable MSOs, satellite television providers and telecommunications companies) receive a commission of up to 5% of the net sales of merchandise sold via the television programs to customers located in the programming distributor's service areas pro-rated based on market share.  In addition to sales-based commissions, QVC also makes payments to distributors in the United States for carriage and to secure favorable positioning on channel 35 or below or in the general entertainment area on the distributor's channel line-up.  QVC's programming distributors earn significantly more from QVC than they do from other television shopping networks because of QVC's materially higher sales productivity.  As a result, QVC's programming distributors have a strong incentive to give QVC the most attractive channel positioning available to any television shopping network.  Achieving a strong channel position - either a low channel number or, increasingly, attractive channel adjacencies - is a meaningful driver of the television shopping network business model.  Once again, QVC's scale and sales productivity create a self-reinforcing beneficial feedback loop in this respect.

QVC's scale and sales productivity also provide it with advantages over its competitors in a variety of other ways.  Generally, there are always economies of scale with respect to technology investments.  QVC can also afford to invest more in its programming and attract the most desirable program hosts because of its superior scale and sales productivity.  QVC may also realize scale advantages in its distribution and warehousing infrastructure.

Merchandise Planning - QVC is more sophisticated in terms of its merchandise planning than its competitors, and this greater sophistication is a key factor in its superior sales productivity and scale, which in turn drive numerous other self-reinforcing advantages.  QVC's competitors have struggled to replicate QVC's success in the merchandise planning function, primarily due to cultural factors according an industry executive and former QVC executive with whom we spoke.  As a result, we view QVC's sophistication in terms of merchandise planning as a sustainable competitive advantage relative to its peers.

Brand Equity - QVC's viewers trust QVC more than its peers.  According to one industry executive, QVC has developed a much stronger reputation for price integrity than its peers, which is a key factor behind that customer trust.  If QVC says a certain price is the lowest price at which a product will ever be offered, viewers believe that to be true more so than they would if another television shopping network were to represent the same thing, and therefore those viewers are more likely to purchase the product.  It took QVC a long time to develop this trust with its viewers, and it is a tough moat for competitors to replicate or otherwise overcome.

These numerous and self-reinforcing competitive advantages enable QVC to deliver phenomenal financial performance.  QVC's EBITDA margin is over 20%, and its asset productivity is exceptional.  While there isn't enough publicly available information to isolate return on invested capital figures for QVC, QVC's return on tangible invested capital ("ROTIC") is almost certainly above 50%.  HSN's ROTIC is above 50%, and that figure includes HSN's poorly performing Cornerstone business.  QVC's cash flow margins are more than twice as high as those of HSN (excluding Cornerstone), so it is virtually certain that QVC generates higher ROTIC.  QVC has also consistently gained market share in the past and performed exceptionally well during 2008 and 2009.  From 2004 to 2009, QVC grew its domestic revenue at a CAGR of approximately 4.0% despite the severe global economic weakness in 2008 and 2009.  In contrast, unadjusted GAFO retail sales as reported by the Department of Commerce grew at only a 2.1% CAGR over the same period.  QVC's total net revenue declined only 1.3% in 2008 and increased 1.0% in 2009.  The resilience of QVC's financial performance during an extremely weak period for the global economy and financial markets provides clear evidence of the quality of QVC's business.  Very few businesses can deliver such attractive and resilient financial performance.

QVC also has material growth opportunities.  While QVC's programming is fully-distributed domestically, QVC should still be able to generate attractive growth in its domestic business due to favorable demographic trends and e-commerce/multi-media initiatives, among other factors. 

QVC will benefit for years from the aging of the baby boomers, the youngest of which are now about 46 years old, because QVC's core customer tends to be an older woman. 

E-commerce and multi-media also represent growth opportunities for QVC.  The portion of QVC's revenues that come from e-commerce transactions as opposed to telephone transactions has been increasing rapidly, reaching 32.0% of domestic revenue in 2Q10 compared to 27% of domestic revenue in 2Q09.  QVC realizes several benefits from its e-commerce business.  First, e-commerce transactions are less expensive to process than telephone transactions.  Second, QVC can offer a much broader assortment of products on its e-commerce website than it can through its linear television programming.  While approximately half of QVC's e-commerce transactions involve on-air products that might have otherwise been purchased over the phone, the other half of QVC's e-commerce transactions involve products not featured on the linear television program and which may represent incremental sales.  Finally, QVC can further enhance the effectiveness of its selling process by offering incremental content on its e-commerce websites (e.g. user reviews, more product information, bonus video content, community Q&A, etc.), by reaching out to customers through email and other forms of electronic communication, and by leveraging social media networks, such as Facebook, to enrich the social experience that QVC's viewers desire.  All of these factors combined should allow QVC to continue to gain share of domestic retail spending for the foreseeable future.

