Qurate Retail Inc. (NASDAQ: QRTEA)

Written on April 1, 2021

Price at time of writing: $11.82

Disclaimer: This report is not financial advice - please do your own due diligence.

Business Description

Qurate Retail is a global retailer focused on televised home shopping. The company’s main asset is QVC, which contributes 80% worth of the company’s yearly revenues. QVC is a channel that runs 24/7 where hosts advertise different products, including home décor, jewelry, and clothes. QVC itself can be thought of as two businesses: QxH, which includes QVC US and Home Shopping Network (which QVC acquired in 2018), and QVC International, for all QVC ex-US purchases.

The other marginal businesses are Zulily and Cornerstone: Zulily is an online retailer that offers daily deals and Cornerstone is an aspirational home retailer.

For the purposes of this writeup, we will focus exclusively on QVC as the other two businesses are small relative to QVC and its revenues are flat/in decline.

Variant View / Why Now?

Today, the stock trades at $12, which is 6 times free cash flow per share. We think that this is a harsh view (but more importantly, an attractive price) for a resilient business that has a:

Loyal and high-spending customer base
Asset-light and scalable business model
A+ and creative management team that is expediting the return of capital

1) Loyal and High-Spending Customer Base

QVC was an obvious COVID-beneficiary; the stock’s cheapness today represents the myopic view that as people begin to shop in brick-and-mortar stores again, QVC sales will inevitably decrease starting in 2H 2021. What the market has not priced in, however, is that QVC’S customer base is extremely loyal and has incredibly low attrition rates.

Consolidated customer count did increase by 9% in 2020, largely because of COVID. Total consolidated customers were approximately 16.5 million which includes 11.6 million QxH customers and 4.9 million QVC International customers. In total, QVC had 15.2 million and 15.5 million customers in 2019 and 2018, respectively.

Once a customer purchases her first order on QVC, there is a high likelihood that the customer will continue shopping on QVC for the rest of her life. QVC has long stated its durability of its 90-day test as an indicator of high customer lifetime value - about 25% of new customers will purchase a second order within 90 days of their first purchase. Even during COVID, this number remained stable, which indicates that these new customers have a similar profile to existing customers. We can also point to the fact that 86% of shipped sales during 2020 came from repeat customers as further evidence that QVC’s customer base is extremely loyal.

QVC also has an obsessive focus on retaining what they call a ‘best customer’, who they define as one that makes 20+ purchases in a year. And with good reason: best customers were 16% of all customers but account for 69% of all shipped sales in 2020 – remarkably close to the often-preached 80/20 rule. Moreover, a best customer will purchase, on average, 69 items in a year and spend $3.3k in any given year. Contrast this with the average QVC customer, who spends $1.4k per year on 27 items – that is still a lot of shopping. The most important takeaway, though, is that best customers have a 99% yearly retention rate, and 2% of new customers convert to best customers in their first year of joining QVC.

To entice new customers and personalize her shopping experience, QVC is transitioning from a purely linear TV model to a more personalized and interactive video ecosystem. This transition is necessary since new customers are more digitally driven, as 89% of new customers’ purchases were online, trending upwards from 79% 3 years ago. QVC has achieved this transition through continued engagement of their channel hosted in Roku, Amazon Fire, YouTube, and the QVC and HSN websites.

QRTEA’s management is constantly looking for new avenues to engage their customers. In Q1 2021, QVC is launching a web experience where users can create their own shopping networks and tune in to their favorite items and personalities. The goal is to create a more dynamic community using livestreams and allowing users to ‘tune in’ to live shows.

2) Asset-light and Scalable Business Model

QVC has built a scalable and high-margin business model. Since it has no floor plan, it can manage its inventory at its centralized warehouses, much more efficiently than a traditional brick-and-mortar retailer. This flexibility allows QVC to not only react quicker to changing trends and demand by testing different programming shifts, but also not worry about declining footfall into its stores. Gross margins have stabilized around 34% over the past three years, compared to Walmart’s 25%.

QVC’s asset light business model also presents an advantage over its competitors. Capital expenditures are ~$270 million, only 2% of revenues. These expenditures consist mostly of improved distribution centers, which should continue to enhance margins going forward.

