LBW Commentary Q2 2016
How LBW See’s It Every quarter it seems we start our commentary with a new “OMG” (yes, LBW used “OMG” as an acronym for “OH MY GOSH”) event and Q2 of 2016 did not disappoint. Headlines were flooded with the BREXIT (a hype word for the United Kingdom exiting the European Union) event to our very own reality TV show, that is the United States (“U.S.”) presidential race. All joking aside, it seems that the U.S. as well as the world has become even more unpredictable, from slow anemic growth across the world to central banks’ monetary policies that seem to be changing every other month. This erratic environment has assisted in the creation of volatility we have seen in the markets year-to-date. Combine the impulsive nature of the world today with the U.S.’ almost seven-plus-year bull market, your result: “The tides have raised all ships, now the storm is causing choppy waters”.
Our quote is clever (LBW’s opinion of course), but what do we mean? The explanation around the quote starts with the seven-plus-year bull market the U.S. has experienced, thus far. For example, the S&P 500 hit a bear market low on March 9th, 2009 at a price of 677 and a P/E (remember we wrote about P/E ratios last quarter) of 10.3x, 5.6x less than the S&P 500 25-year average P/E ratio. In simple terms, on March 9th, 2009 the market was cheap, dirt cheap. Combine a cheap market with Quantitative Easing (QE) and artificially low interest rates – the U.S. markets only had room to go but up. Now, fast forward to June 30th, 2016 – the S&P 500 sat at a price of 2,099 (210% price increase from the 2009 low) and a P/E ratio of 16.6x, 0.7x more than the S&P 500 25-year average P/E ratio. The aforementioned data represents the first part of our quote “The tides have raised all ships”, or the companies that make up the S&P 500 were so cheap it did not matter which stock you picked, the tides were on the rise. Today, value is present, but one must dig to find it, leading us into the second part of our quote “now the storm is causing choppy waters”. With the shifting economic and political scenes around the world, such as BREXIT, the U.S. presidential race, and global monetary easing, this creates a storm and with it being high tide (market’s being fairly valued), the waves are tossing companies’ market prices to and fro in increasingly erratic directions. Today’s environment is not conducive to placing a bet on all ships, but to research and invest in ships in which the intrinsic value is truly understood and to subsequently purchase them with a margin of safety at an attractive price. Volatility in the markets can create opportunities as well as mistakes. As mentioned above, understanding the company you are purchasing is important, regardless of the environment. However, and to repeat our quote “The tides have raised all ships, now the storm is causing choppy waters”, understanding the true value of a company is heightened in the current environment and assists in reducing risk. LBW performs continuous and in-depth research, on our current and on-deck holdings, in order to truly understand each stock’s price to value relationship. This leads me into Nathaniel’s Beautiful mind, as he will explain the recent Liberty Media trackers’ transaction and the importance of understanding the companies you invest in. Welcome to… Nathaniel’s Beautiful Mind It is absolutely critical that we understand what we’re actually investing your (our clients’) money in. If we don’t understand what a company’s business is, if we don’t understand how variable A or B could affect a company, or if we cannot decipher how to properly value a company, we simply put the company into the “too hard” pile. Now, this is not to say that we discard companies never to return. In fact, Liberty Media is one of those companies that has taken us years to fully wrap our arms around after having initially discarded it. Liberty Media, in its current form, began within Tele-Communications, Inc. (“TCI”), the company that John Malone led as CEO until it was sold to AT&T in 1999 (the deal was announced in 1998, but was finalized in 1999). This most-excellent chart, created by blogger Glenn Chan, not only details the evolution of TCI and how Liberty Media came to be, but also the other entities, of which there are many more, that originated from TCI. Please note that it was last updated on November 11th, 2014, and does not include the new Liberty Media trackers or the impending spinoffs from Liberty Ventures (“LVNTA”). If it’s too hard to read, please click on the link and you will be taken to a much larger version for you to review at your leisure.
