Many contend the true value of Seeking Alpha lies in the comment streams.

Recently, I’ve noticed the same investor’s name, a highly respected name, keeps popping up in various comment streams.

I strongly regret not watching his annual interviews in the past. What a mind and broad vision he has.

It would seem prudent to get caught up on this man’s latest observations and actions – one of which includes a major investment in Discovery (DISCK).

The Investor On Our Minds

Source

John Malone is the name I keep encountering in recent comment streams. This description of him, albeit dated, from a Vanity Fair bio is arresting.

Three facts to bear in mind about John Malone: He’s the largest known personal landowner in the U.S., controlling 2 million acres in several states. He’s the most powerful executive in the cable industry, running Liberty Media and wielding sizable stakes in Lions Gate Entertainment, Discovery Communications, and Starz. And most people know very little about him, even though he’s worth $6.5 billion and has his tentacles in almost every major cable company in the country.

He’s a force but he’s not without battle scars, some of which may be considered rightly-deserved. It’s widely reported former Vice President Al Gore, as a senator in the early 1990s rallying for the regulation of cable rates, once compared Malone to “Darth Vader” and called him the godfather of a cable Cosa Nostra.

John Malone started his career at Bell Labs of AT&T (T). But, it was his move to Tele-Communications Inc. (TCI) that proved instrumental for his career and reputation.

Malone transformed TCI from a debt-ridden backwater company into the world’s largest cable television company.

In 1993, Entertainment Weekly named Malone the most powerful person in Hollywood in support of the belief that ‘He who controls technology controls the future.’ At the time, the proposed merger of TCI with Bell Atlantic was deemed to change the face of content delivery.

Recently TCI has been involved in the design of a revolutionary new fiber-optics-friendly cable box that will change not only what America watches but how we watch it – from movies on demand to interactive programming.

But, the merger proved too difficult and fell apart in the fall of 1994. In the summer of 1998, Malone engineered a lucrative sale of TCI to AT&T. The deal closed in 1999 proving lucrative for both Malone and shareholders.

AT&T’s $45.8 billion stock-and-debt offer for TCI gives Malone, already a billionaire, an additional $4.4 billion.

Three years later, as Comcast (CMCSA) looked to acquire these same local cable assets from AT&T, Malone became the head of the AT&T spin-off set up to house TCI’s content, Liberty Media. By this point, Wall Street considered Malone somewhat “unpredictable.”

The oldest parlour game on Wall Street is trying to figure out what Malone is up to. It is a game that goes back decades to the very beginning of the cable TV industry, when Malone gained fame and fortune by turning the quirky idea of taking TV to rural, mountainous areas into a Wall Street wonder.

This “parlour game” earned Dr. Malone the moniker of “swamp alligator” – a creature that “lies quietly in the mud waiting for prey to come into range before it pounces.”

But, it seems Malone’s attention had turned to networks and programming. In 2013, Malone’s interests broadened to a global perspective. In February, Liberty Media acquired Britain’s Virgin Media. The acquisition transformed Liberty Media into one of the world’s largest broadband providers. In a CNBC interview with David Faber in April 2013, Dr. Malone expounded on his intentions. He projected the cable industry would see consolidation, both domestically and globally. He predicted traditional cable bundling, which he called “bloated,” would be defunct within five years.

The future is streamed video online so it is important the cable industry move to manage that competitive threat by acquiring streaming competitors or launching their own services to assure video programming revenue can be protected.

He has staunchly lobbied for the industry to control both the delivery and the content for decades even if it created oligopolies.

He is scathing about regulatory attempts to prevent monopolies and mergers. Governments, he says, are “antediluvian” in their approach to the emerging new world economic order. Instead of trying to prevent mergers and collusion between media and communications companies, Malone says governments should actually promote the creation of “super-corporations” (such as his own) with enough capital to exploit the potential of new technology.

His approach to business has been characterized as ruthless and hard-nosed. But, Dr. Malone describes himself as “straightforward and very honest, brutally so sometimes.”

In early 2015, the New York Post reported on a comparative analysis between Dr. Malone’s investment record to the record of Warren Buffett.

