Case Studies

Liberty Latin America Site Visit

In the fall of 2020, Liberty Latin America (LLA) completed the purchase of AT&T’s wireless business in Puerto Rico at an attractive price, merging LLA’s dominant fixed internet business on the island with AT&T’s dominant wireless business. We expect the convergence of fixed networks with wireless networks to continue for the next decade around the world. These mergers allow significant synergies as more of the wireless traffic can be offloaded at a low cost to the fixed infrastructure, the fixed connectivity deep into neighborhoods greatly reduces the cost of deploying 5G, customer churn is reduced, and customer servicing costs fall with some of the savings shared with the customer improving the offer. LLA is also pursuing this strategy of fixed/wireless convergence in Chile and Costa Rica, so we wanted to study its progress up close in their biggest market.

A couple of weeks ago, we were thrilled to have the opportunity to spend a day with Liberty Puerto Rico’s CEO, Naji Khoury, and his outstanding team. We spent time discussing their strategies for integrating the two systems and merging the customer relationships. We also discussed the business challenges and opportunities for Liberty Puerto Rico specifically and across the telecom industry. We visited one of their stores with Naji to learn how they are adapting to service fixed and mobile customers in a single retail format. We also spent time in the field with Ricardo Portela, the VP of Technical Operations, and a crew that was deploying new fiber optic cable to homes in a neighborhood and converting an existing hybrid fiber-coaxial (HFC) cable block to fiber. Essentially all new builds in Puerto Rico and across LLA are fiber to the home (FTTH). The cost to deploy fiber has declined and the costs to operate a fiber network are lower than HFC making fiber the future of fixed internet connectivity.

Figure 1. Cook & Bynum team and Liberty Puerto Rico team together in San Juan

Serendipity is an important part of on the ground research. While on the island, we made connections with smaller competitors and learned a lot from their perspective on competing with Liberty Puerto Rico. On the wireless side, we visited several stores of our two primary competitors, America Móvil and T-Mobile. Importantly, we also learned how frequent power outages are on the island since Hurricane Maria. The government-owned electric utility has been mismanaged for decades. As a result, most middle-class Puerto Ricans have some backup plan for dealing with these outages including generators, batteries, and solar panels. Management of the transmission and distribution part of the utility was recently privatized, and power outages should improve over the next few years. These outages impact Liberty Puerto Rico’s competitiveness. HFC cable systems require a power source at the junction boxes in a neighborhood to operate. When the power goes out in a neighborhood, the internet connectivity does, too. However, FTTH systems only require power at the modem in your home to operate since the signal is carried via light pulses down the fiber to a node. This difference during power outages is not material in most places in the world, but the high frequency of power outages in Puerto Rico makes it a meaningful competitive differentiator. We could not have learned of this competitive threat without visiting Puerto Rico.

In November of 2020, the FCC announced the results of the Uniendo A Puerto Rico Fund, a fund subsidizing the construction of a fixed broadband network to the entire island. Liberty won 55% of the municipalities and dollars ($71.5m) available in this process, with the remainder going to America Móvil. Each company will expand their network to provide all homes in each municipality with at least 100Mpbs service. We were encouraged that none of the small fiber overbuilders or wireless broadband competitors won any of the FCC money. We see the outcome of this process as creating a big disincentive for further overbuild on the island. In addition to the fixed broadband money, Liberty Puerto Rico has won $100m to improve its wireless infrastructure.

A few conclusions are worth sharing:

• Liberty Puerto Rico’s business is operating at a high level with significant momentum.
• We were impressed by the clarity of the objectives and the depth of the team at Liberty Puerto Rico.
• The financial benefits of fixed/wireless convergence will begin in the fourth quarter of this year and accelerate as we move towards the end of 2023.
• We expect the fixed/wireless convergence to work by increasing profits in Puerto Rico and many other markets around the world. This is significant because LLA is pursuing a similar strategy in Chile and Costa Rica.
• Liberty Puerto Rico’s most important competitor is America Móvil. In Puerto Rico, America Móvil is poorly managed with a bad brand, poor customer service, and spotty mobile and fixed networks.
• T-Mobile is being aggressive in the less desirable pre-paid mobile space and is acquiring customers. Liberty Puerto Rico plans to counter this threat by introducing a better pre-paid mobile program in the fourth quarter.
• Small FTTH internet companies are building networks in the wealthiest neighborhoods with the goal of stealing customers from Liberty Puerto Rico’s fixed HFC cable internet business. These buildouts have accelerated Liberty’s conversion of those neighborhoods from HFC to fiber. One of the competitors we met with has less total subscribers than the number of subscribers that Liberty Puerto Rico added last quarter. We will continue to watch what these small fiber overbuilders are doing closely, but it is not currently a major threat to Liberty Puerto Rico’s profitability.
• Power outages are a major problem in Puerto Rico, and Liberty Puerto Rico is accelerating the conversion of its HFC network to FTTH to address it.
While on the topic of LLA, we would like to highlight and update some of the topics we referenced in our first quarter 2018 letter when we first introduced the investment.

