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Morningstar | Liberty Global Optimistic About Deal With Vodafone, but We Remain Dubious; Maintaining FVE

Liberty Global reported a mixed third quarter, with strength in the U.K. through Virgin Media but continued weakness in Switzerland and Belgium. The financial results continue to be clouded by the dichotomy between continued and discontinued operations, as the deal to sell the firm’s assets in Germany, Hungary, Romania, and the Czech Republic remains pending. We continue to peg the probability of the deal coming to fruition at less than 50%, and thus continue to incorporate discontinued businesses in our model, obfuscating year-over-year comparisons. We will maintain our fair value estimate of $38 per share as well as our narrow moat rating. At current levels, and despite the noise, we see an attractive margin of safety and would recommend the name to investors looking for exposure to geographically diversified cable assets.

Reported revenue, excluding the assets up for sale, was $3 billion, a 1.9% year-over-year increase. Including revenue from discontinued operations, revenue grew 5.3% as operations in Germany continue to post strong results. In terms of subscriber growth, the firm saw 28,000 and 100,000 net adds when excluding and including tentatively sold assets, respectively. We again saw countervailing forces at play, as Virgin Media subscriber strength offset persistent headwinds in Switzerland and Telenet in Belgium. More specifically, Virgin Media delivered net adds of 54,600 and 36,4000 within its fixed-line telephony and broadband product lines, respectively. Conversely, Belgium and Switzerland saw net subscriber losses of 69,900 and 38,500, respectively.

In Belgium and Switzerland, management remains sanguine about its competitive positioning longer term, as it has instituted multiyear turnaround plans in both countries. However, these are intensely competitive markets, and any expectation of growth or excess returns for the firm’s businesses in these countries demands healthy skepticism.

We remain pleased with the firm’s performance in the U.K., as the business in this country will become even more paramount if the proposed asset sales are approved. The firm is continuing steady buildouts through Project Lightning, expanding the scope of its network in this market. While larger U.K. competitor BT has bemoaned increasing competitiveness particularly as it relates to broadband, Virgin Media continues to tout the superiority of its network from a performance perspective, and management indicated that the competitive landscape remains the same from its vantage point.

CEO Michael Fries intimated that Virgin Media believes the deal with Vodafone is on track to close by the summer of 2019, with the transaction formally filed with the EU in October. While management views the German Federal cartel office’s request for a partial referral as par for the course, we think it supports our skepticism regarding the deal’s prospects for approval. If the deal does go through, management plans to hold the cash proceeds strategically and continue to buy back stock. The firm repurchased $400 million during the quarter, bringing the total buy back to $1.7 billion thus far in 2018. While we agree with management’s view that the shares are at a discount to intrinsic value, we would still support some modicum of debt repayment. The firm remains leveraged at around 5 times EBITDA, exacerbating the risks to its operating model should any of its core markets go into a downturn.