Description
Charter Communications is the 4th largest cable operator in the US, passing ~12mm homes and providing telephone, high-speed Internet and cable television services to over 5mm customers in 25 states. As a result of series of debt-fueled acquisitions and a significantly over-extended balance sheet (>10x leverage for the better part of the decade), Charter filed for a pre-packaged Ch. 11 bankruptcy on March 28, 2009. It re-emerged from bankruptcy on November 30, 2009 and was listed on the Nasdaq (CHTR) in September 2010.. The reorganization wiped out ~$8B of Charter's $21B debtload, while saving the company ~$830mm in annual interest expense. Most of Charter's stock is held by its pre-petition creditors (~75%) and by founder Paul Allen (~8%). While Charter remains highly-levered at ~5x EBITDA, it is now in-line with industry norms.
What initially attracted us to Charter was that it was an underfollowed, poorly covered 'post-reorg' equity that still has the post-Ch. 11 and a 'poor operator' stigma attached to it. Historically, Charter has lagged the industry on several metrics in part due to financial constraints that kept a tight rein on 'growth' capex, restraining its ability to deploy digital set-top boxes and Voice-over-Internet Protocol (VoIP) telephony, as well as rolling out DOCSIS 3.0 - a standard for bonding cable channels to allow for extremely high-speed broadband services.
For the first time in several years, management can focus on running the business instead of being steered by the capital structure. The 'new' Charter Communications has the longest runway in the industry to catch up with peers on both operating and financial metrics. The Company has the lowest levels of product penetration in the industry, yet the least amount of overlap from telco fiber initiatives (Verizon's FiOS and AT&T's U-Verse). After years of losing video subscribers to satellite providers, Charter (and the industry as a whole) is poised to win share back with its high-speed data offerings that the satellite operators cannot match. This year, the Company will spend $1.3-1.4B on network upgrades in what will likely be its peak capex year. By the end of 2011, Charter will have fully rolled out DOCSIS 3.0 - allowing upstream and downstream data speeds of well over 100Mbps. Over the next 2-3 years, Charter may be able to reclaim analog bandwidth - potentially doubling its network capacity. Additionally, Charter's recent multi-year agreement TiVo highlights its next-generation TV strategy - deploying Tivo's set-top boxes, HD user interface and IP applications across its subscriber base. Disclosure statement exhibits project fairly steady, conservative growth of ~6% top-line and EBITDA margins approaching the larger operators in the industry. To note, the industry has expanded at double-digit rates with the introduction of voice products and the expansion of broadband services.
Charter Communications faces about the same level of competition as other cable companies from the satellite broadcasters for video services, though far less overlap than peers from the telephone companies. However, these competitors can no longer use Charter's bankruptcy as a weapon to poach subscribers. In other words, Charter gets more and more competitive with their only real competitor - the satellite broadcasters, and possess the least amount of overbuild in their territories. The story becomes of one of executing the 'cable playbook' and managing the balance sheet.
Charter's management team has done an incredible job reengineering the Company's balance sheet into a more manageable liquidity and maturity profile. Charter has been very active this year in terming out its capital structure. In April, the company issued $900mm 7 7/8% Holdco notes due 2018 and $700mm 8 1/8% Holdco notes due 2020, which were used to tender for the $800mm 8 ¾% notes due 2013 and the $770mm 8 3/8% notes due 2014. In late September, the company issued another $1.0B 7 ¼% Holdco notes due 2017, which were supplemented with cash on hand and used to pre-pay ~$1.3B of credit facilities. With its entire debt complex trading above par value, any future refinancing will likely come with a lower interest expense.
Charter is currently levered at ~4.7x EBITDA and has been successful in paying down debt/terming out its capital structure. We expect the company to de-lever at ~0.5x leverage per year to ~4.3x in '11 and ~3.8x by YE12. Charter was also able to preserve a significant amount of net operating losses (~$6B) through the bankruptcy process. In fact, we expect the company will not pay cash taxes until at least 2014. In our view, EBITDA is the wrong lens to look at this type of company. Rather, we focus on FCF yield with Charter trading in excess of ~18-20% FCF yield over the next 2-3 years. At some point - whether by year-end 2011 or in mid 2012 - we expect Charter to trade more in line with peers at 10-12% FCF, or ~75-100% in the next 12-18 months.
Ultimately, we believe Charter Communications is an attractive takeover target in the consolidating cable industry. Charter trades at a high-teens FCF yield, faces declining capital intensity and has ~$7B in NOLs - shielding the Company from cash taxes for the foreseeable future and further enhancing its M&A appeal. Two recent transactions within the cable industry further highlight Charter's value: 1) Cablevision's purchase of privately-held Bresnan Communications; and 2) Management-buyout of Mediacom Communications (MCCC). Both deals were done in excess of 7.5x EBITDA, translating to >50% upside to where Charter Communications is currently valued. Additionally, Paul Allen recently lost his supermajority stake in the Company leaving the pre-petition creditors in effective control of the Company. In our opinion, an eventual sale is now more likely as Allen was widely viewed as a potential roadblock to a sale.
| MULTIPLES |
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2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
2013 |
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| EV / Sales |
|
|
3.3x |
3.0x |
2.8x |
2.7x |
2.6x |
2.5x |
2.3x |
2.2x |
| EV / EBITDA |
|
|
9.5x |
8.7x |
7.9x |
7.3x |
7.0x |
6.5x |
6.1x |
5.8x |
| EV / Unlevered FCF, Actual |
21.9x |
21.2x |
16.3x |
13.4x |
13.1x |
12.9x |
10.6x |
9.7x |
| Unlevered FCF Yield, Actual |
4.6% |
4.7% |
6.1% |
7.5% |
7.7% |
7.7% |
9.4% |
10.3% |
| P / Actual FCF, per share |
|
-20.5x |
-20.5x |
-26.5x |
23.8x |
9.4x |
11.7x |
7.0x |
5.7x |
| FCF Yield, Actual |
|
-4.9% |
-4.9% |
-3.8% |
4.2% |
10.7% |
8.5% |
14.4% |
17.4% |
| P / E, per share |
|
-11.4x |
-14.5x |
-20.2x |
-241.9x |
-40.1x |
34.1x |
17.4x |
12.8x |
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| EV / fully taxed Unlevered FCF |
22.3x |
20.9x |
16.2x |
14.3x |
12.7x |
13.3x |
11.4x |
10.8x |
| Unlevered FCF Yield, Valuation |
4.5% |
4.8% |
6.2% |
7.0% |
7.9% |
7.5% |
8.8% |
9.2% |
| P / Valuation FCF, per share |
-12.9x |
-15.3x |
-19.6x |
26.3x |
10.4x |
15.3x |
8.4x |
7.2x |
| FCF Yield, Valuation |
|
-7.8% |
-6.5% |
-5.1% |
3.8% |
9.6% |
6.5% |
11.9% |
13.9% |
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| EV / PSU |
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$2,215 |
$2,048 |
$1,958 |
$1,918 |
$1,909 |
$1,832 |
$1,792 |
$1,747 |
Catalyst
- Continued de-leveraging/refinancing
- Operational momentum
- Sellside initiations
- Improved liquidity
- Sale of unperforming clusters
- Outright sale/takeout