Pay no Attention to the Man Behind the Curtain

Est. Reading Time: 15-20 Minutes

The action in a magic show is never occurring where the magician or their assistant is wanting you to look, it’s always somewhere else. 

While perhaps not as exciting as a magic show (OK, definitely not as exciting), the world of corporate spin-offs contains its fair share of sleight of hand. Arguably one of the top “magicians” in this realm is the former CEO of Tele-Communications and now the chairman / largest shareholder of Liberty Media, John Malone.

In 1990 Malone spun out Liberty Media from Tele-Communications in what proved to be one of the most artfully designed, and convoluted, offerings in spin-off history. The majority of the Street balked at the structure and took a pass only to watch Malone’s stake 10x over the course of two years.

Now, with Liberty Media spinning out the Atlanta Braves into an independent entity with a similarly convoluted structure, might there be another sleight of hand occurring?

First, a retelling of the 1990 saga is in order because it is not only interesting but it’ll give context into Liberty’s fondness for overly complex structures.

Case Study: Liberty Media / Tele-Communications Spin-Off

We’ll make this as concise as possible, because the current situation is a doozy.

Tele-Communications (TCI), then the largest cable operator in the country, announced in January of 1990 its intent to spin off its programming assets and some minority interests in cable-television systems. All told, the assets were estimated to be roughly $3B in value.  

Due to its size, nearly 25% of all households, TCI was in a position to make or break new launches of cable channels putting it squarely in Washington’s cross-hairs. The proposed spin-off was to alleviate some of this pressure from Washington and to provide more flexibility by separating programming assets from controlled cable systems.

Two months after the initial announcement a change was made. Rather than proceed with a typical spin-off, in which shareholders receive shares of the newly formed entity, TCI had chosen to use a rights offering claiming tax reasons for this election. In a rights offering shareholders could elect to exchange a certain number of TCI shares for shares in the newly formed entity.

In addition to this change in structure, Turner Broadcasting was removed from the spin-off and by October TCI’s 50% stake in Discovery was also removed. By January of the following year, the estimated value of the spin-off had shrunk from $3B to $600M. With a total market capitalization for TCI of approximately $15B, this was hardly newsworthy anymore. Additionally, Liberty was to be spun out with a maximum of 2M in outstanding shares versus the 415M shares outstanding for TCI.

According to the Wall Street Journal, analysts described the almost 400-page prospectus as “one of the most complex transactions of its kind” and one that caused confusion for investors. The Journal went on to report, “on a pro forma basis, for the nine months ended Sep. 30, 1990, Liberty reported a loss of $20.4M after a preferred stock dividend requirement, and a $9.77 a share loss.”

In short, this seemed like a bum deal.

TCI shareholders were to receive one transferrable right for every 200 shares of TCI owned. Each right allowed for the exchange of 16 shares of TCI for one share in the Liberty Media entity. At about $16/share for TCI, this imputed a price of $256 per share of Liberty. So, for institutional investors, the proposition became to trade a highly liquid/lower share price holding for a higher priced illiquid share structure. Which is, by definition, off limits to many institutional firms.

If any readers who have made it this far are annoyed with the structure, just wait for the overview of the current situation. But, in regards to the historical example, why go through all this trouble?

For starters, the rights offering was structured so that the number of shares of Liberty would not exceed 2M. Meaning, if only 1M rights were exercised to purchase Liberty, only 1M shares of Liberty would be issued, but at the same 16 TCI share conversion ratio. Any common stock not issued in the rights offering would be replaced by preferred stock to be owned by TCI. Since the same assets were to be transferred regardless of how many shareholders elected to exercise their rights offering, the split of equity ownership in those assets would be wholly dependent on how many shareholders elected to exercise their rights.

So, in the event that 1M shares were exchanged, 1M preferred shares would be issued to fill the gap to 2M and the equity of Liberty would now be split by 1M shares rather than 2M. Adding a bit of insult to the parent company, the preferred shares carried no interest payments for fifteen years.

