Qurate Retail
trading at 4x Free Cash FLow!!!
By Manuel Maurício
October 08, 2021
Symbol: QRTEA (NASDAQ)
Share Price: $10.44
Market Cap: $4,25B
Introduction
I first heard about Qurate Retail one year ago through Gary Mishuris. I even wrote about it in the All in Stocks Facebook Group.
At that time, this was a special situation. In typical John Malone fashion, the stock was trading for $10 while issuing a special cash dividend of $3 per share, together with preferred shares worth $1.5.
That would mean that the shares, after the special distribution, were priced at $6. Depending on how you were to calculate the Free-Cash-Flow, the stock was trading in between 2x and 4x FCF. Very cheap!
In hindsight, I should’ve invested then.
But I didn’t.
Today the stock is again trading at $10 and I suspect there’s still a lot of upside to it. Let’s dig in.
Business
Qurate Retail is a media conglomerate whose main asset is QVC. If you’re not an American, you’ve probably never heard of QVC – unless that is, you’re an avid Shark Tank follower (they talk a lot about QVC on Shark Tank).
For the sake of simplicity, I’ll be using the terms Qurate and QVC interchangeably.
QVC is the major (Direct-to-Consumer) shopping channel in the USA. They sell everything, from meatballs (hello Mama Mancini’s), to clothing, coffee machines, electronics, you name it.
Now, I know what you might be thinking.
TV shopping is something of the past and it couldn’t possibly prosper on the internet age.
Not so fast. Let’s first take a look at the customer metrics and financials then we’ll talk about the industry dynamics.
Audience
When one thinks about home-shopping one typically thinks of low income, poorly educated shoppers, but it turns out it’s nothing like that.
The target audience of QVC are educated women between the age of 35 and 65 with above average income.
From the total number of customers that comes into the platform, only 2% becomes what the company calls “Best Customers“.
The Best Customer status is achieved when a customer buys 20+ items in their first year.
These are QVC’s core fans; those that will stick around for decades (yes, decades). They represent 16% of all customers and account for 69% of all sales.
It’s these customers that matter most.
And it looks like that the company has been successful at retaining them.
The business is so sticky that the retention rate for these Best Customers is 99% (in the US), which is just crazy.
We’re talking about a retailer, not a software business.
Interestingly enough, one would think that the average age of the best customers would be going up, following the natural process of aging, but that turns out not to be the case.
On a recent conference call, the CEO mentioned that as he has gotten 20 years older while at the job, the best customer cohort was actually getting younger.
Although the chart below tells us nothing about the existing cohort of Best Customers, it tells us that the new customers have been trending younger.
“Our data shows that once a QVC shopper makes three purchases, they’re statistically a customer for life,” – Mike George, CEO
Segments
Now, I’ve told you that Qurate is synonym of QVC, but that’s not the whole thing. There’s a few other segments inside Qurate.
First of all, QVC merged with its largest competitor Home Shopping Network (HSN) in 2018 and that’s the big blue piece of the pie that we see in the chart below.
Then there’s QVC International and Zulily.
Back in 2015, Qurate acquired Zulily, a direct-to-consumer e-commerce company focused on promotions.
Whereas QVC will buy its inventory (often exclusive stuff made just for QVC) prior to airing the shows, Zulily will only order the inventory after it has sufficient orders to get good deals with the factories.
This leads to a weird model where customers often need to wait for days in order to get their products – a very different approach and target demographic from the core QVC business.
I see the Zulily acquisition, in part, as I see the giant tobacco company Altria buying Juul (electronic cigarettes).
The company saw a new and strong trend and they didn’t want to miss out on it, paying big bucks for an asset that wasn’t that good.
In the case of Altria, one could argue that Juul was the only real threat to traditional cigarettes business so Altria did the right thing.
The same can’t be said of online shopping where Zulily’s competitors are a dime a dozen.
Whereas QVC is relationship-based, Zulily is transaction-based. The relationship that QVC creates between customer and host is much more sticky than any promotion.
So, with Zulily’s acquisition, Qurate was (kind of) trying to get into Amazon’s turf.
The opposite is also happening with Amazon Live.