Additional growth opportunities abound for QVC internationally.  In QVC's existing international markets, Germany, Japan and the United Kingdom, QVC has the opportunity to grow its business to varying degrees by increasing the percentage of households that receive its programming, increasing the conversion of households to customers, and increasing spend per customer.  QVC also has greenfield opportunities in several significant markets, including China.

Unlike in the U.S., where the penetration of QVC's programming is probably at its full potential, in Germany and the United Kingdom QVC believes it can increase its penetration of households to close to 100%.  QVC also has room to grow its customer conversion and annual spend per customer in those markets towards the levels achieved in the U.S.  In Japan, QVC has a significant opportunity to grow the distribution of its programming, as its programming only reaches about half of Japanese households currently.  QVC can also grow its Japanese business by increasing conversion and annual per customer.

In terms of greenfield expansion, QVC plans to launch a television shopping network in Italy in October 2010.  QVC Italy should launch with wider distribution than other greenfield expansions, and QVC is hopeful that it will therefore be able to achieve profitability relatively quickly.  There are also several other high potential markets for greenfield expansion over time.  Of these markets, China seems to have the most potential.  QVC will enter China at some point, but China does currently present some regulatory and infrastructure challenges.  At its recent investor conference, QVC indicated that it would probably announce its next greenfield market within 12 to 18 months.

(Figures in millions)
	Country	GDP ($)	TV Households
	US	$14,265,000	115.7
	Japan	4,924,000	48.4
	China	4,401,000	373.0
	Germany	3,688,000	38.0
	France	2,866,000	23.8
	UK	2,674,000	25.6
	Italy	2,314,000	21.8
	Russia	1,677,000	50.3
	Spain	1,612,000	14.7
	Brazil	1,573,000	56.2
	Canada	1,511,000	12.4
	India	1,210,000	116.7
	Mexico	1,088,000	25.6
	Australia	1,011,000	7.7
	South Korea	947,000	17.9
(Source: QVC Investor Presentation dated March 11, 2010)

Valuation

We estimate QVC generated approximately $850 MM in unlevered free cash flow in 2009 and should generate approximately $920 MM in 2010.

 

(Figures in thousands)
			2009	2010E
	Operating Income		$1,019,000	$1,154,850
	Add: Purchase Accounting Amortization9		325,000	325,000
	OIBA		1,344,000	1,479,850
	Less: Taxes		(517,440)	(569,742)
	NOPAT		826,560	910,108
	Add: Depreciation & Amortization		203,000	191,000
	Less: Capital Expenditures		(181,000)	(181,000)
	Unlevered Free Cash Flow		$848,560	$920,108
	Implied Growth		-	8.4%

(9) Not tax deductible; estimated

We value QVC at $13.150 billion to $15.350 billion, a range that reflects a 7.0% to 6.0% unlevered free cash flow yield on our estimate for unlevered free cash flow in 2010.  QVC's closest competitor, HSN, is publicly-traded and provides a good point of reference for valuing QVC.  HSN's current market valuation implies a 6.8% LTM unlevered free cash flow yield.  QVC should be valued at a somewhat lower free cash flow yield than HSN due to its superior financial performance, competitive advantages, and incremental growth opportunities (HSN does not have any international presence).  Our valuation range also seems appropriate relative to the 30-year treasury yield of 3.7% and the forward earnings yield on the S&P 500 of 7.7% in light of the fact that QVC is a great business with above average growth opportunities.

One can get another point of reference for valuing QVC by looking at the valuation implied by the transaction in which Liberty acquired its controlling interest in QVC from Comcast.  Liberty acquired the 56% of QVC that it did not already own from Comcast in 2003 for $7.9 billion, which implied an equity value for QVC at the time of $14.1 billion and an LTM unlevered free cash flow yield of 3.8%.  Given that QVC has grown since 2003, the terms of the Comcast transaction clearly suggest that our valuation of QVC is conservative.

