|Shares Out. (in M):||288||P/E||0||0|
|Market Cap (in $M):||97,600||P/FCF||20.5||0|
|Net Debt (in $M):||66,000||EBIT||0||0|
Zero points for originality, but I believe Charter is a long with a decent risk-return profile.
I believe there is a high probability of earning a >15% IRR over the next 3 years if management can execute their plan. There is also positive optionality as there are many interested acquirers. It is reasonable to think Charter doesn´t want to sell now since there is a lot of runway in integrating and improving the acquired assets. Once this process is done and the operation reaches a more “mature” stage, I think they would be willing sellers at a premium. Now, on the downside, some of the major risks are an acceleration in video sub-losses, technological changes, aggressive FTTH rollouts and regulation. We will touch on the risks at the end of the write-up, but we believe the risk-return profile here is attractive after considering these.
Charter´s stock went on a run since early 2016. Starting with the closing and successful integration of the enormous Time Warner Cable acquisition. Then in early 2017, there were rumors (further confirmed by management) that Verizon was interested in acquiring Charter. Some months later, Softbank and Altice were mentioned as interested acquirers. The probability of any of these two acquiring the Company are low (at least in my opinion). Softbank might try to use Sprint stock as part of the deal, and it seems like this is not a currency that Charter´s board would be willing to take. In the case of Altice, they have another business model of basically pushing price, cutting costs and are comfortable with ~6x leverage. Charter has a completely different operating model and would prefer a more conservative financial profile. So while speculation has been high, the reality is that these two might not be viable buyers (unless they go all out with a huge premium or big cash consideration, which seems like a low probability). The major block so far (I believe) is that management and the board are confident they can drive value by executing their business model.
About 2 months ago, the stock started to decline after some of those m&a rumors receded. Last week, Charter reported earnings that didn´t meet expectations. The stock took a significant hit and we think this is a good opportunity to enter the name.
Why is this an attractive investment?
Tom Rutledge is considered the best operator in the industry. He did a great job as COO of Cablevision from 2004 to 2011, making it the most profitable cable company in the US. In December 2011 he joined Charter, which had recently emerged from bankruptcy. At the time, the strategy was clearly stated. He was going to invest in the infrastructure, insource jobs and improve the product and packaging in order to drive penetration. This process would translate into short term pain (higher capex, higher opex and lower revenue growth as new product packaging depressed ARPU). After some years, results started to show and the profitability of the company improved dramatically.
The process went as follows: in mid 2012 Charter introduced new product pricing and packaging. Later, they started moving all customers from legacy analog systems to digital and finished the process by the end of 2014. This strategy enabled the company to offer a better product since it released spectrum in the network which could be used for more HD channels, speed, etc. A better video product offering reversed video sub losses trend and in 2015 they had positive net video adds (this is remarkable given industry headwinds, i.e. cordcutting). Also, HSD net adds increased dramatically as the company was successful in their volume growth strategy over driving pricing and profitability in the short term.
We also show Comcast figures as proof that while the industry had some tailwinds, the results at Charter show a dramatic improvement above the industry performance. At Comcast we can appreciate a reduction in video sub losses and marginally increasing HSD net adds, but improvement is not as radical as in Charter.
This process at Charter caused a high level of capex intensity, mostly due to growth (CPE, line extensions, etc) and the all digital strategy (which was finalized in 2014). These investments took some time to show in the growth profile of the company but as the years went on, growth accelerated. This left the Company growing at a fast pace, with a reduced level of capital intensity and higher free cash flow per passing (from $82.91 in 2012 to $122.51 in 2015).
The reason why this background information is important is because Rutledge and his team are going over the same process in a much larger footprint: Time Warner Cable and Brighthouse.
It is also important to note that the process should be less dramatic since the acquired assets are in a better shape, given Charter went through a bankruptcy process and there was a long period of underinvestment. Also, Tom Rutledge used to be the President of Time Warner Cable and he knows the asset perfectly well.
Since Charter closed the acquisition, Rutledge has implemented a similar strategy: insourcing much of the labor force to improve customer service, going all-digital and improving/simplifying product packaging and pricing. So far, the integration is going according to plan.
