It is commonplace to hear talk about how the Coronavirus pandemic will accelerate the rate of change for how we fundamentally live, work, and play. Not being able to leave your house for a few weeks has forced people to rethink their willingness to buy couches without sitting in them, cars without test-driving them, and vegetables without checking their ripeness. Inevitably, everyone is going to buy cars, clothes, groceries, and furniture online and have it delivered to their doorstep in two hours or less. The consensus is that Amazon is going to win the lion’s share of this business as we move from a brick and mortar world to a virtual one. Yet, Amazon (and Wayfair and Instacart et al) have yet to solve some fundamental problems – what should I buy when I don’t know what I want? what if I need help choosing the best product for my needs? what if I just want some retail therapy? Kit Yarrow, a consumer psychologist, has discussed the reasons why we shop. In a Time Magazine article, she lists the following reasons as the psychological factors that drive humans to shop:

• We shop to visualize the future just like Steph Curry visualizes his next 3 pointer to improve performance and reduce anxiety.
• We shop to increase our confidence. There is truth to the statement that “clothes make the man.”
• We shop to indulge our creative side – a collector of scotch or purses or belts can tell you what intricate details make the products special to them.
• We shop for relaxation and escape – a way to escape from daily stresses at the home or office.
• We shop for connection with others.

It is these factors that have given retailers like Best Buy, Home Depot, and Nordstrom a way of competing with Amazon on service, selection, and curation. But, what if there was a retailer that excelled at the shopping experience (connection, entertainment, escape) but also had the positive characteristics of its ecommerce competitors (convenience, endless inventory, minimal capital required)? It exists and has existed for almost 40 years. QVC is a retailer with the magical attributes of a SaaS business.
I already know what you’re thinking: are you f*cking kidding me? Isn’t that just a bunch of scammy As Seen on TV products? Isn’t it just taking advantage of uninformed old ladies? Let me assure you, it is not; by the time we are done hopefully you’ve been convinced as well.

So, first off, let’s get a flavor for the kind of experience that draws QVC viewers back day after day, week after week, month after month, year after year. You may not be their target demographic but you have to concede that this isn’t some infomercial impersonal hard sell – the hosts are providing entertainment, empathy, information, escape, discovery, and social connection – just like a girls trip to the mall. Even though this is just a blooper reel from a few years ago, you’ll understand what attracts people. In fact, you will see why many initially watch QVC even with no intention to buy a product. Enjoy the video.

Maybe, you caught Jimmy Fallon in there? Hopefully, you got a good chuckle out of whatever you watched. If you want more, there are tons of videos on YouTube. Otherwise, let’s get to it. I’m going to break this deep dive up into the following parts:

HISTORY OF QVC
STRATEGY
WHO IS A QVC CUSTOMER?
FINANCIAL MODEL
MANAGEMENT & CAPITAL ALLOCATION
RISKS
RECENT DEVELOPMENTS

HISTORY OF QVC

QVC was not the first television shopping channel to get on-air. That honor goes to HSN which actually started as a radio program in 1977 before making the move to cable in 1985. But, in 1986, serial entrepreneur Joseph Segel (Franklin Mint, NSTL) with backing from Ralph Roberts at Comcast saw an opportunity to change how products were sold online and started QVC. He insisted upon building a relationship with the customer, avoiding the hard-sell, and informing and entertaining. They started using celebrities like Susan Lucci and Joan Rivers to endorse products and even signed a two-year deal with Sears to add legitimacy to their offering (this was when people actually shopped at Sears). Over the next few years, he acquired the Fashion Channel, CVN, and JC Penney’s Shopping Channel thereby consolidating the industry down from tens of competitors to 2 main channels by 1992 – Home Shopping Network and QVC.

The real star power started coming in 1992 when Barry Diller bought a 3% stake and then became CEO when Segel retured in 1993. As an aside, QVC attempted to bid for Diller’s former company Paramount Communications and eventually lost out to Viacom – QVC owning the rights to Top Gun and Trading Places would have been … interesting. Anyway, under Diller, QVC began the process of launching new networks, domestically (Q2) and internationally (Grupo Televisa in Mexico and BSkyB in Europe). In 1995, ever the dealmaker, Diller tried to merge QVC with CBS but The Roberts’ didn’t want to lose control of their prized asset so Comcast and Liberty Media acquired it all for $2.2 billion (Liberty would shortly be merged into TCI as well). The controlling shareholders already own ~35% (Liberty 18.5%, Comcast 16%) and once the deal was completed, Comcast owned 57% and Liberty owned 43%. They promoted QVC EVP Douglas Briggs to CEO to take Diller’s place and QVC had gross sales of around $1.4 billion at this time.