Warren Buffett is hailed as the world’s greatest investor — but rival investing legend John Malone has him beat in more recent times and in rockier markets, an analysis reveals.

Buffett won the first tracking period [1973 to 1998] by a hair. That is, through his Berkshire Hathaway holding company, Buffett’s shareholders enjoyed a CAGR of 31.1 percent. For the same period, Malone’s TCI recorded a CAGR of 30.3 percent – also a great run — just not quite as great as Buffett’s.

For the second Buffett-Malone matchup [2006 to 2014], Malone was the hands-down winner. By precisely how much, however, is another matter. The advisory gives Buffett’s Berkshire Hathaway a CAGR for this second tracking period of 10.5 percent. Liberty revealed the CAGR for its relevant entities from mid-2006 to mid-November 2014 was 30 percent.”

In 2016, Gabelli & Co. launched an exchange-traded fund trading at $10 per share, Gabelli Media Mogul (MOGLX) , to track Malone’s investments.

Gabelli Media MogulSource

The assets of Liberty Media have included all forms of media – the Atlanta Braves (BATRA) (BATRK), the Formula 1 racing league (FWONA) (FWONK), Sirius XM (LSXMA) (LSXMB) (LSXMK) (SIRI), TripAdvisor (LTRPA) (LTRPB) (TRIP), Live Nation Entertainment (LYV), Liberty Broadband (LBRDA) (OTCQB:LBRDB) (LBRDK), GCI (GLIBA) (OTCQB:GLIBB) (GLIBP), Qurate Retail (QRTEA), as well as, previously, Expedia (EXPE), Starz and Lions Gate (LGF.A) (LGF.B) and even Barnes & Noble.

As far back as the TCI days, Dr. Malone was intent on creating value rather than succumbing to Wall Street pressure to show profit.

A standing joke around TCI was that if TCI ever did report a large profit, Malone would fire the accountants. Malone had to “teach” the street what was really important – there is a big difference between creating wealth and reporting income. A focus on cash flow rather than reported income was hard for most to accept and was controversial for decades but those who invested alongside Malone would come to benefit greatly.

Thus, it was no surprise in April 2016 when the company proposed and completed a recapitalization of Liberty Media into three tracking stocks: Liberty Media Group, Liberty Braves Group and Liberty SiriusXM Group. In January 2017, with the acquisition of Formula 1, the Liberty Media Group tracking stock was renamed the Formula One Group and tickers, subsequently, changed. As shown in its latest investor presentation from November 2019, its diversification and recapitalization have indeed created value.Liberty Media Value CreationSource

According to Forbes, Dr. Malone is now worth $7.3 billion.

Malone’s Latest Investment

In November 2019, Dr. Malone invested almost $75 million in 2.67 million shares of Discovery Class C stock. It wasn’t a new venture for him. He’s been tied to the company for 32 years and was already the largest individual shareholder. It is believed he used the proceeds from a final Lions Gate divestiture in October 2019 to help fund the investment. He now holds almost 12.2 million shares in the company when including shares held by his spouse and a trust.

Discovery is a content provider delivering over 8,000 hours of original programming annually through real life entertainment brands. In 2017, Discovery announced it would acquire Scripps Networks and its home, food and travel IP and content. The company’s niche in the content marketplace, beyond real life entertainment, is its aggregation of local content.DiscoverySource

The combined entity was expected to capture 20% of the audience demographic aged 25 to 54 during prime time.DiscoverySource

The transaction closed in March 2018. As a result, Discovery’s total revenue increased 54% from $6.87 billion to $10.55 billion in 2018. Scripps Networks contributed approximately 29% or $3.06 billion.

Through the first three quarters of 2019, revenue has improved 7% to $8.27 billion as compared to $7.74 billion for the same period in 2018. Adjusted diluted earnings have increased 29% to $2.70 per share from $2.10 in 2018. The bottom line has benefited from synergies achieved by integrating Scripps Networks as the costs of revenue have decreased $720 million. Free cash flow has increased 28% to $1.98 billion from $1.54 billion.

Harkening back to Dr. Malone’s visions in 1993 regarding interactive programming, Discovery’s Food Network brand launched a direct to consumer product, the Food Network Kitchen app, in October 2019. The product is the first of its kind and uses a proprietary streaming technology owned by Discovery.

