Qurate Retail ($QRTEA) — Initiation (8/30/21)

Price: $11 Market Cap: $4.6bn Valuation: 5.5x EBITDA Category: General

There has been a ton of back-of-the-napkin analysis on this name lately.

I’ll try to provide only new insights and why I think this is a good trade.

I can’t describe what they do better than they do:

Qurate Retail, Inc. is a Fortune 500 company comprised of seven leading retail brands – QVC®, HSN®, Zulily®, Ballard Designs®, Frontgate®, Garnet Hill®, and Grandin Road® (collectively, “Qurate Retail GroupSM”). Globally, Qurate Retail Group is a world leader in video commerce, among the top 10 e-commerce retailers in North America (according to Digital Commerce 360), and a leader in mobile commerce and social commerce. The retailer reaches approximately 218 million homes worldwide via 14 television networks and reaches millions more via multiple streaming services, social pages, mobile apps, websites, print catalogs, and in-store destinations. Qurate Retail, Inc. also holds various minority interests and green energy investments.

QVC US (QxH) is the largest piece of the business with QVC International and Zulily making up the other segments:

Segment financials

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There are a few main topics to address in this bet:

  1. Where we’ve been — recent performance
  2. COVID bump and then wind down
  3. Long-term risks to the business
  4. Cash flow and what makes it work

1) Where we’ve been…

Stock came out of the financial crisis strong, ran up to high $20s. It stuck in a range from $20-30 from 2013 all the way to 2018 then fell precipitously leading up to COVID. The stock was at $8 right before COVID and now sits at $11.

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But the returns have been a bit better lately than the chart shows. In late 2020, Qurate paid $3/share in special cash dividends and another $3/share in a 10-year 8% preferred stock. So if you bought at $8 in January 2020, you now have $17 in total value and have done quite well.

Recognize that if you’re buying shares today, you’re getting in after the latest series of capital returns. There has been no public commitment (yet) to more special dividends.

2) COVID bump and wind down…

Qurate gets a large portion of revenue from e-commerce (62% of total) and the remainder comes from cable network product sales — both benefitted a ton from COVID // work from home // shift to online buying in 2020.

Qurate financial overview

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  • Revenue fell 4% in 2019 and then grew 5% in 2020 while operating cash flow was ~$1.3bn in each of 2018-2019 and then jumped to $2.5bn in 2020!
  • You’ll notice EPS jumped 55% in 2020 to $2.99/share and so far in 2021, earnings have grown another 26% — a better measure might be to say that 1H21 EPS ($1.02) is 23% higher than the $0.83/share earned in 1H19..
  • 2Q21 EPS is flat YoY despite way higher interest expense, preferred stock dividends, and a slightly higher share count — fairly impressive honestly.

Now that COVID is fading a bit… consumers are getting out more, shopping at brick-and-mortar more, and competition for digital buyers is creeping higher. The big question is: can Qurate sustain the revenue and cash flow baseline from 2020?

From a revenue standpoint, the answer looks like maybe — 1Q21 revenue grew 14% off a very low 1Q20 comparison and Q2 revenue grew 2% off a strong 2Q20 comparison. There was (and still is) this big fear that revenue should be turning negative off of 2020 comps but Q2 in particular is encouraging.

Revenue / OIBDA comparisons YoY

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One benefit I’ve noticed from the COVID bump/unwind in my own online retail business was the influx of new customers who signed up for our email list in 2020. Marketing to these customers is very valuable over time and gives us good insight into customer demographics. QVC has been no different… And while the growth rate is coming down, the total list size is way higher than it was pre-pandemic; very valuable for future promotions.

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To conclude here: revenue, earnings, and cash flow were up massively in 2020. Revenue is continuing to grow, earnings are leveling off (for a reason), and cash flow is coming down (for a reason). So far in 2021, business is performing better than a pandemic one-hit-wonder.

3) Long-term risks to the business…

QVC and HSN (home shopping network) have had long histories of good growth but the rise of e-commerce and cord cutting has left investors weary that the business has any terminal value — for example, this stock was essentially cut in half during 2019 from $20 to $10 per share.

There was a good blog post late last year covering the negatives for Qurate (and QVC in particular) — to sum it up, bearish on the outlook for the business as hosts go direct to consumers and cut out the middleman (in this case Qurate). My view on the business is very different. I see QVC as a distribution channel not unlike Amazon’s marketplace for third-party sellers, or ebay, Wayfair, etc. If I have a product or brand, then QVC is a potential outlet for me to move product. They happen to use celebrities/hosts to promote those products via cable TV or through their websites. I know that if QVC approached me to sell my products, I’m going to be able to reach an enormous audience and they’ll likely stock my inventory upfront to boot.