In 1997, sales climbed above $2 billion. By 2003, Liberty, which was now a spin-off from AT&T which in turn had acquired TCI in 1999, exercised its rights in its agreement with Comcast and acquired all of QVC at a $14 billion valuation. During this time, QVC reached over 85mm households and had grown to represent more than 30% of Comcast’s overall business! You should spend a minute to think about that – both from the angle of how large a portion of Comcast it was and also from the point of view of how Comcast has grown and changed since. Meanwhile, Liberty Media also had stakes in AOL Time Warner, News Corp, Starz, Discovery, Interactive Corp (hi again, Barry!?), Motorola, and Sprint – all familiar names to students of John Malone.

You might be surprised to know that QVC was not only growing rapidly but also remained at the forefront of retail. They saw the importance of online retail and had websites in the US, UK, and Canada by 1998 and 10% of sales came through its websites in 2003 growing to 25% by the Great Financial Crisis. They even had a brick and mortar store at the Mall of America. Mike George, CMO at Dell, became CEO of QVC on April 15, 2006.

As QVC continued to penetrate more households, it grew sales and profits rapidly during the 2000s. US household pay TV penetration would peak in 2014 at 108 million homes and international sales would peak due to currency headwinds in 2012 at $2.9 billion. QVC would repeatedly state that future growth would be harder to come by as they saturated their markets even as they launched new channels in established markets and tried to launch new markets in Italy and France. In 2013, they announced a 49% stake in a Chinese JV with China National Radio to try and enter the most populous market in the world. Continuing to search for new avenues of growth, they acquired Zulily in 2015 as a way to tap into a younger consumer and grow their online capabilities. Still, 2016 saw their first sales declines outside of a recessionary environment and fears around cord-cutting, linear TV, and Amazon’s Death Star soured investor sentiment.

Liberty, through its stake in Interactive, found itself with ownership of 38% of their main competitor, Home Shopping Network. After a long dance, they finally purchased the 62% that they didn’t own in 2017 along with the promise of significant synergies. They folded the HSN business into QVC and renamed the segment QxH in 2019. QVC France was shuttered that same summer; an acknowledgment that de novo home shopping was no longer a viable strategy. Sales declined throughout 2019 and household penetration in the US was down to 92 million homes while international remained relatively flat at its highs. Worryingly, trailing twelve month customer count also declined for the first time.

And, this brings us to today in the midst of a pandemic. The company’s cash flows are holding up well – they continued to broadcast and ship goods throughout lockdowns around the world. Meanwhile, merchants are looking for an outlet to move inventory. Anecdotally, performance marketing spend was up >1000% as QVC tried to capture new customers. And, on their Q1 2020 call, they were quite optimistic about customer and sales growth despite retail brick and mortar traffic down 70% in the first week of May! (NOTE: I started writing this in April and QVC has since reported some astounding growth metrics during Covid-19 which we will touch on at the end of this post.)

Qurate’s strategy is to provide its predominantly female shoppers with a different and more pleasant shopping experience than anything found online. They aim to recreate the feeling of a girls’ shopping trip whose vibe is more “Let’s see what we can find to buy while we entertain ourselves!” than “I need to re-stock toilet paper and toothpaste.” Amazon has quite a bit of Qurate-envy and has tried on a couple occasions to copy parts of the QVC model – more on that later. The slide below describes some of the differences between the experience for the end consumer:

The list above brings to mind Charlie Munger’s lollapalooza effects. Some of the psychological biases at play are the following:

• Scarcity bias – Each day’s TSV – Today’s Special Value is only available for a short time. Hosts will let shoppers know that products are almost sold out.
• Social proof – Knowing that a product is selling quickly encourages shoppers to view it favorably.
• Liking bias – Shoppers create one-way friendships with the hosts and studies show you are more likely to trust people you like.
• Authority bias – Products are often sold by their creators or celebrities.

So, the elements above are great but it’s all for naught if you get to the store and all the products suck. Here, again, Qurate excels with a very powerful product funnel – almost 1/3 of what they sell is exclusive to QVC/HSN. They constantly bring their shoppers things that are new, different, and special. They also get real-time feedback from sales and let the customers guide them on what products they are interested in most: a retailer with a constantly optimized floorplan.

Maybe the most important part of the equation (and what’s most relevant investment-wise) is making sure that the shoppers know where to find the “store.” Qurate has been at the forefront of meeting the customer wherever she wants to be: cable TV, online, mobile, Roku, AppleTV, over-the-air, etc. They have historically done this by providing a strong value proposition for their distribution partners; paying them up to 5% of sales as commission. This tactic incentivized the cable MSOs to give QVC very favorable channel placement. As the TV ecosystem has become more fractured and customer viewing habits have changed, Qurate has taken advantage of online and performance marketing to drive new customers to their streams and channels. Still, this is the main risk to the business model. I am highly confident in the value proposition but you still need customers to walk through the metaphorical doors if you want to make a sale.

When we combine all of the above, you end up with a customer base that is extremely loyal and feels like they are part of an exclusive club.

WHO IS A QVC CUSTOMER?