ECOMMERCE BUSINESSES

Liberty Interactive has controlling interests in a number of ecommerce businesses (collectively, the "eCommerce Businesses"), including Provide Commerce, Inc. ("Provide"), Backcountry.com, Inc. ("Backcountry.com"), Bodybuilding.com, LLC ("Bodybuilding.com"), BuySeasons, Inc. ("BuySeasons"), Lockerz, LLC ("LOCKERZ"), and LMC Right Start, Inc. ("Right Start").  The eCommerce Businesses generally operate in niche markets, are profitable, and are collectively growing revenue at a rate of about 20.0% per year on a pro forma basis.

(Figures in thousands)
			Fiscal Year	Fiscal Year	2010
			2008	2009	Q1	Q2
	Revenue		$776,000	$931,000	$268,000	$295,000
	Adjusted OIBDA		71,000	103,000	18,000	28,000
	Less: Depreciation & Amortization		(30,000)	(38,000)	(10,000)	(11,000)
	Less: Stock-Based Compensation		(14,000)	(16,000)	(4,000)	(9,000)
	Operating Income		27,000	49,000	4,000	8,000
	Less: Taxes @ 38.5%	38.5%	(10,395)	(18,865)	-	-
	NOPAT		16,605	30,135	-	-
	Add: Depreciation & Amortization		30,000	38,000	-	-
	Less: Capital Expenditures		(20,000)	(20,000)	-	-
	Unlevered Free Cash Flow		$26,605	$48,135	-	-
	Y/Y Growth
	Revenue		-	20.0%	10.3%	14.8%
	Adjusted OIBDA		-	45.1%	-28.0%	-33.3%
	Unlevered Free Cash Flow		-	80.9%	-	-
	Margins
	Adjusted OIBDA		9.1%	11.1%	6.7%	9.5%
	Y/Y Chg.		-	191 bps	-357 bps	-685 bps

(12) In the first quarter of 2010, Liberty made the decision to change the way certain third-party discount services are offered to its customers, which will negatively impact the year-over-year revenue growth of the eCommerce Businesses until the change is lapped.

We value the eCommerce Businesses at $772.0 million to $1.150 billion.  The low end of this range reflects Liberty's collective cost of acquiring the most significant of the eCommerce Businesses, Provide, BuySeasons, Backcountry.com, and Bodybuilding.com.  The low end also implies approximately a 5.0% yield on our estimate of unlevered free cash flow for 2010, which is a conservative valuation in light of the significant growth opportunities available to these companies and the high returns they almost certainly generate.  The high end of our valuation range reflects at 3.0% yield on our estimate of unlevered free cash flow for 2010.

RISKS

The businesses attributed to the Liberty Interactive Group are consumer-driven.  Any weakness in consumer spending will negatively impact the performance of these businesses to some degree.

A variety of factors could negatively impact the number of viewers QVC is able to attract to its network, including:

 

• increasing fragmentation of television viewing audiences as more programming options become available to the viewing public in the form of new television networks and time-shifted viewing (e.g., personal video recorders, video-on-demand, interactive television and streaming video over broadband internet connections);

 

• placement of the QVC television network in digital programming tiers, which generally have lower levels of television viewer penetration than basic or expanded basic programming tiers; or

 

• higher channel position placement for the QVC television network or less attractive channel adjacencies.

 

QVC depends on a limited number of multichannel video programming distributors ("MVPD(s)") for carriage of its programming.  The cable television industry has been undergoing a period of consolidation, and there are only a limited number of direct-to-home satellite distribution companies, the other primary type of MVPD.  QVC's increasing reliance on a few MVPDs could present a variety of risks.

 

Liberty's tracking stock structure does not limit its legal responsibility, or that of its subsidiaries, for any of its liabilities.  The assets attributed to one group are potentially subject to the liabilities attributed to the other groups, even if those liabilities arise from lawsuits, contracts or indebtedness that are attributed to such other group(s).  Liberty's creditors will not in any way be limited by its tracking stock capitalization from proceeding against any assets they could have proceeded against if Liberty did not have a tracking stock capitalization.

 

The proposed split-off transaction is conditioned on numerous factors, including receipt of a private letter ruling from the IRS, the opinion of tax counsel, government regulatory approvals, an affirmative shareholder vote, and resolution of Liberty's recently filed lawsuit against The Bank of New York.  If Liberty is unable to consummate the split-off transaction, the market price of Liberty Interactive Group Series A Common Stock may continue to reflect a substantial "tracking stock discount."

 

- Split-off transaction in late 2010 / early 2011

- Very high cash flow yield