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Why Investing in Liberty Capital Is Almost a Sure Bet

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As always, there are risks. But Liberty Capital is a media-tracking stock that's a lot like a dollar you can buy for $0.58.

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Editor's Note: Michael Brush is the editor of the stock newsletter Brush Up on Stocks and a weekly market columnist for MSN Money.


Usually when something look too good to be true, it is. But the John Malone media-tracking stock Liberty Capital (LCAPA) appears to be a clear exception to this rule -- one that can be a great way to make some money.

Why? Because it's a lot like a dollar you can buy for $0.58. This makes it a relatively safe buy-and-hold value stock that should produce decent returns within 18 months, or a way to generate income with a simple options play.

Here's what I'm talking about. Liberty Capital is a tracking stock that represents the value of a bunch of assets inside parent company Liberty Media. Those assets range from a big stake in Sirius XM Radio (SIRI) to the Atlanta Braves baseball team.

The key for investors: Liberty Capital stock trades at a 58% discount to the value of all the assets that back it. The stock recently sold for $48, but the collection of assets it represents add up to $82 after debt, according to Robert Routh a media analyst with Wedge Partners.

I think investors can exploit this valuation disconnect for fairly safe profits. In the July 28 issue of my investment newsletter, I suggested shorting the Liberty Capital $40 and $45 puts with September and October expirations. Since then, the two positions with September expirations are up 55%-65%, and the two with October expirations have gained 15%-30%. I'm telling my readers to roll positions over when these expire.

I think all of those positions will eventually produce 100% gains -- because that huge valuation discount provides a cushion of support for Liberty Capital stock. This cushion means that when you sell someone out-of-the money Liberty Capital puts, it's more likely they'll expire worthless. Of course, the stock could also get put to you, let's say in the event of an overall market panic that takes Liberty Capital stock down a lot. But that wouldn't be such a terrible thing since the stock would likely rebound sooner or later -- again because of that huge discount.

Here's some more detail. As a tracking stock, Liberty Capital represents the value of the stock holdings of its parent Liberty Media in Sirius XM Radio, Time Warner Cable (TWC), Time Warner (TWX), Sprint Nextel (S), Viacom (VIA), Motorola (MOT), AOL (AOL), Live Nation Entertainment (LYV), and CenturyLink (CTL). All of this plus a few other stocks and the value of some media assets recently added up to $107 per share for Liberty Capital, calculates Routh, who regularly makes some great calls on media stocks. Subtract around $25 in debt, and you get an enterprise value of around $82 for Liberty Capital. That's the tracking stock that sells for just $48.

Why the huge disconnect? First of all, a lot of mutual funds cannot own tracking stocks, which reduces demand for the Liberty Capital tracker. Second, Liberty Capital is saddled with a "complexity discount" -- meaning the situation is so confusing many investors just avoid it. Plus, there's no guarantee the discount will ever go away.

For buy-and-hold investors, what might make that happen? One catalyst will be ongoing share buybacks, believes Scott Stevens of Strata Capital Management, which owns the Liberty Capital tracking stock. Stevens is worth listening to because Strata Capital Management was up 11.1% year-to-date net of fees as of August 17, compared to a 2% decline for the S&P 500. Next, believes Stevens, Liberty Capital has over $2 billion in cash, and it might use some of for an accretive acquisition.

And eventually, Liberty Capital should be converted from a tracking stock to a regular asset-backed common stock, which would help the complexity discount go away. Malone should get the ball rolling on this front when he converts another stock tracking assets in the Liberty Media parent company. That tracker is Liberty Media Interactive (LINTA) which represents the Liberty Media's home-shopping channel QVC and a stake in Home Shopping Network.

The conversion should happen around the end of this year or in the first quarter of 2011. That alone might wake other investors to the potential in Liberty Capital because it's on the same track, and put a bid underneath the stock. A third Liberty Media tracker will also be converted at some point, or Liberty Starz Group (LSTZA) which represents Liberty Media's Starz Encore pay TV channel. Another catalyst might be the sale of the Atlanta Braves by the end of 2011.

Of course there are risks here. Much of the value behind Liberty Capital is in the form of other stocks. So if all those stocks sink in a big market meltdown, Liberty Capital will fall, too. Liberty Capital is particularly exposed to the fate of Sirius XM Radio. Through ownership in convertible preferred stock, Liberty Capital effectively owns 40% of Sirius. Every $0.10 move in Sirius stock equates to a $2.80 change in the net asset value of Liberty Capital, calculates Stevens.

But even if Sirius stock were cut in half from recent levels of around $1, Liberty Capital would still have an enterprise value of around $68 by Routh's calculations -- or well north of its $48 stock price. And given the turnaround in play at Sirius, it seems unlikely its stock will fall that hard. But in this economy and this market, stranger things have happened.

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No positions in stocks mentioned.

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