Digging a bit deeper, Liberty also wasn’t as bad off as the pro forma or newspapers had indicated. The bulk of Liberty’s assets were made up of equity stakes in other companies, the revenues of which were not consolidated into Liberty’s income statement.

What was the outcome?

Only about 700,000 shares of Liberty were issued versus the 2M potential. Malone retained 20% of the new entity versus his 2% stake in TCI. He of course converted all of his rights. Less than a year after the offering Liberty split its stock twenty for one. The greater liquidity attracted more investors and by the end of the second year it had increased 10x in value. Malone netted $450M in 1993 dollars all told.

Quite the sleight of hand. But to be fair, all of this was presented in plain sight and few opted to suffer the brain damage of trying to figure it out.

History Doesn’t Repeat, but it Might Rhyme

First a caveat, this is not claiming that Liberty is setting up another 10x return over two years. But it is up to its old ways of unreasonable complexity and convoluted structuring. This time with the Atlanta Braves baseball team and the surrounding real estate assets. 

Here is a link to the Form S-4 for those who’d like to have a headache.

Liberty Media is comprised of the Atlanta Braves baseball team, Formula One and Sirius Satellite Radio (which is comprised of an 82.4% stake in Sirius and other things like Pandora and a stake in Live Nation). Instead of being a normal company, with a single tradable share, they have separate shares (known as tracking shares) that track the performance of each of these components of the business. Adding further confusion, each segment has a tradable Class A, Class B and a Common Class. The various stock tickers are as follows:

SiriusXM: LSXMA (Class A), LSXMB (Class B), LSXMK (Common)

Formula One: FWONA (Class A), FOWNB (Class B), FOWNK (Common)

Braves: BATRA (Class A), BATRB (Class B), BATRK (Common)

You are reading that correctly; one company has nine stocks.  

Since about 2015, the market has been commenting that the Atlanta Braves would be more valuable if spun out as a stand-alone entity given the high price tags attributed to professional sports teams. While not incorrect, there seemed little interest from Liberty to break out this segment, until now.

Liberty Media Corporation Announces Plan to Split off Atlanta Braves

Since this announcement, there has been a lot of excitement (well, at least for the circles that care about this stuff) and speculation on what the team might fetch in a sale scenario to a private buyer. But, similar to instances in the past, might we be better off looking beyond what is being put to the forefront?

On the surface, this would seem like a decently straightforward transaction. Liberty intends to take the three tracking stocks (BATRA, BATRB, BATRK) that make up the Braves business and convert them into the same three Class A, B and Common share structure but now entirely outside of the Liberty parent entity. Having voting rights, A and B classes of shares will vote on the conversion and if passed there will be a one for one conversion of each of the three share structures.

Sounds like a pretty good deal, and I’m ready to be a proud owner of the oldest Major League Baseball team.

But of course, there is more to the story. In conjunction with this conversion, Liberty intends to shake up the remaining structures around SiriusXM and Formula One.

Subsequent to, but as a contingent part of, the Braves spin-out, Liberty intends to break SiriusXM into two separate parts of SiriusXM and its stake in Live Nation. Formula One will remain siloed into the same tracking stock structure it currently sits in.

This is part of the voting approval of the Braves, so if you want a stand-alone MLB team, you’ve got to approve these moves as well. 

I’m getting the sneaking suspicion I am meant to focus on the Braves.

Digging a bit deeper it turns out that both the SiriusXM and Formula One structures own 1,811,066 and 6,792,903 shares in the Braves Group respectively. What these shares represent in terms of new spin out ownership is a bit vague as Liberty has not called out what the share count will be but it currently sits at about 405M, so we can get an idea. Further, they list the expected carry value of these shares in the 2022 annual report as $59M and $219M for SiriusXM and Formula One respectively. That might be a better indicator.

From Liberty’s fillings:

“The intergroup interests represent quasi-equity interests which are not represented by outstanding shares of common stock; rather, the Formula One Group and Liberty SiriusXM Group have attributed interests in the Braves Group, which are generally stated in terms of a number of shares of Liberty Braves common stock, and the Liberty SiriusXM Group also has an attributed interest in the Formula One Group which is generally stated in terms of a number of shares of Liberty Formula One common stock.” 

