One of the most significant holdings in the equity portfolio of Seth Klarman (Trades, Portfolio)'s Baupost Group at the end of the first quarter was Liberty Global PLC (LBTYK, Financial) (LBTYA, Financial)(LBTYB, Financial). According to the hedge fund's 13F, it owned 54.6 million Class C shares of the company at the end of March, giving it an 11.1% portfolio weight.
This position is interesting because the company has substantially underperformed the market over the past five years.
Indeed, since the end of July 2016, the stock has returned -16%, excluding any dividends or other shareholder payouts.
The billionaire investor
Liberty's largest investor is John Malone, the telecom billionaire who is one of the greatest investors of the 20th century. He also sits on the board of the company. This makes the company's performance all the more interesting because Malone has a reputation for generating substantial returns for investors through different investment structures and other corporate actions.
Liberty is currently in the process of pushing through one of its most transformational deals in many years.
After selling off the majority of its European business to Vodafone, the company is combining its Virgin Media division in the U.K. with O2, an established mobile telecommunications enterprise.
When complete, the company will be the second-largest telecommunications and media group in the U.K., coming in second place behind the formerly state-owned BT Group PLC (LSE:BT.A, Financial).
Discussing the deal on the company's first-quarter conference call, CEO Mike Fries said:
"We're creating the clear number two operator in the market after BT, with 42 million fixed and mobile subs, £11 billion of revenue and nearly £4 billion of EBITDA. But we're also combining two best-in-class infrastructures, including the largest and most admired mobile platform with 40% of the market and the U.K.'s fastest broadband network, serving over half the country with one gig speeds by year-end."
On top of these advantages, the group is looking to achieve 540 million pounds ($746.4 million) of annual synergies.
The bigger business
When this manager is complete, Liberty will be a much larger enterprise. If its track record of capital allocation is anything to go by, the group will prioritize additional share repurchases.
Management has been aggressively buying back stock when it believes the shares are undervalued. The company recently introduced a $1 billion share repurchase authorization and spent around half of this in the first four months of the year to "take advantage of the value gap on our stock."
On the first-quarter conference call, Liberty's CEO also mentioned that across the group, there's the potential for $12 billion of synergies on a net present value basis.
If this estimate proves correct, I do not think it is unreasonable to assume the company could have several billion dollars of excess capital to return to investors over the next few years. The company could even return the entire amount if it cannot find any other compelling investment opportunities.
To put this figure into perspective, Liberty currently has a market capitalization of $14.7 billion.
However, there is no guarantee the company will achieve these synergies or return this much to investors. I should also note that the company has a lot of debt. At the end of 2020, the group's debt totaled $31.3 billion. Adjusted Ebitda for the period was around $4.9 billion, implying a debt-to-Ebitda ratio of more than six. This could become a problem if interest rates rise substantially in the years ahead.
However, it is easy to see the potential for this business from here. Not only does the company have the potential to unlock billions of dollars in savings and additional cash flow over the next few years, but it also has a strong track record of returning excess cash to investors.
For investors like Klarman, who are willing to wait years for a company's value to emerge, Liberty may look appealing as an investment.
