Why John Malone Is Making Tracks to Alaska

Cable legend John Malone has figured out a novel and characteristically complicated way to turn his two tracking stocks — Liberty Interactive and Liberty Ventures — into asset-backed equities: buy a small cable company.

Malone’s target is General Communication Inc., a small cable and telephone company based in Anchorage, Alaska, with about 107,700 basic video customers.

GCI, as it is called, also has a history with Malone. Its founders, Ron Duncan and Bob Walp, got their original funding to start the business from Malone’s Tele- Communications Inc. and, until 1986, GCI was a wholly-owned subsidiary of TCI.

GCI went public in 1987 and has carved out a nice business for itself. As the largest cable and telephone company in Alaska, GCI had 2016 revenue of $933.8 million and cash flow of $288 million.

And though Malone’s GCI purchase harkens back at least slightly to another Liberty cable investment — the 2013 purchase of a 27% interest in Charter Communications — the purpose for the most recent deal is different. While Liberty saw in Charter an underperforming asset that could be used to acquire other cable operators, which it did by buying Time Warner Cable and Bright House Networks last year, the GCI deal appears to be primarily a financial play.

The structure of the GCI deal is, in typical Malone fashion, complicated. But it essentially kills two birds with one cable stone.

As part of the deal, Liberty Interactive, currently a tracking stock that follows the performance of home-shopping channel QVC, will purchase GCI in a reorganization where certain assets and liabilities of its other tracking stock, Liberty Ventures, will be contributed to GCI in return for a controlling interest in the MSO. Liberty Interactive will then spin off its controlling interest in GCI in the combined company — renamed GCI Liberty — to the holders of Liberty Ventures, in return for their shares of Liberty Ventures. Liberty Interactive would then officially become QVC Group.

Basically, what the transaction does is this: It allows Malone to transform Liberty Interactive and Liberty Ventures into asset-backed equities, with Liberty Interactive becoming a pure-play programmer with QVC as its largest holding. GCI Liberty, the former Liberty Ventures, which had been an amalgamation of investments — including online invitation and social planning service Evite, interests in Liberty Broadband and florist FTD, and minority interests in Time Warner Inc. online vacation lodging company Interval Leisure Group, Charter Communications and online lender and real estate business LendingTree — becomes a purer-play distributor.

Per to the deal, QVC Group would assume the interests in Time Inc., Time Warner and Interval, while GCI Liberty would keep the Liberty Broadband and Charter interests with GCI as its anchor asset. According to Pivotal Research Group CEO and senior media and communications analyst Jeff Wlodarczak, GCI Liberty will contain 95% cable-business assets after the deal is done.

Malone is also paying a hefty premium for GCI: The price, $1.1 billion or $32.50 per share, is a 58% premium to the price the stock was trading at on April 3, the day before the deal was announced. GCI investors flocked to the stock on April 4, driving it up 64% ($12.83 each) to $33.39, suggesting they believe the price could go higher. GCI stock continued to rise on April 5, trading at $35.68 each (up 7%) that afternoon.

Tracking stocks are a good vehicle for unlocking value of assets otherwise trapped in a larger public company — Liberty has used them to showcase programming and other assets, and other companies like Sprint, which issued a PCS tracker in the 1990s, used it to let shareholders participate in the rising value of its Personal Communications Service technology. But trackers can’t be merged into other entities — they need to be asset-backed. There are also some favorable debt connotations to converting a tracker into an asset-backed stock.

Wlodarczak said that while trackers can take on debt, any borrowing is usually backed by the parent company that created the tracker and actually owns the asset. Trackers can take on margin loans, which can be risky if the market drops. Having a security with hard assets that generate meaningful cash flow “makes it less risky to put higher value margin loans on those stakes in the event the market declines materially,” he said.

While GCI Liberty is attracting all the investor attention, FBN Securities analyst Robert Routh noted that the deal could also facilitate a long-awaited merger between rival retailers QVC and HSN. Liberty Interactive owns a 38% interest in HSN, and making the stock an asset-backed one could be the final piece of the puzzle in putting the two assets together.

Routh said he expects QVC Group to begin buying back shares almost immediately — it has about $376 million remaining on its buyback authorization, and the analyst expects that to increase significantly. That new, asset-backed equity currency could also be “used in the future to effect a merger of QVC with HSN, something that should have happened years ago, at least in our opinion,” he wrote.

Liberty and Malone have been creating and unwinding tracking stocks for decades, dating back to the first iteration of Liberty Media back in the 1990s, a tracking stock that emerged after Malone’s sale of TCI to AT&T in 1999.

In the past several years, Liberty has converted a handful of trackers into asset-backed equities, including Liberty Starz, which became Starz in 2009 and was sold to Lionsgate Entertainment in 2015; and Liberty Entertainment, which in 2009 spun out its interest in DirecTV and created the Liberty Starz tracker. He’s also created a few: Formula One Group, the tracker that was formerly Liberty Media Group; Liberty Braves, which includes its interest in Major League Baseball’s Atlanta Braves; and Liberty Sirius, which includes its interest in Sirius XM Radio.

SIDEBAR: Tracking Malone
Cable legend John Malone has been a pioneer in the tracking stock concept and has created and unwound trackers for years. Here are just a few examples.

May 2006: Liberty completes its restructuring and issues two new tracking stocks, Liberty Capital Group and Liberty Interactive Group
March 2008: Liberty completes its reclassification of the Liberty Capital Group tracking stock and issues a new tracking stock for the Liberty Entertainment Group
November 2009: Liberty completes the split-off of Liberty Entertainment and business combination with DirecTV. The remaining businesses are redesignated as Liberty Starz Group.
August 2012: Liberty issues a new tracking stock, Liberty Ventures Group.
August 2014: Liberty Ventures completes the spin-off of its controlling interest in TripAdvisor Inc. and BuySeasons into a new asset backed stock; Liberty TripAdvisor Holdings.
July 2016: Liberty Ventures Group tracking stock completes the spin-off of its subsidiary, CommerceHub Inc., into a new asset-backed stock
November 2016: Liberty Ventures Group tracking stock completes the split-off of its interest in Expedia Inc. and its subsidiary Bodybuilding.com into a new asset backed stock, Liberty Expedia Holdings Inc.

Liberty Interactive