3) A+ and Creative Management Team that is Expediting the Return of Capital

Qurate is run by an extremely experienced team in capital allocation, led by none other than Greg Maffei and John Malone from Liberty Media. John Malone effectively controls the company with over 90% ownership of Qurate’s super-voting B shares. Greg Maffei and CEO Mike George are the other two largest individual shareholders, each owning ~7 million and ~3 million shares, respectively, as of the April 2020 proxy statement. Performance bonuses are shareholder-friendly, since they are granted along the execution of three key performance indicators: revenue, operating income before depreciation and amortization (OIBDA), and free cash flow.

Over the years, they have demonstrated their flexibility to return capital to shareholders in creative ways at Qurate. Over the past decade, Qurate had proceeded with a levered-buyback approach, repurchasing close to $7 billion worth of shares. The market, however, did not respond positively to the buybacks as the company struggled to integrate HSN and Zulily into their supply chain. But in their 2Q 2020 earnings call, Maffei announced that Qurate was going to change directions. In September 2020, Qurate distributed $3 worth of an 8% yielding preferred security, and a $1.5 special dividend. Given that the common equity was trading around $10 when the return of capital went ex-, this represented close to a 45% return on capital on the basis. The preferred securities continue to trade above par, highlighting that these securities are not only money-good but also offer a healthy yield.

This new approach presents a more concrete opportunity for investors to monetize their cost basis rather than wait for terminal-year growth of their cash flows.

Valuation

After the most recent special dividend + preferred equity issuance, Qurate’s common equity is highly leveraged, yet trading at an insanely attractive free cash flow yield.

As mentioned previously, QVC benefited from COVID since its customer count increased to 16.5 million in 2020 from 15.2 million in 2019. Let’s assume, as a punitive downside case scenario, that QVC loses all those incremental 1.7 customers in 2021. This outcome is unlikely given QVC’s customer base, but the investment’s attractiveness shines through when you consider it in this light. Also assume that Zulily revenues decline by 5% YoY for the next five years and Cornerstone stays flat.

QVC’s yearly interest expense (including the preferred security) is ~400 million, and we assume a 25% tax rate for simplicity. Amortization and depreciation expenses are in line with expectations listed out in their investor presentations, and most net working capital items are maintained at the same % as of revenues as they have been for the past three years. The only item that was accounted for differently was the deferred tax liability. Malone and Maffei are experts at indefinitely deferring tax judgement day, but the day comes eventually – so the liability is paid down by $100 million for the next five years.

These conservative assumptions ultimately lead QVC to produce $950million - $1.1 billion of cash flow from operations and $700-850 million of free cash flow each year for the next five years. Given Qurate’s 428 million diluted shares outstanding, yearly free cash flow per share stands between $1.64 – 2.00. Qurate is trading today at $12, which implies that the duration to recover your cost basis is just six years - again, keep in mind that this was a downside case. This duration is insanely low for an operation the size of Qurate’s – a bet on Qurate’s equity represents little downside risk with massive upside potential over the next five years.

Risks

1) QVC is overly levered.

Mitigator: Qurate’s yearly interest expense (including its interest in the preferred security) comes at ~$400 million. Relative to Qurate’s yearly operating profit of $1.9-2.1 billion, a LOT would have to go wrong for Qurate to default, or raise additional debt to sustain operations.

2) QVC will be disrupted by Amazon.

Mitigator: Amazon has already tried to disrupt QVC in the past but failed. In 2016, it launched Amazon Style Code Live, which was its own take on a QVC-like shopping experience - it pulled the plug less than a year later. Amazon re-launched its service as ‘Amazon Live’ in 2019 (amazon.com/live), but there is no direct link to access it from its home page. Amazon does not disclose Amazon Live specific numbers, so as pure ‘anecdata’, I tuned into Amazon Live on a Tuesday at 8Pm eastern and found that the main stream had a grand total of…123 viewers.

It is also worth mentioning that QVC’s product offering is completely different to Amazon’s. When you browse items on Amazon, you already know what you want to buy. QVC has a fanatical fanbase that is already used to QVC and looks forward to tuning into QVC, even for pure background noise, when she is home. In fact, QVC is already mindful that its customer is incredibly price-savvy, which is why it is conscious of offering its products at attractive prices relative to its competitors.