In a report last month, the Information Technology & Innovation Foundation, a Washington, D.C.based group advocating broadband-friendly telcommunications policies, ranked the U.S. 15th among the 30 countries in the Organization for Economic Cooperation and Development in terms of household availability and usage of high-speed digital cable television and telephone services. Michael Fries, president and CEO of Liberty Global, doesnt need a formula as complicated as the ITIFs which is based on numbers of subscribers, download speeds and pricing to conclude that the international market is ahead of the U.S. in broadband. His company is partially responsible for that international lead.
Englewood, Coloradobased Liberty Global, a 28,000-employee offshoot of media mogul John Malones cable TV empire, serves only non-U.S. territories 11 European countries, Australia, Chile and Japan with the exception of a small operation in U.S. commonwealth Puerto Rico. Two of Libertys markets Japan and the Netherlands, which have broadband penetration rates of 55 and 77 percent of households, respectively rank in the ITIFs top five. (The U.S. is at 57 percent broadband penetration but lags well behind in average download speeds Japans 63.6 megabits per second is the worlds fastest, seven times the average in the Netherlands and 13 times that in the U.S. and the U.S. price per megabit of $2.83 is high compared with $1.90 in the Netherlands and only 13 cents in Japan.)
Fries, 45, who has worked in Malone-connected cable operations for 18 years and has been CEO since 2004, says that being exclusively international gives the company an advantage in understanding and responding to a different brand of competition and regulation than Libertys domestically focused counterparts encounter. It is important to understand that we are a pure-play international cable business, which is our operating focus and which has done a fair amount to create value, says Fries. Liberty Global boasts a $12 billion market capitalization and annualized revenue of $10.4 billion as of the first quarter, 16 percent ahead of the full-year 2007 figure of $9 billion.
High interest expenses and derivatives losses contributed to a net loss of $156 million in the first quarter, $20 million more than a year earlier and, at 45 cents a share, 38 cents worse than the analyst consensus estimate. The stock, which the company has been buying back, closed May 27 at $36.04, down from last summers peak of $45.00. But Fries stresses free cash flow, which jumped to $128 million from $58 million in the first quarter. That, combined with shrinking the number of shares, ought to create a pretty compelling valuation story, explains Fries, who elaborated on the companys growth and outlook in an interview with Institutional Investor U.S. Editor Jeffrey Kutler.
How are you and Liberty Global related to John Malone and Liberty Media Corp.?
In 1990, I joined United Global, which was a spin-off of a company that John Malone bought. I was part of the team that built the international business. Over the years, John had invested in some of the things we did as well as his own international activities. He put Liberty Global together by combining UnitedGlobalCom, which I ran, with Liberty Media International in June 2005. The only way we relate to Liberty Media today is that we share a first name, a building we are on the first floor, and they are on the second floor and a chairman, John Malone.
Do any other cable companies have a comparable international profile?
There are public companies in certain markets, such as Virgin Media in the U.K. or Telenet, which we control, in Belgium. There are private equity institutions that have successfully invested in international cable. But you dont see other consolidators or strategic operators in our space. We are an operating company, pure and simple; we are not a holding company or financial company.
What is the logic behind separating out the international cable business?
A lot of what we are trying to achieve from a product and technology standpoint is similar to what you see in North America. An example is triple play, a term we invented in 1998 and that is now used all over [to describe a bundle of cable TV, voice telephony and broadband Internet services]. We are using the same technology, with very comparable economics and margins and a similar approach to the balance sheet and capital structure. The difference is that we have to be more nimble because regulatory environments differ, say, between Japan and Europe. We also have to be more innovative because the competition is more robust. Its not as easy to bring the scale benefits of a global footprint to bear as it is in a single country, and that is something we are good at. We centralize almost all of our technology procurement and capital expenditure. Were good at managing different capital pools and different cultural and content environments.
Has that put you ahead of the U.S. technologically?
We launched broadband and voice earlier. We have been more aggressive on speeds; we are at least 20 to 25 megabits everywhere, and as high as 60 in Japan. We are not as far along on the digital TV front. But there we have the benefit of drawing on applications and expertise developed in the U.S. Being in many of the top broadband markets, we have to innovate quickly, push speeds and be creative in our service bundle. That has helped us in the long run to be more nimble and play offense.
Dont you have to deal with differences between countries?
Each country is a little different. We run the European business with a common brand, Internet protocol backbone and technology platform. We have corporate marketing. While we are centralized, we also empower local CEOs to execute their budgets and make key decisions locally.
How do you match up against different competitors?
The good news is that we are facing phone companies that are generally not quite as innovative and not building fiber networks. Satellite competitors if they are there at all are generally offering a low-end, unsophisticated product. On the flip side, the phone companies are generally nationwide, so the market is not as fragmented as in the U.S. and we have to scale up to compete with them. Many of them are also former monopolies, which is one reason regulators like us to come in as a competitor.
Is it more difficult to manage in emerging versus developed markets?
That distinction isnt so strong. Most of our revenues come from first-world markets Australia, Japan, Western Europe. Even many of our Central and Eastern European markets are developed. Romania may be an exception. Chile is a stable country from a financial and fiscal point of view. We would consider as emerging markets Ukraine, China, Russia, India, Brazil which are markets we are not in today and are evaluating whether we should be, most likely by way of acquisitions.
How actively are you pursuing such opportunities?
Over the past three years, we have doubled the size of our business in numbers of customers [to 16 million], mostly through acquisitions. We are always focused on accretive transactions. Today the slowdown in credit markets has stalled M&A activity to a large degree. We are doing small transactions almost every week, but big transactions are on hold.
What are you telling investors about the decline in net income?
Net income for us is a difficult metric because of accounting changes and other factors. We are an operating-cash-flow-driven business, and [in the first quarter] that number was up 34 percent on a reported basis and 14 percent on a same-store or organic basis. Thats the metric that our banks look at when we borrow capital and is what will ultimately drive free cash flow after capital expenditures and interest. Free cash flow was up 122 percent in the quarter.
Where do you stand with stock buybacks?
We have repurchased $4.5 billion [worth], almost a third of the company, in the past two-plus years and have another $650 million authorized. Were doing it because we believe it represents a great value, and there is no point in sitting on the cash and earning 4 percent when we think our stock at these levels provides an excellent return.
Is the next frontier geographical or technological?
The growth opportunity we have is, first and foremost, to capitalize on the digital transition. In Europe, 80 percent of our customers are still getting 35 channels for 15 ($23.40). There is no question that they will want high-definition channels, a digital video recorder and video on demand. So there is great upside just in migrating the customer base into a digital TV experience and in selling more core products.