Description

Note: FCF/S and EBITDA replace EPS and EBIT, respectively for figures above. 

CEO

Charter Communications (CHTR) is a US-based cable operator run by Tom Rutledge, considered to be the best cable executive inNorth America, and backed by John Malone, the "father of the modern cable system." Tom joined CHTR in February 2012 from Cablevision (CVC) where he delivered ~135% return to shareholders over his seven-year tenure as COO vs. 26% for the S&P 500. During his tenure running cable at CVC, Rutledge drove broadband penetration from 17% to 49%, EBITDA/homes passed from <$250 to >$400 (both industry-leading metrics), and FCF from ($1.1) billion to $550 million; he was also the innovator of the $99 triple-play bundle. Rutledge's success in driving CVC's high speed data penetration, minimizing video subscriber losses, and expanding the company’s commercial services business made him the perfect fit for CHTR. He has upside of 1.3m share and options with a notional value of over $150 million.   

Thesis

• Broadband penetration – at sub 35%, is the lowest among theU.S.cable companies, and we believe the company could easily get to 40% within the next three years
• Minimal overlap w/FiOS – under 4% with FiOS (VZ) across geographic footprint vs. CVC/CMCSA/TWC at 45%/15%/12%
• Operational changes – Rutledge has revamped, simplified, and re-priced triple-play packages to drive product penetration and improve customer value proposition; creates stickiness and better opportunity for ARPU expansion; refocused customer service efforts and added 100 HD channels to top tier package; goal is to increase penetration, extend customer life, further reduce churn, and thereby reduce transaction costs
• Malone investment – with new $2.6 billion (27% stake) by Liberty Media, market is expecting consolidation of cable industry and future capital return; has recently made public intention to acquire Time Warner Cable (TWC) or other cable assets; in fact, there are at least 15 private cable assets ranging in size from 150,000 subscribers to over 4.5 million that could be viable acquisition candidates; Mediacom, which only has a 1% overlap with FiOS, 1 million customers, and a contiguous network with CHTR's existing footprint looks like a possible candidate
• Bresnan/Optimum West acquisition – beyond the accretion to FCF/S that Bresnan brings to CHTR, Rutledge's statements around the operational improvements at Bresnan provided confirmation of his plan for CHTR and set a timeline for when performance is set to accelerate, as evidenced below       

• Capex efficiency – current capex spend is 23% of sales, lower cost equipment and exiting investment cycle should lower to peers levels within the next few years
• Buybacks – in 2011, repurchased $733 million of stock through public and privately-negotiated transactions (~13% of shares in 8 months); focused on deleveraging in 2013/14 to 4.0x-4.5x range, then has ability to do $4.5bn+ of dividends/buybacks over time under new credit agreement
• Tax assets – will not pay cash taxes until 2017/18, with NOLs per share currently valued at ~$15 ($7bn+ loss carryforwards) and has $9bn+ tax basis

Summary Financial Projections – 2013E includes 1/2 year contribution from Bresnan

Risks

• Competition – telcos, satellites, alternative fiber, over-the-top
• Programming cost increases – content providers renegotiating contracts at higher rates with escalators
• Consumer pushback on price increases – programming cost increases flow through to consumers
• Regulations – will broadband become regulated utility?
• No M&A transactions – market is pricing in pro forma synergies from combinations
• Leverage – 5x+ net leverage today

Catalyst