Liberty Interactive (LINTA) is one of two tracking stocks created in May 2006 for Liberty Media, which owns a broad range of businesses, including electronic retailing, cable television, video programming, media, broadband distribution, and interactive technology services. The tracking stocks were created to unlock the value of Liberty Media, which was trading at a discount. Liberty Interactive comprises the following businesses -- QVC, home shopping through TV and the Internet Provide Commerce, which retails perishables such as flowers, meats, fruits and candies through its website BUYSEASONS, that operates BuyCostumes.com, an online retailer of costumes, accessories, decor and party supplies and Backcountry.com the operator of leading outdoor and action sports eCommerce sites (Backcountry.com, BackcountryOutlet.com, TramDock.com, DogFunk.com, SteepandCheap.com and WhiskeyMilitia.com). Liberty Interactive also includes Liberty Media's 25% stake in Expedia, an online travel agency, 24% interest in IAC/InterActiveCorp, and 20% interest in GSI Commerce, which offers e-commerce solutions to brick and mortar retailers. In addition to the U.S., the company operates in Europe, South America and Asia.
Liberty Media's other tracking stock is Liberty Global group, which includes all of Liberty's assets that are not attributed to the Liberty Interactive group, including Liberty's interests in Starz Entertainment Group and News Corporation.
We think Liberty Interactive can achieve mid-teens EPS growth on average over the next four years driven by low double-digit revenue growth and expanding margins, as higher-margin Internet sales accelerate, overseas margins expand significantly, penetration of the higher-end designer market rises, and stock buybacks continue.
Leading Market Share
QVC is the leading home-shopping retailer with a 63% share of the market, far ahead of its largest competitor HSN, which holds a 26% share, and ShopNBC, which has a 7% share. QVC's channel positioning is a major competitive advantage. Roughly 42% of its viewers can find "below channel 15", compared with HSN, which has 11% viewership for its "below 15" channel.
QVC reaches about 91% of U.S. television households, and with roughly 7.5 million domestic customers has an 8.3% penetration among households. While we think "television homes reached" has plateaued it has been flat for several years the customer base is stable with more than three-quarters being repeat customers who tend to spend more each year as they become comfortable shopping through television. Recently, QVC has added several high-end designer clothing lines, and we expect more high-end lines to be added in the coming months, diversifying QVC's customer base, and raising its average selling prices (ASPs). We think QVC can continue to grow revenue at a CAGR in the mid single-digits of the next five years, driven by higher ASPs (up 1% in 3Q07), a 1% growth in purchases per customer and 0.5% increase in market penetration. Near-term into late 2008, however, we expect the challenging retail environment to constrain QVC's growth to the low single digits, or slower if domestic consumer confidence worsens (revenue was up just 2% in 3Q07).
Leveraging Strong QVC Brand Eliminates Advertising Costs
Liberty's Internet operations are a primary growth engine. We expect QVC.com to continue leveraging the QVC brand to rapidly grow its Internet operations, which currently account for 21% of domestic sales. QVC.com is on track to grow its revenues and EBITDA at a low teens rate, and we think it can continue growing aggressively over the next few years, albeit at a decelerating rate as the operations grow in size. Moreover, QVC.com's margins are higher than Internet retail competitors because its advertising spending is almost nil compared with 15%-20% for most online retailers the company leverages the QVC home shopping network's brand and generates customers from among those who view the TV channel. Further, QVC.com shares a warehouse with the network and thus lowers its overheads.
QVC is poised to tap the higher-end segment of the market with plan to add top tier brands to its collections backed by new marketing and advertising campaign that showcase the company's new catchphrase iQdoU', and the new logo Q'. The top tier brands include Harry Slatkin, one of the leading home fragrance brands, Calvin Klein Intimates, Samsung electronic goods, Garmin, which is the number one Global Positioning System (GPS) provider, Skil power tools, and Acer computers, which is one of the fastest growing computer brands. QVC rolled out its new comprehensive redesigned QVC.com website, which includes an integration of the video and web experience, and improved shopping tools in a more compelling visual design that is aligned with the brand new look.
International Margins Poised to Grow with Scale
International operations, which account for roughly 30% of revenue (2006) are expected (reasonable, in our opinion) to grow in the low double-digits through 2007. Moreover, as the company achieves scale in international markets margins should expand moving closer to domestic EBITDA margins of 23.5%.
Acquisitions: A Secondary Source of Growth
The company is also driving growth though strategic acquisitions. During 2006, the company acquired Provide Commerce and BUYSEASONS (the operator of online costume retailer BuyCostumes.com), and in 2Q07 the company completed the acquisition of Backcountry.com. The company is seeking other immediately accretive acquisitions of online commerce companies with strong management teams and good track records to drive sustained growth at Liberty Interactive.
Share Buybacks Could Continue to Bolster EPS Growth
Since the creation of the Liberty Interactive tracking stock in May 2006, Liberty has repurchased 97.9 million shares 14% of the shares outstanding at the time of creation of the Liberty Interactive tracking stock at an average cost of $20.15 per share for a total of $1.975 billion. There is another $1 billion remaining under its repurchase authorization. We would not be surprised to see it request board authorization for additional buybacks as it seeks to deploy its increasing free cash flow (we note that management expects a 3-5 year CAGR in operating cash flow in the high single to low double digits) and control leverage in a targeted range. Management has indicated that it feels a leverage ratio (Net Debt/EBITDA) in the range of 4x to 5x is appropriate for the company up from its previous target of 3x-4x.