The King of Cable Still Has The Midas Touch

Billionaire John Malone amassed a vast fortune by putting aside his emotions and relying on cold, mathematical logic. As he aptly put it: “They haven’t repealed the laws of arithmetic… yet, anyway.”

This month, Malone’s trading methods were made available to individual investors through a new exchange-traded fund (ETF). If you’re looking for growth opportunities in an overvalued and volatile market, this fund is worth considering.

Malone is one of the few individuals who can actually claim to be a mentor to super-investor Warren Buffett. With an estimated net worth of $9 billion, Malone is an icon of the cable industry. Over the course of his forty-year career, he pioneered many business and investment practices that seemed outrageous at the time but which are common practice today.

On December 1, Gabelli Funds launched Gabelli Media Mogul NextShares (NASDAQ: MOGLC), an ETF that buys shares in companies that Malone or his Liberty Media Group executives have started, spun-off or are investing in directly.

Christopher Marangi, portfolio manager of the new fund, was often asked by clients to name the Malone companies most worthy of investment. He finally decided to create a basket of the best of them. With net assets so far of $1.51 million, the fund seeks capital appreciation. The fund is priced daily and now trades at about $100 a share, with a reasonable net expense ratio of 0.90%.

Liberty-related investments encompass about 32 stocks, mostly in the cable and media industries, with a combined market value of roughly $340 billion. Gabelli Media Mogul NextShares will cherry pick the standouts.

It’s good to be the king…

Called “The King of Cable,” Malone now joins the rarefied circle of achievers who are rich and successful enough to merit an investment fund that tracks their financial decisions. And small wonder: Malone has delivered market-thumping returns to shareholders that exceed those of even the Oracle of Omaha himself.

Malone served as chief executive officer of cable and telecommunications giant Tele-Communications Inc. (TCI) from 1973 to 1996. AT&T (NYSE: T) purchased TCI in 1998 for $54 billion. Through a series of deals, AT&T’s cable television assets eventually ended up in the hands of Comcast Corp. (NASDAQ: CMCSA).

Malone is currently chairman of Liberty Media (NASDAQ: LMCA), Liberty Global (NASDAQ: LBTYK), and Liberty Interactive (NASDAQ: QVCA), all multi-billion-dollar media behemoths.

Veteran fund manager Chris Marangi is a student of John Malone’s trading methods. So are we. We’ve broken down the best investment practices of the King of Cable, so you can incorporate them into your own wealth-building strategy:

1) Spot Trends Early

Successful entrepreneurs (and investors) are able to view all relevant trends, synthesize them, and then make decisions based on what they think will happen down the road.

As an engineer with a Spock-like ability at analysis, Malone grasped earlier than any other cable executive that the crux to creating value in the fast-growing cable television business was to grow big through acquisitions.

Malone was alone among business executives to put aside income growth in favor of cash flow to fund expansion. The industry was dotted with smaller and weaker players; he gobbled them up like Pac-Man.

2) Maximize Leverage

By expanding the size of TCI, Malone maximized both financial leverage and leverage with suppliers, particularly programmers.

In a cable television system, the largest total operating expense is fees paid to programmers (HBO, Showtime, MTV, ESPN, etc.). The bigger a cable company, the better it can negotiate lower programming costs per subscriber. In turn, the more subscribers a cable company has, the lower its programming cost, and the higher its cash flow, per subscriber.

As the head of TCI, Malone pursued these economies of scale with relentless single-mindedness, more so than any of his peers in the industry.

For investors, that means using the various tools at your disposal to leverage gains. A good way to harness the power of investment leverage is to buy a stock of a company that uses leverage at the corporate level (such as, say, a gold mining stock).

Corporate leverage (aka, debt) is a powerful driver because it directly multiplies the corporate earnings of the company, which in turn drives stock prices.

3) Look for Hidden Value

In seeking to buy companies, Malone created simple value criteria: only acquire another cable operator if the price translated into a maximum multiple of five times cash flow after the easily discerned benefits from programming discounts and overhead cost reductions had been implemented.

He often performed these calculations on the back of a napkin. In this manner, he unearthed the hidden value in an acquisition.

Just like Malone and Buffett, you should be a value player who pinpoints investments with prices that are unjustifiably low according to their inherent worth. A value investor looks for strong balance sheets, robust cash flow, quality products, market domination, and astute management.

4) Challenge Orthodoxy

The most successful investors think for themselves and avoid conventional wisdom. Few leaders in American business history were more adept at challenging the status quo than Malone.

Case in point: During the early days of Malone’s rise, Wall Street focused on earnings per share as the key metric for evaluating a company. Alone among his peers, Malone rejected this notion to instead emphasize cash flow. At the time, it was a radical approach.

In the process, Malone single-handedly invented a new financial lexicon, one that’s taken for granted today. You’ve doubtless heard of the term EBITDA (earnings before interest, taxes, depreciation, and amortization). Well, it was Malone who brought it to the fore.

Malone embraced EBITDA because it sharply defined the cash-generating power of a business before interest payments, taxes, and depreciation or amortization charges. Earnings were taxed, but cash flow could minimize taxes and also serve as steroids to expand a company’s scale.

Malone sheltered TCI’s cash flow from taxes by leveraging debt to build new systems and by depreciating the costs of construction. In fact, as TCI hiked its cash flow by twentyfold during Malone’s tenure, it never paid significant taxes.

Do you have a comment about Malone’s methods, or about investing in general? Drop me a line: — John Persinos

A peek inside the black box…

Malone’s success underscores the importance of unwavering focus on a disciplined strategy. The same holds true for us as investors.

Jim Pearce, chief investment strategist of our flagship publication Personal Finance, has taken that approach for years. But he always knew he could do better. That’s why he partnered with an MIT-trained engineer for years to create the most rigorous, disciplined trading system in our company’s history. It’s called the Rapid Profits Matrix system, and after testing it himself Jim opened up a limited number of spots in October. He called this new service Systematic Wealth.

Here’s a look at what a few of those charter members are saying, after only 2 months of use.

“Thanks, Jim. SW is working very well for me” – Roger H.

“Thank You, Jim Pearce!!!! IF I were a woman, I’d hug and kiss ya…..LOL”  – Larry J.

“At least everything you’ve recommended on Systemic Wealth has gone up and right now HCHC is my only loser despite the drop in the Dow and S&P. So you are definitely delivering on your promise and I am very grateful.” – Janis B.

During uncertain times such as these, it’s imperative to use a rigorously objective process for identifying stocks that are priced fairly and offer significant upside potential. As John Malone said: the laws of math still apply. That’s why we’ve decided to open up access to this system one more time before year end. Go here to access Jim’s new trading system now, while it’s briefly open for new investors.