Pair trade idea – Liberty TripAdvisor vs TripAdvisor
Liberty TripAdvisor (LTRPA) was spun off from Liberty Media on 27 August 2014. The main asset is 22% of cash flow rights and 57% of voting rights in TripAdvisor (TRIP). The reason LTRPA was spun off was to seek a tax efficient way to realize the value of the TRIP shares owned by Liberty. The tax basis for those shares was ~$500 million for a company now worth $2.3 billion. A merger between LTRPA and a third party would be far more tax efficient. The block of shares that LTRPA owns is potentially very valuable as it is the only way for TRIP management to stave off hostile acquirers. Yet LTRPA shares are trading at a discount to equivalent TRIP shares. We see a hedged pair trade as the most attractive way to take advantage of this situation, providing decent returns with little to no market risk.
TRIP was created as a spin-off from booking website Expedia. TripAdvisor itself is a travel website that offers user-generated reviews and information on hotels, restaurants, attractions and other travel-related information. Its revenues are based on ads and is thus more of an aggregator than the commission based revenue models of Expedia and Booking.com. It has 60 million members, 280 million unique visitors a year and 170 million reviews, which creates a strong network effect that makes it hard for incumbents to compete – similar to the moat that Amazon has through its product reviews. The business is growing and growing in clout. About 30% of TripAdvisor revenue comes from Expedia. The valuation of TRIP itself at 11x revenue is probably double of what it should be, given 10% top-line growth and no major economies of scale in its ad-based business model that justify a large increase from current 30% operating margins. Rather the margins are on a downward trend due to acquisitions.
Liberty Interactive, run by John Malone, had been acquiring TripAdvisor shares over a long time and now holds 57% of the voting rights. John Malone himself owns 40% of LTRPA voting rights, which makes him the controlling shareholder. You get 0.42 shares of TRIP for every share of LTRPA that you buy (31/74) – I am counting only the cash flow rights.
CEO Greg Maffei has said:
- TRIP and LTRPA merger will likely not happen due to tax implications
- Alibaba mentioned as a potential acquirer (with a $25 billion war chest)
The value of majority control
According to an Israeli study, the price of 1 percentage point of voting power was worth about 2% of the firm’s equity. Another study showed that the value of a control block in Brazil, Chile, France, Italy and Mexico showed that the value was at least 25% of the market capitalization. A third study in Anglo-Saxon countries revealed a value of less than 10%. A fourth study showed an average control value of 14% of market cap. Having said that, take-over premia tend to be lower in countries with strong law enforcement, good investor protection rules and pro-investor takeover rules. The United States would qualify. We should therefore err on the side of caution and exclude the developing country study from the sample. It is worth noting, that when Liberty Interactive acquired the shares of then TripAdvisor chairman Barry Diller, it paid a 63% premium to the market price of $38 for non-voting shares. Such is the value of a controlling block of voting shares. I believe more of this value will be captured by the Series B shares (ticker LTRPB) than Series A as the voting rights are 10x larger, but liquidity is non-existent. We apportion the take-over premium below to voting rights of Series A (71%) and Series B (29%).
By far the largest part of the value of LTRPA comes from the shares in TRIP. The total value of these shares at market value is $2.7 billion. If you add $1 billion in premium for the fact that Liberty TripAdvisor holds the majority of the voting rights, you get a total value of $3,7 billion. The rest of the businesses in LTRPA, primarily in e-commerce website conglomerate BuySeasons are negligible. It has had a cash burn of approximately $10 million a year. Assuming 5 years to fruition for LTRPA to be taken over, the cash burn will be approximately the same to corporate level cash of $50 million. I expect John Malone to terminate this business as he is rational allocator of capital. Deducting corporate level debt we get to a total value of LTRPA shares of $3.3 billion, a 44% premium to last day’s price of LTRPA.
To gain control of TRIP, a potential acquirer needs to gain control of Liberty TripAdvisor as it holds 57% of the voting rights. To gain control of Liberty TripAdvisor, it is not enough to buy all Series B shares as they only provide 30% of the voting rights. John Malone also does not have character nor the track record of screwing minority shareholders in his holding companies. The most likely scenario is a full acquisition of LTRPA by a third party using shares as a currency as this would be the tax efficient option. In this case, I estimate a 40%+ upside to LTRPA shareholders with little or no risk given the opportunity to short equivalent TRIP shares at a very low cost (0.3% to borrow at Interactive Brokers). Liberty TripAdvisor is already in play, as has been indicated by Greg Maffei many times and a takeover offer is likely in the next year or two. It is hard to imagine a plausible downside scenario. Might Liberty TripAdvisor sell its TRIP shares on the open market (at a high tax basis)? Unlikely, given the track record of John Malone and Greg Maffei with regard to capital allocation.
Buy LTRPA and sell TRIP in the proportion 1:0.42 LTRPA:TRIP equivalent to 20% of the portfolio, as downside risk is deemed to be low.