So, the bet we are making while investing in Charter is that Rutledge can do something like what he did in Old Charter in a much larger footprint. I think there is a decent chance he will be able to accomplish this. In case he succeeds, what can we expect?
As part of the TWC & Brighthouse transaction, Charter released a proxy with some financial projections. Numbers looked like this:
Charter might not reach these goals in the stated time since the transaction closed later than originally expected. Having said that, if they are able to reach anything close to these figures in a reasonable amount of time, the stock should yield attractive returns in the medium term.
As expected, they project revenue growth to accelerate in the next year as they have already introduced new product packaging and service in 2016/17. Margins should expand over time given lower opex per customer as service quality improves, churn/transactions per customer go down and business migrates to HSD being the primary service. Finally, they expect capex to decrease radically from 18.5% of revenues in 2017 to 11.8% in 2019 as they complete the all-digital rollout and other network investments (we think this will be difficult to accomplish, but the trend is important). Also, lower spending on CPE due to a reduction in STBs prices and a cloud based offering that enables cable companies to service the devices remotely should help.
The logical question: is this plan achievable? Let´s start with comparing Charter to the 2 other largest players in the industry: Comcast and Altice USA.
*We include “purchase of intangible assets” in Comcast capex since a large portion of this line is investments in software for the cable business
Comcast serves as a good comparable given their scale and relatively similar levels of FiOS and U-Verse overlap. Having said that, Comcast is a much more profitable company. This can be observed in their higher margins and EBITDA per passing. We think over time Charter will be able to close this gap. New Charter has been an undermanaged asset for years. Now they have arguably the best management team in the industry and have reached a scale comparable to Comcast. There is no structural impediment to reaching, or even surpassing, Comcast in terms of profitability.
We also include Altice USA, given they are the third largest operator in US. They have an aggressive model of cost cutting that should push margins for the coming years. They have stated that margins in US cable are too low and that over time should move closer to 50%. They argue that in Europe there is more competition, so they have learned how to run a lean organization. We think this is ambitious and in some years we will know if their strategy is prudent. We don´t expect Charter to reach similar profitability metrics. In case Altice USA proves that this business model is sustainable, we should expect other larger operators to push towards achieving similar results. If they don´t, then Altice might acquire these assets in order to operate these assets more efficiently (similar to what 3G has done in the Consumer Staples sector).
Charter and the rest of the industry should benefit from sector tailwinds:
-Broadband Penetration: In the US, residential broadband penetration is between 75-80%. Penetration has grown slowly from the low 70s in the last couple of years and we expect that trend to continue. Over the next few years, broadband penetration might push towards 90%. Also, we expect an acceleration in household formation, after several years of depressed figures, to help growth as well.
S&P Global Market Intelligence
-Broadband Market Share: Cable companies have been taking share from telcos for years now. Cable is capable of offering higher speeds compared to telcos who rely mostly on a copper network. Their DSL offering in most of the cases is not able to deliver speeds of over 10 Mbps while Charter offers 100 Mbps in 75% of their footprint and 60 Mbps for the other 25%. Telcos have been investing on driving fiber deeper in their network but still they fall short of cable speeds. This is the case because signals degrade while going through the copper wire and this gets worse as the distance between the home and the DSL hub increases. The same market share dynamic is occurring in the SMB and Enterprise segment where telcos are losing share. Cable companies are able to offer a better product and more services, which have helped them take share. Cable has grown at an accelerated rate (over 15% CAGR for the last decade) in this segment for those reasons. Also, as the cable industry has consolidated, some of the largest players are able to offer services in many markets which is ideal for the Enterprise segment since they have needs in various locations. We expect that cable should continue to take share in the coming years as data consumption continues to increase exponentially and the need for higher broadband speeds is accentuated.
S&P Global Market Intelligence
-Video Market Share: Video is a segment that should continue to shrink at a moderate pace. Having said that, cable providers have done a good job at shrinking at a slower pace than the overall industry. We expect cable to accelerate share gains from Satellite video providers over the coming years and this should help in preventing a collapse in Charter video subs. Tom Rutledge expects that industry wide linear video subscribers should continue to decline, but Charter will have more subs in the medium term than current subs. We are not sure if that will happen, but the truth is that cable has improved its relative video proposition versus satellite, and this should help Charter to take share from these competitors.
