LME + A Moat = $$$

One of the reasons why I have scaled back the writing on this blog is because I found myself rushing and making mistakes. Typically, when a 10-K, 10-Q, or an 8-K drops, I read it through over and over again and spend days thinking it over. My knee-jerk reactions are almost always wrong, so I try to take my time to protect myself from my often misleading Pavlovian responses. Now, there are times when my knee-jerk reactions may be correct in their conclusions, but the reasoning behind them is wrong. And that is often worse.

My point is that I took a month or two off to think. To re-read. To think again. To imagine that I screwed up, that I was wrong all along, and then figure out how I was wrong. That’s the basic process.

And after the thinking, my conclusion is this:

An investment in QVCGA is a simple one.

If you buy QVCGA, there is $250M in cash sitting at holdco, unencumbered by the Credit Agreement. There is also a 60% stake in CBI that is unencumbered by the Credit Agreement. CBI itself has $80M in cash plus other assets with no debt. The only thing standing in the way of the A shares are the P shares. And as I’ve written at length, these P shares are governed by an extremely weak Certificate of Designations and weren’t even issued for cash. They were issued to common shareholders to lever up the common. And given the fact that Greg Maffei and John Malone own both the As and the Ps, I see a conflict of interest that will favor the common shares under Delaware law, incentivizing the board not to screw over the A shares lest they face a losing legal battle. At a market cap of less than $100M, on this basis alone, QVCGA is attractive.

But of course, if you own A shares, you also get a free option on the golden goose—QVC.

Liability Management

There’s been a lot of talk about liability management with QVC lately, and I think even stockholders of the company are handicapping this poorly. I don’t find it unlikely for the A shares to get max value here. In fact, outside of a one-off black swan type event, I’d say the most likely event is a debt cleanup that doesn’t dilute shareholders at all. That is my base case.

The reason for this is fairly simple. All liability management exercises are going to be based off of the facts and circumstances of the individual company’s situation. What does management want? What do the credit documents allow?

First, what does management want? What does Greg Maffei want? What has been his track record for the last two decades at the helm of this company?

Maximize equity returns.

That is what he has done historically, and I see no reason for him to all of a sudden not care about maximizing the value of the A shares, which has been his job since 2005. Again, Greg Maffei never “retired” from Liberty Media. He retired from a spin-off that is basically just Formula 1. QVC is the stub. QVC is Liberty Media.

Second, what do the credit documents say? This is my favorite part.

QVC’s Credit Agreement and QVC’s bond indentures are all extremely covenant-lite. The Credit Agreement has no significant “J. Crew blockers.” It allows for over $2 billion of loans to be made to unrestricted subs/non-guarantor subs, which would prime existing lenders. The banks already signed off on this. Consent isn’t required, because it’s already been given. Bond buybacks and exchanges are allowed already too. I’ve seen many people suggest that the banks need to “sign off” on whatever happens next. They don’t need to sign off on anything. QVC can just do it. They were given the green light back in 2021.

This is what liability management is all about. In 2021, the banks all lost their minds and started giving away all of these concessions in order to increase their loan book, and now they’re paying the price.

Kirkland & Ellis, who QVC has hired, are the market leaders in liability management transactions, and their expertise is to take advantage of these loose credit documents and find out-of-court solutions to force creditors’ hands. The Wall Street Journal already reported that QVC’s banks formed a co-op in preparation for a liability management transaction.¹ The credit agencies also said they expect a liability management transaction. And the credit agreement has plenty of holes for Kirkland & Ellis to poke through, and we have shareholder-minded management at the helm. I’m not sure why people in the market doubt this. Liability management is actively being pursued, and the residual value that could be obtained by shareholders in an LME is substantial.

And if I’m wrong? Well, there is value at the parent that has already been siphoned away from creditors. This is a nice place to be as an investor.

The Anatomy of A Moat

One of the things I’ve liked to say is that QVC is a turnaround, a cyclical, and a special situation all wrapped into one. But I think that discounts what makes QVC so attractive. It’s also a cash flow machine with a moat.

Now what is a moat? A moat is a unique characteristic of a business that is hard for a competitor to replicate.

I don’t think people understand how hard it is logistically to do what QVC does. People think Amazon can do it, but they can’t.

When QVC does a Today’s Special Value, they take the inventory risk, have it drop shipped, or sell it on consignment. No matter which option they choose, there are all kinds of risks. If they pick the wrong product for the TSV and it doesn’t sell well, they’re in a pickle no matter what. If they own the inventory, they’re stuck with it. In the other two options, their vendors are upset and won’t want to sell on QVC anymore. There’s a lot of risk to this business model.

Other retailers buy goods and let them sit in a warehouse or on a shelf and they get picked and packed or purchased in the store. That has its own set of challenges, but it’s not what QVC does. QVC, on the other hand, curates a daily set of products to be put on air (or on social media) and sells them through—that day or within a few days. 25% of their daily sales come from the Today’s Special Value, and that doesn’t even factor in the halo effect. That means they need to have the fulfillment capability to deal with a massive order dump of a single product and then do it again tomorrow. And the next day. And the day after that. The beauty of this model is that, if successful, you’re often getting paid to sell the goods before you ever have to pay for them, which makes QVC a negative working capital business. Beautiful.

In order to do this successfully, you need to have a very skilled team of buyers. This comes from decades of data and know-how that nobody else has. Name another company that has the data and the know-how to curate a set of products that are highly likely to sell through on a single day at a given price. And then you have to have a new set of products for the next day to keep retention high. But even if the buying team picks the right products, you need to have the right on-air talent to pitch the products successfully through a time-tested on-air strategy. And even if you pitch the product successfully, you need a good fulfillment network that can successfully fulfill a massive order dump of a single product (or set of products) and then be ready to do it all again the next day without screwing it up. This takes a lot of planning and execution, plus really good relationships with your vendors.

Amazon’s business model is a storefront that people browse like a library that never changes.

QVC’s business model is a storefront that is completely different every single day. Amazon would have to fundamentally change how they source products and fulfill orders to succeed in QVC’s space. There’s a reason why they keep trying and failing.

High-velocity retail has a lot of execution risk, and QVC has figured out how to execute at scale. Some people seem to think that if you can make a video on TikTok you can compete with QVC. There’s so much more to this that I don’t think people have thought through. Sure. Anybody can set up a TikTok Shop, but that’s not where the moat is. The moat is in the ability to select the right product for a given day, sell it through, and then do it again the next day—billions of dollars worth per year. That is a uniquely challenging task that QVC has mastered, and they’re bringing it to social media with force.

Who’s going to compete with that at this scale? Who has the ability to take 25% of their fulfillment capacity to focus on one product? Who has the buying teams? Who can generate the amount of video content that they do? Who has the vendor network? QVC already has over 100,000 affiliates working with them. Who else can support that? QVC can, because if a product goes viral, they’re already prepared to sell millions in a single day of a single product. And then they have a completely different product for the next day. And the day after that.

If you can do just one of these things, you probably don’t have a moat. It’s the ability to do all of them at scale that puts QVC is in a league of its own.

1. As it happens, K&E is currently litigating the legality of bank co-ops right now in a separate case. This could be an interesting development. Ultimately, I find it unimportant that QVC’s banks have formed a co-op (in terms of negotiations), because the ultimate value grab is the low bond prices, and the bondholders have not banded together (as far as I’m aware). It is also interesting that not all of the banks are a part of the co-op, so perhaps some banks will get left out.