Ok, so using their estimates of value is a better route to take than considering share count. And to add another layer of complexity, it looks like SiriusXM also has a cross stake in Formula One.

From Liberty’s Form S-4:

“The number of notional shares representing the intergroup interest in the Formula One Group attributed to the Liberty SiriusXM Group was 4,165,288 as of December 31, 2022 (provided, that, as of March 22, 2023 the number of such notional shares was reduced to 1,051,238 as a result of the attribution of cash from the Formula One Group to Liberty SiriusXM Group for the settlement and extinguishment of 3,114,050 such notional shares, which represents the portion of the intergroup interest that was settled and extinguished for cash in connection with Liberty Media’s repurchase of approximately $591 million in aggregate principal amount of its 1.375% Cash Convertible Senior Notes due 2023).”

So, we can take the stated book value of SiriusXM’s stake in Formula One at year end 2022 and reduce it to 25.2% (1,051,238 / 4,165,288). This value is $233M x 25.2% = $58.8M.

To recap,

The SiriusXM Group owns about $59M of Braves and $58.8M of Formula One.

The Formula One Group owns about $219M of Braves.

This of course is just Liberty’s book value reporting. Should the Braves get bid up in the open market this would increase. I would also not be surprised if SiriusXM’s stake in Formula One has not reduced by the estimated value above as there is not actually a rule around share count equalling any particular value, it is just a “helpful” estimate on their books.

Why is this ridiculous pass-through ownership important, we just want the baseball team right?

Maybe not.

There is one more feature of this spin-off worth noting, and then (finally) we might be able to consider valuation. That is, how the conversion of the Brave shares are treated given this imbedded ownership.

At the conversion of the Braves shares into a wholly external entity, the stakes held by SiriusXM and Formula One must be dealt with somehow.

For SiriusXM, the equivalent value of New Braves A Class shares will be liquidated in the open market and go towards paying down the 1.375% Cash Convertible Senior Notes due 2023 (same notes that were paid down by Formula One this year in the excerpt above). As of year-end 2022, these were carried at a value of $790M versus the overall book value of SiriusXM’s debt at $13.08B.

We need to reduce this by the rough value of the Formula One payment mentioned above. So, going into the Braves spin-out we can assume this book value is approximately $615.8M ($790M less the approximate $174.2M from that Formula One share count reduction).

Against the back drop of $13B, a reduction of $174.2M from Formula One and maybe $59M from Braves Class A shares for a total nonorganic reduction in debt of $233.3M is not terribly meaningful. But that is at book value. Once the new Braves Class A stock begins trading, we may find this estimate is purposefully sandbagged.

Further, as called out in the S-4 exerpt, the total reduction of this $790M was $591M. The specifics of how are not detailed. So realistically to total new balance of that might sit closer to $201M, but we’ll put a pin in that.

For Formula One, there is (of course) a different treatment of this Braves conversion. Rather than getting Class A Braves shares, the consideration for the quasi-equity stake in Braves held in Formula One will be a distribution of Braves Common shares to shareholders. While the spin-off will change this value, as of year end 2022 Liberty considered this stake worth $219M on the balance sheet. That is rather interesting given most of the speculation around expected sale prices of the Braves lands in the $2B zone.

The final component, is that Liberty intends to convert the SiriusXM shares into SiriusXM and Live Nation shares. Per the Form S-4, holders of SiriusXM shares will receive one share of SiriusXM and a share of the newly created Live Nation tracking stock.

This throws a bit of a wrench into everything, even though we’ve already got several wrenches.

At this point we can reframe the whole ordeal into three distinct options:

(1)   We want to simply buy the Atlanta Braves baseball team and the surrounding real estate (which we haven’t touched on but it is actually not that material).

(2)   We want to buy shares in Formula One and focus on that business while retaining a decent stake in the Braves albeit somewhat undefined.

(3)   We want to buy shares in SiriusXM and focus on that business while retaining a small stake in Formula One and have the Braves stake reduce the debt load of the company, while also receiving a separate stake in Live Nation.