And it is becoming increasingly apparent that owning and operating our own tech architecture is a distinct competitive advantage and one that should allow us to further scale opportunities across multiple verticals, meaningfully driving global functionality, efficiencies and speed to market.

Food Network Kitchen delivers live and on-demand interactive cooking instruction with Food Network personalities. Live classes may also include Q&A opportunities. The app allows its collection of 80,000 recipes to be searched, sorted and bookmarked for future retrieval. Ingredients from recipes can be added to a digital shopping list. App developments on tap include the ability to order culinary tools used in cooking demonstrations and a 24/7 support line.

In early November, during the third-quarter earnings call, the launch, only two weeks active, was hailed as a glaring success.

The consumer demand on the classes has been so high so far that we’re actually going to make two changes. We’re going to expand the number of live classes from 25 per week to 40. We’re also happy to announce the opening of a brand-new Food Network Kitchen studio in Los Angeles. So we’re going to double [capacity].

In September 2018, Discovery tasked Peter Faricy with leading its digital and DTC businesses. He previously spent a decade building Amazon’s (AMZN) Amazon Marketplace, the segment dedicated to third-party sellers. Discovery’s potential is what attracted him to make the move.

We have a group of brands and a group of networks and shows and talent that consumers absolutely love. Finally, in my view, the winners in the direct-to-consumer world are going to be people who can take the great content, like we have at Discovery, but also build really great products that consumers love. That last piece was something I learned to do at Amazon over my 13 years there.

Under his leadership, Discovery developed the Food Network Kitchen and did so as a uniform interactive platform capable of rapid expansion. It’s already announced plans outside the Food Network brand. These plans include an app for Chip and Joanna Gaines’ Magnolia brand, a product-focused on the natural history and science content obtained from the BBC and a cycling-centric product.

Stay tuned because we have a bunch of good ideas and we’re going to be pretty aggressive, I think, coming out of the gate.

The Malone Interconnectivity

Dr. Malone serves on the board of directors for both Qurate Retail, home to QVC and HSN, and Discovery. In addition to his investment in Discovery, he purchased $1 million of Qurate’s shares on the open market in May 2019. With his reputation as a hardball businessman, it is not difficult to imagine him pushing for interconnectivity between Qurate’s product lines and Discovery’s HGTV, DIY and Home brands.

And yet, Qurate is not the only Malone holding with potential for interconnectivity. Discovery Turbo and Motor Trend could easily cross paths with Malone’s Formula One Group. Discovery’s Travel Network and Malone’s TripAdvisor would also be natural complements.

Though he serves on the board and is the largest individual shareholder at Discovery, it is pertinent to note his investment is in the company’s Series C common stock. And, those holders do not have voting rights. Thus, his leverage as a shareholder is obviously limited and would only go so far.

Investment Rationale

However, business matchmaking wasn’t the reason cited for his most recent Discovery investment when specifically asked during another CNBC interview with David Faber in November 2019. Rather, it was that same theme mentioned nearly twenty years ago – interactive programming.

I believe they will solve these issues [direct-to-consumer] and that they are dramatically undervalued right now.

In the interview, he emphasized repeatedly his belief that the DTC, direct-to-consumer, relationship will be the key going forward.

Because the real payday is the relationship with the customer, the information about the customer and being a gateway.

If you have a direct-to-consumer relationship and scale with growth and you have pricing power, it’s pretty powerful. It’s a very powerful business model.

As far as considering Discovery undervalued, Dr. Malone looked immediately at market cap compared to levered free cash flow. Discovery’s market cap currently hovers near $21.4 billion. Its TTM levered free cash flow is $5.6 billion. Debt obligations for 2020 are $1.4 billion.Discovery

Source: Author-created using Seeking Alpha data

Discovery shares have appreciated around 7% since Dr. Malone purchased at an average cost of $28.03 in November. But, it’s certainly not likely he committed $75 million for a trivial 7% gain.

Disclosure: I am/we are long QRTEA, T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I belong to an investment club that owns shares in QRTEA and T.

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2020-01-15