Liberty Global's expansion in Latin America will reshape the profile of Europe’s biggest cable operator and set off a wave of deal-making in the region. It's also an opportunity for the cable billionaire John Malone to revamp his company's unnecessarily complex stock structure.
Liberty Global on Monday completed its 3.5 billion-pound ($5 billion) cash-and-stock takeover of Cable and Wireless Communications. The deal adds operations in 18 countries including Colombia and Peru to the company's existing operations in Puerto Rico and Chile.
The new unit will bring in about $3.5 billion in annual revenue and $1.4 billion in operating cash flow, making it Liberty's second-biggest operation after Britain by sales and third-biggest country by cash flow after the U.K. and Germany.
Liberty is expanding into a market where broadband and pay-television still have room to grow just as it faces tougher competition in Britain and Germany, its two biggest markets, where telecom incumbents are pushing all-inclusive fixed and mobile offers. The shares have slid 25 percent in the past year, a reflection of both the takeover and investor concern about companies that depend on high-yield debt.
But it won't be easy to replicate in Latin America the strategy Liberty perfected in Europe over the past 15 years: making debt-backed acquisitions to roll up a fragmented cable market. Not only are there macroeconomic and political risks, residents in many places have lower purchasing power, so recouping network investments takes longer. Billionaire Carlos Slim's America Movil and Telefonica dominate almost everywhere.
Once the Cable & Wireless deal is completed, shareholders must contend with a complex corporate structure that includes an unusual tracking stock of questionable utility called LiLac. The securities, created last July, are designed to track the performance of Liberty's Latin American business.
Malone is a big fan of tracking stocks, which allow investors to buy exposure to only part of a business without requiring the company to spin off the operation. Malone likes them so much that his media group has three in the U.S. alone.
Tracking stocks are rare for a reason: they have governance weaknesses, especially when they’re used as currency for deals as in the Cable and Wireless. LiLac answers to Liberty's board, and since it doesn't have legal independence it cannot go bankrupt on its own. LiLac shares can be called in by the parent, and will never benefit from a takeover premium since no buyer can bid directly for them.
Shareholders in the parent must also be concerned the European business was used to help fund a large purchase in Latin America, only four months after the original LiLac tracking stock was created, supposedly, to make the two regions more independent.
Liberty says it will initially focus on organic growth in Latin America, but as the deal machine warms up, the company should either spin off the business, or simply eliminate the tracking stock and treat it as a normal business unit.
Liberty CEO Mike Fries says he wants to run the Latin American business for a while before considering hiving it off. He's held out the possibility Liberty will give its shareholders the 67 percent of LiLac it will own after the deal.
He should do this soon -- in the interest of fairness and to ensure that Lilac's free float has critical mass. It may trigger some instability for both the Europe and LiLac shares. But that's a small, short-term price to pay for investors to be able to choose whether they want to accompany Malone on his Latin American adventure.
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