All of the sudden, SiriusXM seems to have the most downside protection and Formula One has potentially the most upside optionality due to its larger Braves stake being distributed to shareholders.

What might these entities be worth?

On the Revenue in 2022

SiriusXM brought in $9B

Formula One brought in $2.57B

The Braves brought in $588M

 

On Operating Income in 2022  

SiriusXM made $1.92B (21.3%)

Formula One made $173M (6.72%)

The Braves made ($28M) (-4.76%)

 

On Net Income in 2022

SiriusXM earned $1.29B (14.3%)

Formula One earned $558M (21.7%)

The Braves earned ($35M) (-5.95%)

Year-End 2022 Financials Link

At this point I have little interest in the Atlanta Braves given the structure we’ve labored to figure out. Formula One is a very attractive capital light business that is arguably underutilized, but the operating income is a more valid metric as about half of their net income came from a tax benefit. Additionally, they have a decent upside if their stake in the Braves gets bid up in the open market but we are also banking on Liberty optimizing the Formula One franchise. As an unscientific marker of how much they could grow, Formula One has a bit more fans globally than the NFL. The NFL monetizes their fans to the tune of $150/fan/year against Formula One’s ~$7/fan/year.

But that is potential and under the operating income lens of today, SiriusXM shines through. Which is surprising because my gut reaction was to assume it is a “melting ice cube” business. However, the financials would indicate otherwise.

Additionally, you get a separate vehicle to value the Live Nation stake which has been beaten down due to COVID but is coming out of that extreme headwind for their business. This against the backdrop of streaming services disrupting the previous record sales model and ensuring artists must tour if they want to maximize the monetization of their content.

At the approximate market capitalization at the time of this writing, you can pick up SiriusXM for about 1x sales with the kicker of a small holdback of both Formula One and a Braves facilitated debt reduction. Further, we have not considered that debt reduction we said we’d put a pin in earlier. Considering a roughly $591M reduction in SiriusXM debt, we can expect earnings have been set up for an increase from year end 2022.

Also worth noting, the net earnings figure of $1.29B for SiriusXM backs out $210M worth of earnings from the non-controlling interest in the other entities. While the amount of cross earnings are zero for the Braves and a trivial amount for Formula One, at 16% of the core business’s earnings it is a meaningful boost in value for SiriusXM.

What are the professionals doing?

In these situations, it is valuable to look at what the insiders are doing. In the historical example, it would’ve been easy to follow Malone, who unfortunately no longer has such a direct involvement. But it is worth noting that none of the Liberty management is following the Braves spin-off permanently. They will run it, but there is language in the S-4 on finding replacements and no talk of a reduction in their responsibilities to Liberty.

Further, we can look at what so-called “whales” are buying via Form SG 13G submissions with the SEC, which basically just say who is buying the securities in meaningful amounts.

Looking through the filings since announcement, you will find several smaller-scale LP funds similar to New West buying up stakes in the Braves and a few buying stakes in Formula One.

I will admit that Formula One initially had my attention. But I think even that may be the lesser option.

Interestingly there is one filling for the SiriusXM shares, and that is by Seth Klarman’s Baupost Group. While they have been a longtime shareholder of SiriusXM shares, they have increased their holdings since the Braves spin-off announcement. Admittedly there are two other groups that have bought and those are Vanguard and Blackrock. However, they have bought shares in all three vehicles and these entities must buy a little of just about everything in the market given their size. So it’s not quite a material data point.

But, Klarman’s presence is telling. His group has achieved an average annual return of 20% over the course of thirty years and is known for venturing off into the obscure areas of the market to invest in things “too complicated” for most. So, it would seem, I might be in good company landing on SiriusXM as the best position to take for this opportunity.

In typical New West fashion, this exercise is not to give a price range or buy/sell recommendations.

But, similar to the Garrett Motion overview for those who were on the distribution list last July (and which also happened to include Mr. Klarman), a price target wasn’t really the point. Asymmetry was. SiriusXM seems to have that in spades over buying the Braves directly.

Given Liberty’s history, the nonobvious route is likely to also be the most profitable.