Description

Investment thesis

1)      Cable One owns top tier cable assets (in non-urban, secondary, and tertiary markets that attract significantly less competition), is run by the best operating team (industry-leading margins, differentiated strategy) and does not suffer from poor corporate governance issues.

2)      Valuation on an EV/EBITDA basis has collapsed almost 60% from the peak to trade at 7.7x 2023E numbers.  This valuation is an all-time low for the company and is an overreaction by a market that wrongly assumes that growth will turn negative as the competitive landscape goes from extremely attractive (currently over 70% of footprint has no other broadband provider capable of offering service of 100Mbps or higher) to irrational, in the market’s view. 

3)      Cable One is worth ~$850/share if it were to stop growth and just stay at steady state.  At current prices, the market assumes growth and competition will destroy almost 10% of that steady-state market capitalization.

What CABO does

Headquartered in Phoenix, AZ, Cable One is a cable broadband provider to residential and business customers in 24 states, with about ¾ of customers located in the following seven:  Arizona, Idaho, Mississippi, Missouri, Oklahoma, South Carolina, and Texas.  The company provides services to approximately 1.2m residential and business customers, with approximately (as of 12/31/21) 1.05m subscribed to data services, 261k to video, and 149k to voice.  For the 12 months ended 6/30/22, thhecompany generated $1.7bn of revenues.

(Source:  Company presentation)

Cable One was spun-off from Graham Holdings Company on July 2015.  It focuses on non-metropolitan, secondary and tertiary markets.  Since a 2013, Cable One has had the correct –but then controversial– differentiated strategy of de-emphasizing video subscriptions and PSU’s to emphasizing growth in free cash flow by focusing their business on residential broadband and on business services. 

The company offers Gigabit data service to virtually all of its homes passed and expects to deploy DOCSIS 4.0 in late 2022, which will enable Cable One to offer symmetrical Gigabit speeds.

Why the assets are valuable

Secondary and tertiary markets are more valuable because they do not attract as much capital as urban assets.  The fact that many of these markets cannot sustain multiple operators serves as a barrier to rational capital.  According to the latest 10-K, the company does not have a competitor capable of offering 100Mbps or higher in over 70% of its footprint.  Of the approximately 30% that do, 18% (60% of the “real” competition) do so with fiber to the premises.  While this number is higher than in previous 10-K’s, the company mentions that the increase has been mainly due to acquired operations and improved tracking capabilities.

(Source:  Company presentation)

Cable One has made the most out of these assets with the right strategy.  Residential broadband and business services exhibit lower in churn, higher margins, and lower in capex requirements than video.   At the time, that strategy was somewhat controversial but Cable One has proven to have the best assets and management, growing faster than larger peers and with industry-leading margins.  Notably, Cable One has expanded margins and broadband ARPU’s without taking pricing actions (other than packaging and upgrades by consumers to higher speeds) since 2015. 

Cable One’s strategy of deemphasizing video and investing in its plant has yielded strong results.  Even though usage has more than doubled in the past five years, Cable One’s plant has become more efficient and utilization at peak has remained in the 20’s% recently.

Valuation

Every several years, the cable industry is the subject of doom projections.  In its latest iteration, competition and this time around, the market is pricing in a perfect storm.  At just over 8x EV/EBITDA (including stock compensation), Cable One is trading at all-time low levels, down from a multiple of around 18x about two years ago.  My numbers project EBITDA including stock compensation well into the $900mm range for 2023 and close to $1.14bn in 2024 assuming the company acquires the 55% stake in MBI it currently does not own.

For 2023, Cable One has a ~7.7% FCF yield (approximated as EBITDA less capex) for a business that is still growing, continues generating strong FCF, and is fairly recession resistant.   Few other areas of the market offer opportunities this attractive.

Fear in the market

Cable companies benefitted from Covid, seeing increased adoption of their services, but over the last year or so, the market has become increasingly –excessively– pessimistic about the sector and the company.  Competitive announcements –mainly of new fiber-to-the-premise projects and to a lesser extent 5G– have convinced the market that competition will ruin the market for everyone. 

My research indicates that 5G is not a big threat.  It will be a negative, on the margin, but wireless just means less wired.  It is unlikely to displace the need for wired connections to the home.  The main concern is an irrational pricing war among competitors that are able to offer very high speeds.

While a larger percentage of Cable One’s markets will become truly competitive (defined as speeds of over 100MBps) in the coming years, it is coming from a low base.  Furthermore, Cable One already competes in ~30% of its markets.  While those markets are less attractive than the uncompetitive ones, my research suggests that pricing if far from irrational.  The most likely outcome in three years, as I see it, is duopolies in ~40% of Cable One’s markets, with ~10% of those markets having more than 2 broadband operators.  MoffettNathanson saw it as follows last year:

The main competitor to Cable One is AT&T.  For years, AT&T could reliably be expected to shoot itself in the foot, with capital allocation all but assured to destroy shareholder value and benefitting Cable One shareholders.  While AT&T has gained some discipline, expectations have become too draconian and do not justify the ~55% drop in EV/EBITDA valuation for Cable One.

Inflation hits the incumbent less hard

Inflation and shortages will hurt all participants but the effect will be greater for the companies that are currently building fiber (AT&T, Frontier, etc) as opposed to simply upgrading from DOCSIS 3.1 to 4.0, like Cable One is.  Management estimates that rebuilding with fiber is ~5x as expensive as it will be for Cable One to go to DOCSIS 4.0.

Management

Julie Laulis became CEO in 2017, replacing Tom Might, who engineered the contrarian strategy ten years ago (Might is still a member of the Board and his industrial engineering background still permeates the organization).  Laulis has been with the company since 1999.  Todd Koetje joined Cable One in late 2021 and became CFO earlier this year.  He used to be a Managing Director in SunTrust Robinson Humphrey’s leveraged finance group. 

Management is compensated on adjusted EBITDA growth and adjusted capex as percentage of adjusted EBITDA.  Compensation is nowhere near the absurdly high levels observed at companies where John Malone is involved.  Cable One does not have corporate governance issues either.  It has a single class of shares and is in the process of removing a staggered Board. Compensation is very reasonable and significantly below other companies in the sector.  The difference is starker when one considers that Cable One has outperformed its peers in growth and margins.

Take-out opportunity

Rumors of a potential acquisition of Cable One have come and gone throughout the years.  They make more sense nowadays given (a) current valuation is at all-time lows, and (b) the Certificate of Incorporation was amended in the last annual meeting, eliminating the requirement of 66 2/3 of voting power required to adopt, amend, alter or repeal any provision in the company’s by-laws.  At $1,000/share and $1,100/share, Cable One would trade at just over 9x and just under 10x 2023E EBITDA, a return of slightly under 30% and just over 40% at current levels.  

Summary

While the Covid tailwind is behind Cable One and the competitive landscape has become less attractive, current valuations reflect a future of negative growth.  If Cable One were to stop investing for growth and just maintain its current levels of FCF, I estimate the company would be worth close to $850/share.  In other words, the market is paying us to grow at current levels.  Cable One is a recession-resistant, low-but-stable grower currently on sale.   

Catalyst

   Better than expected results over the next quarters as the market realizes the scenario is not nearly as challenging as currently implied by valuation.

3)      Potential M&A and further consolidation.  Even though the industry is fairly consolidated, Cable One may be small enough to be acquired by the larger players.  A take-out at $1,000-$1,100/share could be easily justified given valuation and potential synergies to a strategic acquirer or 3-4x more leverage turns in a go-private transaction.