It is commonly believed that the stereotypical QVC customer is old, not financially savvy, not hip, and a gimmick shopper. Below, some charts that should convince you this isn’t the case. (As an aside, Qurate is one of the most data-focused companies I’ve come across. They KNOW their customers and their habits and they are constantly optimizing the business around their data.) First up, their new customers are skewing younger over the last couple years . So, we are still talking about a woman in her late 30s to mid-50s, most likely a mom with kids with disposable income, looking for an easy escape and a deal.

And, this next chart is the one that made me think about QVC differently. These women are not being tricked into buying gimmicky products with a hard sell. They are savvy shoppers; they like nice things at good prices. A QVC shopper is 3.0x more likely to shop at Saks than the average woman! They are also more online – not living in the Stone Age – as evidenced by their increased propensity to shop at Wayfair (1.9x) and Amazon (1.2x). You don’t get much less retain this quality of customer by doing cheap tricks.

This brings us to the idea of retention. How does Qurate do when it comes to keeping their customer in the ecosystem? Extremely well. You would be forgiven if you quickly glanced at QVC’s retention and cohort data and thought you were looking at a SaaS business. 90% customer retention, stable purchase frequency, and growing customer value. Subscription retail before it was cool.

The team has been laser-focused on what they call their best customers. These customers follow the 80/20 rule i.e. in that less than 20% of all customers make up >70% of sales. They buy more than 1 item a week and spend a few hundred dollars a month. They also have better retention characteristics than smokers(!) as 99% return year after year.

Their thesis is that if they can convert just a tiny portion of their new customers to best customers annually then they will have a strong viable business for many years into the future. It’s important to note that they have been converting customers at stable rates for years – despite OTT, Amazon, competition, etc.

FINANCIAL MODEL

The “one-showroom” model allows for a business model that has very low working capital and capital expenditure requirements. This leads to very high margins for a retailer – in fact, better than almost all.

And then, QVC converts OIBDA to FCF at very high rates. The recent 42% rate is conservative given they are digesting their HSN acquisition..

MANAGEMENT & CAPITAL ALLOCATION

This is a John Malone company and it has been run as such for a long time. The team is allergic to taxes, they make heavy use of financial engineering and buybacks, and they like to do strategic/ accretive deals. CEO Mike George has been running QVC for almost two decades; he is always selling. Always. He is also laser-focused on the data – constantly tweaking the sales algorithm to keep in step with the customer. Greg Maffei is the chairman of the company and has been John Malone’s consigliere ever since Malone referred to him as the “put warrant guy” from his days as the CFO of Microsoft. His financial engineering skills are unparalleled. See the Recent Developments section below for the latest maneuver at QVC to unlock value. And finally, John Malone is probably the best media investor of all time. He combines a strong engineering background with uncommon business sense. His track record is on par with Buffett’s in both percentage terms and persistence over time.

I won’t go into the long and winding path that Qurate has taken to get to its current asset-backed status except to say that owning QVC has been a winning trade whether the ticker was LMCA, LINTA, QVCA, or QRTEA. There have been significant and substantial capital allocation homeruns made through use of QVC cash flows. For example, today there are many very happy owners (including myself) of GCI Liberty which was preceded by Liberty Ventures, an offshoot of QVC during its Liberty Interactive days. GCI LIberty owns a large stake in Charter and the most significant cable asset in Alaska. Anyway, this is all another way of saying that if the QVC business were dying (which it’s not), Malone and crew are savvy enough to reinvest the cash flows elsewhere. As I said before when I wrote on capital allocation, management matters.

RISKS

Let’s talk about the bear case a bit. I’m going to use a couple excerpts from interviews with Qurate executives to address cord cutting, fragmentation, and the Amazon/Facebook threat. Please reach out if you want more information on the interviews I’ve conducted.

RECENT DEVELOPMENTS

It turns out that if you tell the entire population of a country that they must stay home for 3 months and shut down malls, home shopping is a beneficiary – a true captive audience. Who knew? When Qurate reported Q2 2020 earnings, they showed extraordinary numbers that even most bulls would never have modeled. They were a massive beneficiary of the lockdowns. While the revenues and OIBDA jumped by 10% each, the more important numbers were around customer metrics because that is the engine of future growth. And on that front, they set themselves up for a great 2H2020. There’s no reason to believe that these customers won’t convert in the same manner as the ones who have come before them for the last three decades.

Simultaneously, the Board declared a massive return of capital which included a special dividend and a clever preferred stock dividend with an 8% coupon. They are attempting to force the market to value the business correctly. My best estimate is that as of 8/31/2020 the equity FCF yield post-dividend will be north of 40%.

This writeup has gone on for way too long and it has not actually touched upon many important parts of the story. However, I hope that in these 3,000 or so words, I’ve been able to paint a picture of a company that isn’t about to disappear overnight and, on the contrary, may be on the cusp of growing sustainably again. As for the things I’ve left out, you, the reader, should make sure you understand the International business (and China), Zulily’s turnaround strategy, the synergy opportunity from the HSN acquisition, their green energy investments, and everyone’s favorite: exchangeables!

Please comment below or contact me at info@micawber.us with questions or critiques.