Source: https://glennchan.files.wordpress.com/2014/11/2014-11-04-updated-liberty-diagram-03.png On April 15th, 2016, Liberty Media’s existing common stock was exchanged for three new tracking stocks: Liberty SiriusXM (LSXMA/B/K), Liberty Braves (BATRA/B/K), and Liberty Media (LMCA/B/K). The intent of this reclassification was because in management’s view, “old” Liberty Media’s stock price was not accurately reflecting its actual Net Asset Value (“NAV”), and the tracker structure enabled each tracker to utilize their respective shares as currency in prospective deals. Since “old” Liberty Media’s spinoff date on January 11th, 2013 – the NAV’s discount to market price has typically ranged from 2-17%. At the time of the reclassification, the discount was approximately 13-15%. It is at this point that I should probably explain a few things. A tracking stock is not a spinoff. Think of it this way: a spinoff moves out from its parent’s (that is, the parent company that the spinoff is originating from) house and into its own house, while a tracker stays in its parent’s house and moves down to the basement. A spinoff is a company that separates from another company, and becomes its own corporate entity. There are two sets of accounting books, and the two companies no longer have anything to do with one another. A tracking stock’s underlying assets and liabilities are technically still a part of the parent company, and the assets and liabilities attributed to it are meant to be reflected in the tracking stock’s market price. The advantages of a tracker versus a spinoff are that the tracker’s market price will more accurately reflect its attributed assets and liabilities (in theory), assets and liabilities can be reattributed amongst trackers, and the trackers can enjoy the benefit of being under one roof such that back office processes and other similar costs can be shared efficiently while a spinoff would most likely see the aforementioned costs increase. Before its tracking stock reclassification, Liberty Media’s assets consisted of SiriusXM (“SIRI”) shares (~63.7% ownership), the Atlanta Braves baseball club and its new ballpark development (SunTrust Park in Atlanta, GA), Live Nation (“LYV”) shares (~34.4% ownership), other smaller holdings including Time Warner Inc. (“TWX”) and Time Inc. (“TIME”), and $500 MM cash. Its liabilities included margin loan debt of $250 MM, $145 MM of notes and loans, and convertible debt of $998 MM for a total of ~$1,393 MM. In Liberty Media’s case, the reclassification assigned the aforementioned assets and liabilities to specific trackers, as listed below:
Liberty SiriusXM: SIRI shares, $0 MM cash, and margin loan debt $250 MM
Liberty Braves: Atlanta Braves baseball club and its new ballpark development, $44 MM cash, and $108 MM debt
Liberty Media (“new”): LYV shares, smaller holdings (as mentioned above), 20% inter-group interest in the Liberty Braves’ tracker that will not be reflected in the Braves’ outstanding share count, $456 MM cash, $37 MM notes and loans, and convertible debt $998 MM
Following the reclassification transaction, all the trackers are still trading at various discounts, but over time, we believe that the market price of each will gravitate towards their respective NAVs. As we quoted from 1993’s Berkshire Hathaway Shareholder Letter in our blog post dated December 14th, 2015, “What is Value Investing”: “As Ben Graham said: 'In the short-run, the market is a voting machine - reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long-run, the market is a weighing machine.’” So, how is this pertinent to this quarter’s subject matter? As it was in 2009 for virtually all of the companies that constituted the S&P 500, we too look for a confluence of factors that indicate the odds are in our favor. We simply choose to focus our attentions on individual companies, and even more specifically, on companies that we understand. If you apply this premise of understanding to the companies you invest in and combine it with the principle of purchasing said companies with an appropriate margin of safety priced in, you have an investment opportunity with a high probability of very good returns on investment.
 https://www.ftportfolios.com/Common/ContentFileLoader.aspx?ContentGUID=4ecfa978-d0bb-4924-92c8-628ff9bfe12d  Liberty Media (2015). Liberty Media Investor Presentation [PowerPoint Slides], slide 9. Retrieved from http://files.shareholder.com/downloads/ABEA-4CW8ZW/1910644060x0x861474/78C0F42B-18BD-4D9B-B35E-854E84830685/2015_-_liberty_media_corp_investor_day.pdf  J.P. Morgan (2016). Guide to the Markets (U.S. 3Q 2016) [PowerPoint Slides]. Retrieved from https://am.jpmorgan.com/blob-gim/1383280028969/83456/jp-littlebook.pdf.  J.P. Morgan (2016). Guide to the Markets (U.S. 3Q 2016) [PowerPoint Slides]. Retrieved from https://am.jpmorgan.com/blob-gim/1383280028969/83456/jp-littlebook.pdf.  All ownership weightings and dollar amounts are as of March 31st, 2016. Liberty Media Corporation, FY16-Q2 Form 10-Q for the Period Ending March 31, 2016 (filed May 9, 2016). Retrieved from http://files.shareholder.com/downloads/ABEA-4CW8ZW/1910644060x0xS1558370-16-5688/1560385/filing.pdf  All ownership weightings and dollar amounts are as of March 31st, 2016. Liberty Media Corporation, FY16-Q2 Form 10-Q for the Period Ending March 31, 2016 (filed May 9, 2016). Retrieved from http://files.shareholder.com/downloads/ABEA-4CW8ZW/1910644060x0xS1558370-16-5688/1560385/filing.pdf  Berkshire Hathaway. Annual Report: 1993 Annual Report. Omaha: Berkshire Hathaway, 1993.