S&P Global Market Intelligence
-Capex Intensity: We expect that cable operators’ capex intensity will decline over the following years. STBs are now mostly cloud based which means they can be accessed and serviced remotely. This will reduce the need to update these devices and the number of customer visits. At the same time, pricing for CPEs is declining due to technological advances. Also, as broadband becomes the primary service, over video, the need for STBs declines. It is also important to note that CPEs and installation are a significant driver of total cable capex. Most cable companies will be done with their all-digital and DOCSIS 3.1 rollout in the next few years which means lower network investment after this period. Finally, as penetration levels reach a “mature” stage in the coming years, the need for growth capex will decrease. All these tailwinds should enable the cable sector to reduce capex intensity over the next few years, which will drive free cash flow generation.
-Margins: Over the following years, EBITDA margins for the industry should improve. Broadband is becoming the primary service, which is close to a 100% gross margin business. In order to provide video, cable companies must pay for content costs which have increased at a very high rate for years. Cable industry video gross margins have compressed from ~60% in 2007 to ~35% at the moment. On top of that, there are associated service (a disproportionate amount of service calls come from video vs other services) and CPE costs with running a video offering, which further reduce profitability. Cable One (a small operator) has argued that video is no longer profitable and that running a HSD focused operation is a better bet. By doing this, Cable One has improved their EBITDA margins from 36% in 2013, to 46% at the moment. We expect that over time, broadband will become a more important contributor to the cable business and this should help drive margins. Also, in case video subs start declining, the impact on EBITDA-Capex shouldn´t be that dramatic for the reasons mentioned above. In case customers drop the bundle offering, cable companies will charge more for the standalone HSD. This reality serves as a tailwind to profitability and a hedge in case cord-cutting accelerates. Finally, we expect that if Altice is successful in sustainably raising the margins at their operation, this will pressure the rest of the companies. Altice achieved a level of opex (ex-programming) per customer per month of ~$43 at their newly acquired Suddenlink business, compared to ~$52 for Charter and Comcast. We can expect that the rest of the industry will copy some of the mechanisms or if they are not able to do it, there will be pressure to sell to Altice.
-Mobile: Cable companies have a dense, fiber-rich network that can be utilized to offer mobile services, especially in a 5g world. Comcast has already launched a mobile offering using an MVNO with Verizon. Comcast currently has more than 250k mobile customers and expects that once they reach 1 million customers or 5% of their HSD base, their mobile service will become profitable and NPV positive. Approximately 5 years ago, Comcast and Charter swapped valuable spectrum for capital and a special MVNO with Verizon. Comcast has mentioned that this MVNO permits them to build a profitable business without investing in a mobile network. Currently, more than 80% of data traffic goes through the wired cable network via wifi. Also, cable companies have been investing in wifi hotpsots that permit customers to access the network once they go outside their home. Charter has mentioned that they will launch their product through the MVNO with Verizon in 2018 and eventually the plan is to utilize their own mobile infrastructure of LTE small cells. We think cable Charter and Comcast will become major wireless operators and that this will become a profitable business by itself. Also, it will reduce churn as experienced by cable companies in European markets.
-ARPU growth: We believe that cable companies will be able to push pricing over the long term given their position as an advantaged operator, offering a superior product. Cable companies will also continue to improve their offering by increasing speeds, improving their video product (better guide, VOD, etc) and including other services (home security, mobile, etc), that will justify price increases. We think that it´s reasonable to expect ARPU growth for years to come, specially once Charter reaches high levels of HSD penetration in its footprint.
-New FCC: Since Ajit Pai took office, he has focused on reducing regulation. We think a more cable friendly FCC might help in M&A and enabling the industry to charge the large players for their service. On M&A, we think that Comcast and Altice USA are interested in acquiring Charter at a reasonable price. A Comcast-Charter transaction seems more “do-able” because we think the Charter board would be willing to take that currency over ATUS stock. It´s also reasonable to think that if Comcast wants to acquire Charter, they will try to do it under this FCC and government. Also, Verizon and Sprint have shown interest in acquiring Charter. We think that cable and wireless consolidation makes sense, given the success these operations have experienced in Europe. There are many possible acquirers and ways to speculate on this, but the reality is that the regulatory environment hasn´t been this favorable in years. We also think that there is a possibility that cable companies will eventually try to charge for the services they provide to large data players like Netflix, Facebook and Google. Most of the data that is “clogging the pipes” is coming from these players, and cable companies want to charge them for the service and infrastructure they provide. This is not built in to the financial projections, but would be a positive for the industry.