Qurate/QVC isn’t going to be disintermediated by hosts, brands, or celebrities. Rather, they have a portion of their business (distributed via cable TV) that is long-term challenged (cord cutting). This piece of the business is pretty small though — of the $14bn in total revenue they get $8.9bn from online sales and the international business (which includes some cable TV) is still growing. So maybe 25% of the business is in decline and the other 75% is exposed to growing markets / channels…

Speaking of growing distribution channels… This was a good slide from the 2019 investor day highlighting the various channels for Qurate and their current penetration.

2019 investor day — market penetration

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On the one hand, e-commerce is well penetrated (90%) and growing; while traditional cable TV is fully penetrated and in decline. A very interesting growth opportunity for Qurate is the OTT aggregators like Sling TV, Roku, YouTube TV, etc. which has fairly low penetration and a good growth outlook. Qurate seems to be adapting to an online-first selling environment.

Leverage is the other risk that became frightening in a hurry as 2019 came to a close. Investors were staring at 3 years of declining OIBDA and revenue down from 2017 levels.

The absolute debt levels haven’t changed much over the past 4.5 years but declining earnings made leverage ratios look worse and investors started extrapolating those declines into the future.

2017-2Q21 debt and leverage

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The table above shows ratios including and excluding the preferred stock as debt. All told, leverage looks manageable even if OIBDA did return to 2019 levels of $2bn.

4) Cash flow and catalysts…

When I think of an “unwind” of any sort with Qurate, it’s centered around cash flow. COVID provided a massive one-time boost to cash flow and it will come back in-line with history. We can already see some of this as of Q2 — FCF is down 67% in 1H21:

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2Q21 earnings call cash flow comments

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Interestingly, if you ignore working capital fluctuations, operating cash flow has steadily grown for years now — including 1H21:

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Since 2017, Qurate returned $3.5bn in capital to shareholders vs. a current market cap of $4.6bn — it took them only 4.5 years to give back 76% of the current market cap.

Qurate capital returns

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Relating back to the $6/share in dividends paid during 2020 ($3 in cash / $3 in preferred shares) — the company spent $1.25bn in cash on the special dividends. This coincides nearly perfect with the bump in FCF generated that year. It’s as if they took the one-time cash flow boost and gave it all back to shareholders. The preferred shares were distributed to shareholders but should only “cost” the company $100m per year in dividends (until redeemed).

Sources & uses of cash…

2016-1H21 sources & uses of cash

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Some notables on cash flow

  • Since 2017, Qurate only outspent cash generation once (in 2018)
  • $3.25bn in buybacks from 2016-1H21 — most at higher share prices
  • Management includes outflows for equity investments but these are building as assets on the balance sheet and may not be a good FCF deduction — totaling >$100m per year and growing however

Here’s what I love about the shift to dividends in 2020… the special dividend model is much more flexible without 1) making a valuation call on your own stock; and 2) potentially disappointing shareholders with a need for ever-greater levels of share buybacks. I’ve seen tons of cheap looking companies buy back stock for years only to see their share price collapse and years of buybacks look like a complete waste in one fell swoop. And when already committed to full blown buybacks, if your shares move higher and you want to slow the pace, it leads to shareholder disappointment. A combination approach is something I’d love to see more companies adopt but few have done it (B Riley is the main user of this method I’ve seen so far).

For Qurate — if they generate $700-800m in baseline FCF (after returning to a normal working capital level), that could leave $100-200m for debt paydown (if necessary at all) and $600m or so for capital returns. They could easily send back $1/share in dividends (10% yield) and repurchase ~4% of outstanding shares each year while still reducing leverage. Those payouts could ratchet even higher if they felt leverage was already comfortable. This looks like a model that would support 20% annual returns…

The trade…

This is a “General” position for me at a close to 2% weight. I think shares could return 20% annually over the next 3-5 years. Perhaps sooner as investors get comfortable with back half results.

Why now after shares have rallied and they’ve paid dividends?

There are 3 reasons for me:

  1. Revenue growth in Q1 and Q2 show there is ongoing value to the business (i.e. not a secular decliner).
  2. The willingness to do special dividends or other capital returns besides buybacks is very appealing — I feel like most companies are bad at judging buybacks and would be better served with large and variable special dividends, precisely what Qurate is adopting.
  3. Valuation still reflects a business stuck in 2018 — This was a cheap stock in 2019… In the $20s, it was >10x earnings and ~7.5x EBITDA… Today it’s even cheaper at 6x 2019 earnings and less than 6x 2019 EBITDA (i.e. no credit for business improvement).
  4. Chairman Greg Maffei’s strange “insider buy” — In May/June 2021, Maffei offered to buy John Malone’s shares at $14/sh. It led to some swapping of B shares for A shares and I’m not certain Greg concluded the purchase from Malone but it’s an interesting setup as the total value is 30m A shares worth >$400m at the offer price of $14 — This would make a hefty insider endorsement for the business.