My insights into Amazon Live are still very limited, but from what I’ve seen other people saying about it, it’s not even close to what QVC offers in terms of quality.
Will Amazon ever get there?
Probably.
But it looks like that what QVC does isn’t that easy after all. In fact, Amazon had tried to build Amazon Live back in 2017 only to shut down the project one year later. Let’s see how it goes now.
Financials
For the past 15 years the revenue has been trending positive, but one could argue that it’s hard to untangle what is generated by the underlying demand and what is generated by the big acquisition in 2018.
The truth is that both Qurate and HsN were struggling to stay relevant in today’s day and age before they merged.
The rationale behind the acquisition was economies of scale, but the HSN integration wasn’t an easy one and the company has been dealing with it ever since.
If we look at the organic growth (backing out the effect of the HSN acquisition) we can see that, back in 2019, the company went through a rough year. Whether that was transitory or not, we will never know because the COVID-19 pandemic completely changed the world – in Qurate’s case, for the better.
During 2020 people stayed home and had more money to buy stuff.
Should we be expecting continued organic growth going forward or should we expect a decline in growth? That’s the 1 billion dollar question.
Although Qurate’s management knows from a very early “age” who will stick around for many years and says that there’s no reason to believe that these new customers won’t behave like the previous cohorts, no one really knows if the growth is here to stay.
Typical of a Malone company, Qurate has had so many twists and turns that the net income figures are meaningless to understand the earnings power of the business.
A better metric is the Free-Cash-Flow. I expect the FCF going forward to be a little shy of $1 billion dollars per year (if we don’t see a radical shift in user engagement).
Balance Sheet
Also as your typical John Malone company, Qurate has debt on the balance sheet. On top of that, it’s not that easy to understand the capital structure so I’ll try to keep it simple.
What investors must focus on is whether or not the company will be able to fulfill its debt obligations in the future and still generate enough cash to make its shareholders happy.
First, we must look at the interest coverage ratio (how many times the operating income covers the interest payments) and second, how the debt maturities are staggered.
The current interest coverage ratio stands at 3.6x. Given the stability of the business, I consider this to be an acceptable level although one should be on the lookout for revenue erosion due to competitive pressures or lack of engagement
Regarding the debt profile and maturities, the management has been smart enough to issue fixed debt and spread the maturities over the period of many years.
This way there won’t be a single year when the company needs to pay down a lot of debt.
It also minimizes the risk of not being able to re-finance a big portion in any given year.
Just like with Aercap, the company relies on the debt markets’ appetite for refinancing its debt when payment is due ( John Malone companies’ usually just kick the can further down the road, never really paying the debt entirely, just replacing existing debt with new debt with longer maturities).
If, for any reason, the debt markets lose the appetite for Qurate’s debt, the Free Cash Flow that was expected to go to the shareholders will have to be diverted into paying down debt.
But, as the company is at a leverage ratio of 2.2x (for QVC only, not the whole company) and it targets a leverage ratio of 2.5x, we could even be seeing the management team raising more debt to repurchase more shares or issuing a dividend.
Which leads me to the guys in charge and capital allocation.
Leadership and Capital Allocation
Both John Malone (Director) and Greg Maffey (Chairman) are some of the best capital allocators of all time.
A whole book could be written about these two.
In fact, a book has been written about Malone.
That is probably the worst cover design I have ever seen. But I digress.
Malone owns around 8% of the company whereas Maffey owns 1,23%.
As the story at the beginning of this write-up illustrates, these guys understand that this is a mature business that generates a lot of Free-Cash-Flow and they’ll do anything in their power to return that cash back to the shareholders in a tax-efficient manner (John Malone is said to be allergic to taxes, hence the high debt in his companies).
We should be expecting further returns of cash to shareholders in the next few months.
“you should expect that we will be looking for a large payout as a percentage of that high free cash flow and how it — what form it takes, whether it’s another cash — special cash dividend or whether it’s increased buyback, we’ll continue to evaluate. ” Greg Maffey, Chairman, Q1 2021
Broad thoughts on the competitive landscape
Everyone is quick to point out that e-commerce and influencers are taking over the world. They are!
But that doesn’t mean the end of Qurate. At least not at the rate that the share price is implying (more on that in a minute).