How will this story play out in the financials?
-Revenue: As experienced in Old Charter, revenue growth should accelerate in 2018 and further in 2019 as they integrate old Time Warner Cable and move these customers to the new packaging. As the promotional period rolls off, revenue growth should hit a positive inflection point in early 2018. Further penetration of HSD and B2B expansion will also help drive growth.
-Margin: As Charter continues to drive HSD penetration, we expect margins will expand due to the reason discussed previously. Also, further integration of the TWC & BH acquisitions will continue to drive synergies over the medium term. In 2020, the model has 40% EBITDA margins, which is close to where Comcast is at the moment. This number is conservative because in 3 years, the cable business will be more dependent on HSD compared to current levels. Also, we believe that Rutledge and his team are solid operators and there is no reason for this delta to persist after the integration period.
-Capex: As Charter ramps up the all-digital transition in 2018, we expect that capex will increase. The Company should be done with this process by 2018. Also, the company will be investing in transitioning to DOCSIS 3.1 (costs to deploy are moderate at less than ~$80 per home) in the following years. We expect that capital intensity will start to go down in 2019 and will hit 14% of revenues in 2020. This figure is conservative when compared to Charter´s proxy model. It is also important to note that the push into mobile will determine capex after 2019. Our model doesn´t incorporate mobile as a significant driver in any income or expense line since the product or the strategy are not yet clear (at the moment, the idea is to do it through an asset-lite MVNO).
-Valuation & Capital Allocation: We expect that Charter will maintain its financial leverage between its target of 4.0-4.5x and will use the proceeds to buyback shares. Also, all the FCF will be used for buybacks. By the end of 2020, we think that 15x FCF and 9.5x EBITDA is a reasonable multiple for an infrastructure company with stable, non-cyclical demand, growing EBITDA mid-single digits and moderate financial leverage. From current prices, the expected IRR using the mentioned assumptions is ~17%.
What are the risks and why is this asset mispriced?
-Cord-Cutting: There is major fear that video sub losses will accelerate as customers transition from a linear TV model to OTT offerings. We think that the linear video market will continue to shrink as customers needs change and the cable bundle price continues to increase. However, we believe that Charter will have better results than the industry as they take share from satellite. Rutledge even expects that Charter will have more video subs few years from now. Finally, video has become a marginally profitable service. If video sub losses accelerate we expect that Charter will increase HSD ARPU and margins will experience a rapid uplift. Also, customers that drop linear video might consume this service through an OTT offering. These OTT services require a high speed broadband connection to function properly and Charter is the best qualified to provide this service in most markets.
-Technological Risk: The idea of this new 5g era has unsettled investors. There is the fear that telcos might deploy small cells and use millimeter waves to improve speeds outside the home and that this might reduce the demand for fixed broadband. We think this technology is still in its early stages and it´s not clear if the model is profitable/reasonable to deploy. Also, it is important to note that these waves are not capable of traveling through walls and might get affected by rain. At the same time, cable companies might be the best fit to deploy these services given their fixed, dense and fiber-rich network. In a 5g world, telecom operators need this type of network in order to connect all the small cells and provide the backhaul service. Comcast and Charter might be able to take wireless share from telcos in a 5g world and at the moment we think cable is in a better position relative to wireless providers in a 5g future. These companies are already using its wifi hotspots as a way to provide this service to its customers outside of the home. Having said that, in this industry there are always technological risks and we must be aware of that (e.g. data compression). It is comforting that cable companies are in a healthier financial condition than telcos which in many cases have a declining business, coupled with high leverage and most of their FCF goes to cover the dividend. Telcos are not in a position to invest heavily for the long term benefit of their business.