While on the topic of LLA, we would like to highlight and update some of the topics we referenced in our first quarter 2018 letter when we first introduced the investment.

On the subject of mergers & acquisitions, we wrote:

“Thinking beyond the company’s existing Latin American and Caribbean markets, Liberty LatAm is positioned to become a scale player in a region that currently lacks one. Liberty Global CEO and Liberty LatAm Executive Chairman Mike Fries is on record stating, “There is a massive consolidation opportunity in a market that remains highly fragmented.”

We expected LLA to be active with M&A at attractive prices, and they have exceeded our expectations by deploying more than $3 billion of capital in intelligent deals during the past three years. This amount exceeds LLA’s current market cap. Their deals include acquiring Cabletica in Costa Rica (2018), Searchlight’s minority interest in Liberty Puerto Rico (2018), UTS in Curaçao (2019), AT&T Puerto Rico (2019), Telefónica Costa Rica (2020), America Móvil Panama (2021), and forming a joint venture with America Móvil in Chile (2021). We anticipate reaping the benefits of these deals in upcoming years as meaningful cost and revenue synergies flow through.

We wrote about the opportunities to improve profitability in their Cable & Wireless unit:

“Liberty LatAm is continuing to improve the profitability of C&W, which itself was the result of the merger of C&W Communications and Columbus International in 2015. Since it acquired C&W in 2016, Liberty LatAm’s management has been focused on taming the company’s bloated cost structure, and the team expects to realize $150 million in annual savings by 2020 via headcount reduction, improved equipment procurement, and scale content acquisition.”

You can see in the chart below the progression of margins at Cable & Wireless, despite the headwinds posed by the pandemic in 2020 and so far in 2021.

Chart 1. LLA has significantly improved C&W margins

Source: Company filings.

We, also, wrote about the value offered by pay TV in LLA’s footprint when compared to that offered by U.S. cable operators.

“About 19% of the company’s 2017 revenues came from cable TV. While cable TV will be under both pricing and volume pressure as over-the-top alternatives (e.g., Netflix) continue gathering subscribers, cord-cutting is much more prevalent in the U.S. than other markets due to the historically high prices of cable TV in our country. Outside of the U.S., cable TV is much cheaper, and it provides some of the best value per entertainment dollar spent (expressed in cost per hours of content consumed). In fact, in many of Liberty LatAm’s markets cable TV remains underpenetrated and aspirational. With these cheaper prices, the incentive to cut the cord is greatly decreased, which makes cable TV revenues defensible and stable for some time.”

Note the table below to see how this has worked out so far. On an organic basis, LLA has gained organic pay TV subscribers while U.S. operators have lost them.

Chart 2. Unlike in the U.S., Pay TV is a stable part of LLA’s business

Source: Company filings.

The days of being a sleepy cable monopolist are long gone. Cheap capital, higher broadband penetration rates, and falling deployment costs are encouraging some overbuild nearly everywhere in the world. A great network, customer service, and fixed-mobile convergence are key to preserving profitability in the face of overbuild for cable companies. Liberty Latin America has been proactive on all these fronts and has done the right things to strengthen its competitive position everywhere. Being a converged player with the combination of the best fixed and best mobile network allows you to offer a better product to customers at a lower cost. This powerful combination enables market share gains and profitability as you are at a huge advantage to unconverged or poorly converged players. LLA is now fully converged in all markets, after M&A in Puerto Rico, Chile, and Costa Rica and years of fixed network upgrades in C&W. LLA remains one of the cheapest positions in our portfolio and trades at 8x our estimate of owner earnings. After it integrates recent acquisitions and completes accelerated network upgrades over the next two years, we expect LLA’s free cash flow generation to improve significantly.