In fact, after going through all of this, there is something of a recurring thing to QVC. And COVID has only helped to increase the top of the funnel and consequently the number of addicts.
QVC is very sticky. It has a very loyal fan base who will buy from it every year on a very predictable basis. It’s not a one time purchase. I wouldn’t go as far as saying that it’s a subscription business (because it isn’t) but for those core customers, it kind of is.
E-commerce is probably the greatest threat to the business. But as much as people like to buy on Amazon, they still want to be guided through all of the options out there.
You go to Amazon to buy a specific item, but you’ll turn on QVC to be entertained. To be told what to buy. Hence the term “shoppertainment” (shopping + entertainment).
Take me for example. I take forever to choose something to watch on Netflix. And I’m not alone in that. In France, Netflix is trying out a linear TV product which is always on, always running movies (just like a regular TV channel).
Because there are people who don’t want to choose (the paradox of choice). They want the content to be curated. The same happens with shopping.
In fact, I would argue that this is the reason why influencers are so relevant today.
Shoppertainmnet also reminds me of Gaia, the esoteric streaming platform (I wrote about it here). People stick to their favorite hosts. The same happens with Martha Stewart, Loni Anderson, and others on QVC.
The typical QVC customer has her TV on all the time on QVC. The hosts become part of her everyday life.
Which leads me to the cord-cutting trend that we’ve been seeing in recent years.
The cord-cutting is probably one of the most important risk factors for Qurate as people are letting go of linear TV and turning to on-demand content and live streaming on social media.
That’s one of the reasons I believe Qurate’s stock is so cheap.
People are quick to associate QVC with TV. But we’ve got to remember that this is a John Malone company. He knows everything there is to know about media.
He and the management team know that there are huge tailwinds in the Live Streaming Shopping experience.
In order to cut the dependency on linear TV, the management has been shifting its focus to new platforms like Roku, Facebook Live, Samsung Live, or Tik Tok.
They’re going for a multi-channel approach. Their goal is to be wherever their clients want them to be.
Diogo Gonçalves was kind enough to send me an example of how QVC is pivoting to social media platforms like Tik Tok. Thank you Diogo.
The question is if these efforts will be enough to keep QVC relevant in the online world.
Competition
I think it’s fair to say that the competition has never been fiercer. Everything that attracts people’s eyeballs is taking precious viewing time from QVC.
Similarly, every platform that delivers stuff to your house with just a few clicks will also be taking customers away from QVC.
Assessing the competitive landscape going forward is the hardest part of any analysis to Qurate Retail.
Risks
- Losing market share.
- Losing stickiness.
Valuation
Now comes the interesting part.
At $10 per share, the stock is trading for 4 to 5 times Free Cash Flow. This means that if you were to buy the whole company today, you’d be getting your money back in 4 years.
In a world of ultra-low interest rates and super-high valuations, this shouldn’t be happening.
Or should it?
I believe that what scares the market is, first of all, the highly leveraged capital structure, and secondly, the idea that Qurate Retail is an old fashioned retailer.
One question that I have come to ask more often when I look at stocks is “does this stock have what it takes to become overvalued?“.
My current opinion is still diffuse as I don’t have a firm grasp on the industry of shoppertainment, but I’m inclined to believe that if the shift to other platforms is successful, investors could easily pay a high(er) multiple for Qurate.
As I said, I still don’t know how the whole live streaming shopping ecosystem will be evolving in the future, but at 4x FCF, the share price seems to be incorporating everything that can go wrong and very little of what can go right.
Qurate is THE world expert in live streaming shopping. They’ve been doing it for 40 years. They should be capable of adapting their expertise to new media.
Conclusion
At 4x FCF, what investors must ask themselves is “is this company going to be here, generating the same amount of cash in 4 years?“. I’m tempted to say Yes.
But I feel that the ecosystem is evolving so rapidly that my conviction in that answer is still not high enough for me to make a move.
I want to spend the next week learning about shoppertainmnent and the future of e-commerce.
I won’t be too worried about writing and my write-up for next week might just be a sentence with my decision. I want to spend the maximum amount of time reading and learning about the industry. If you’ve got any insights than can help me, I would welcome them.
See you then.
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