-Competition & FTTH Deployment: Cable has been able to compete against the telcos given they have a better product offering and service. There is a risk that telcos, or other players, might push into FTTH in order to offer higher speeds, comparable to those offered by the cable companies. About a decade ago, Verizon spent close to $25 billion on building over 18 million FTTH premises and this project was eventually halted due to terrible returns. Currently, AT&T is building more than 6 million additional residential premises with FTTH, which will leave the company with close to ~13 million FTTH passings by 2019. Goggle Fiber has recently slowed down the deployment due to complications in deploying the infrastructure and providing the service. Small local fiber players and municipalities can also threaten certain markets. WideOpenWest is an example of a cable operator that has overbuilds and competes against Charter. Overall, we think competition will increase but Charter should be able to remain as an advantaged, scale operator in most of its footprint. We remain vigilant of new entrants and FTTH deployments, but at the moment the threats are not overly aggressive (this can change).
-Regulation: Title II regulation under the Tom Wheeler FCC raised concerns that in the future cable operators would be heavily regulated. Regulation has always been a risk for the sector, primarily if rates get set by the FCC and broadband gets categorized as a utility. Since Ajit Pai was named Chairman of the FCC, he has been working on reducing regulation. We believe that some of the regulatory risks have decreased under this new administration.
Charter should continue to increase its customer penetration, ARPU and profitability as the company executes on its plan. Eventually, we expect that this company will enter a mature stage of lower growth but lower capex, which will dramatically increase FCF generation. If Rutledge and his team are able to repeat what they have done at other cable assets, this stock should do well over the medium term. In a dream scenario, Charter is acquired in 18-24 months, once the integration is complete.
I will leave you with the following quote on buybacks during the last earnings call:
“We have a fundamental view on the value creation that's going to take place at Charter over time. We're not stock pickers. We don't understand the vagaries of the marketplace from day to day, and we have a fundamental view on what the long-term value creation of the company is going to be. It looked cheap then; it looks cheap now.”
Charter has reduced S/O by ~8% in the last 9 months.
Chris Winfrey, CFO bought $1.0 million of stock this week.
-Completing the TWC & BH integration
-Interest possible acquirers: Comcast, Altice, Softbank/Sprint & Verizon
|Subject||weakness in the stock-|
|Entry||03/26/2018 04:30 PM|
Hi-Do you think the recent weakness is a combination of worries about cord-cutting, growing concern about fixed wireless from 5G, and the negative headlines around the license issue in NYC? Management said that they felt the stock was cheap at $347 (average of where they bought it back last year for total of ~$13B). thanks.
|Subject||Re: Re: weakness in the stock-|
|Entry||03/26/2018 05:59 PM|
1-I generally agree with you that just because management believes it is cheap does not make it cheap. However, here, I would defer to management, and the board, more than usual, because of who is involved, how much stock they own, how good their track record is of creating and realizing value in a cable busines, the size of the share repurchase, the publicly stated reason for the repurchase (the stock was cheap), and the visibility that a cable company at this scale should have into the business.
2-I do think its cheap-I think Charter can do $20B in EBTIDA in 2020--and I think the multiple should expand because of its advantaged position in high speed residential broadband-which is a better business than linear video, and should be a durable business for some time. I also believer that their is optionality on several potential deals, and there is room for meaningful capital return because of incremental borrowing capacity if EBITDA grows--and presumably if EBITDA is growing and the fundamentals are improving, the company will be comfortable taking gross debt higher to repurchase stock. If it goes well, it should really go well if they are levering the equity to buyback stock as the multiple expands and their competitive position in high speed broadband is entrenched through improvements in the product and the essential, non-cyclical nature of the service.
3-If you believe the bull argument, the historical cable multiples are not that relevant because cable was a basically a capital intensive linear video business with an inferior product to nationwide satellite providers with limited pricing power and constrained growth due to lack of nationwide footprint---and many of the legacy cable companies were overleveraged and poorly run. Charter has room to grow its video and internet subs, has a great high speed data product, has superior infrastructure for residential broadband in most of its passings, and has the best management and ownership group in the industry.
The two major risks are 1) a rapid acceleration in cord-cutting which impairs the value of the linear video business well in excess of market expectations; 2) fixed wireless turns out to be a better way to deliver high-speed residential internet and the telcos roll-out it aggressively across the Charter footprint----neither seem likely--but they are risks.
|Entry||03/29/2018 01:45 PM|
Thank you for the great response. I essentially agree with all of this. I may be a little higher on linear video/arpu for video, and lower on wireless losses.
I agree with you about T/VZ---if they believed that 5G fixed wireless had the potential to replace wired broadband, it would seem logical that they would double down on that business, rather than seek to diversify into declining linear video businesses that are getting more competitive, and in T's case, pay $107B for the opportunity to compete with Google and Facebook in digital advertising. Verizon has employed a similar acquisition strategy with AOL/Yahoo-effectively buying companies to for the chance to be third
It seems to me that an effective hedge against the potential threat of fixed wireless, however remote that threat is given the potential consequences of the technology actually evolving into a replacement for wired broadband into the home, would be for Charter,and cable in general, to acquire a lot of spectrum. If I were Comcast, I would rather buy Dish than Sky,given Dish's spectrum position, because then I can guarantee that I remain a dominant connectivity company and will play a huge role in 5G, rather than try to compete in the content business, either as a creator, or distributor, against giant consumer technology companies that have better ways to monetize content. I am talking my book because I own Dish-----but however this plays out, it is hard for me to see how having access to a lot of spectrum, particularly greenfield spectrum for 5G, would not be a long-term strategic advantage for any cable/wireless business. Both cable and wireless are going to need to find new sources of growth to offset their legacy mature/declining businesses (linear video/consumer wireless)----more spectrum that allows those companies to participate in 5G would be a way to generate that growth in a defensible and sustainable way.
|Entry||03/29/2018 02:44 PM|
I've done a fair amount of research on this and concluded that 5G is much more of an opportunity than a threat to cable for reasons cited on this and previous threads.
But I think even better evidence is in actions being taken by the people who would best know the answer to this question than me:
1) Of the wireless players, only VZ is talking seriously about trying to penetrate fixed-wireless broadband (T is much more cautious despite having fiber infrastructure they could leverage, and TMUS is openly dismissing it as a viable business plan). Yet VZ tries to buy CHTR six months ago - why would you do that if thought you could actually win in broadband? To me, it's an obvious admission that it would be more economic to use the cable plant to densify your small cell network than trying to overbuild (which history, including Verizon's, says has always been a losing proposition...but maybe it's different this time?).
2) CHTR, having had those negotiations and seen the bids (from both VZ and Sprint), is aggressively buying back stock. If they were worried about the risk, they would be focused on buying spectrum or a wireless asset to protect the core. Of course they could be wrong in their assessment of the risk, but there isn't any question what they believe given the aggressiveness of the stock repurchases in 2H 2017.
3) CMCSA, which already launched into mobile organically a year ago and has half a million subs, chooses to spend its excess balance sheet capital acquiring an international direct-to-consumer content asset (unrelated to the core cable business). If they were worried about this risk, wouldn't they also be looking to use that capital ($40b) to acquire in wireless? Cable is 70% of their EBITDA, content (NBC and cable nets) are 18%. It's only logical that if you were concerned about the risk to the 70% of your business from 5G, you would acquire/spend there to protect it.
|Entry||04/02/2018 03:19 PM|
Sorry for the late response. Results so far (stock price) have not been good, my apologies.
-finn520: 1) In a recent call, the CFO stated that as a result of tax reform, Charter won´t be a significant cash tax payer until 2021 at the earliest. Tax reform wasn´t a given at the time of the write-up but now that it is, you can come up with an appropiate #. 2/3) Local fiber is a threat. I think that bundling many services helps cable as they are able to bring interesting and differentiated offerings to the table given the scale. If the business ends up being only broadband, think cable churn goes up. Doubt this will happen since operators know this and will try to add home security services, mobile, etc...Also, local fiber is not great at providing services to small residential customers given the amount of time and volume versus $$. Scale operators are better fit to service these large # of customers. Small local fiber players might be good serving local businesses, backhaul, etc...mostly larger accounts (than residential). Sure, if cable fails at retaining their clients, the equity will get killed due to the fin and op leverage. 4) I disagree here (I might be wrong though). The difference is that if Walmart did that, customers would buy their stuff at Costco, Amazon or Target...in this case, customers don´t have good alternatives (DSL is the competition in most of the country and that service is just not as good). Another way to imagine it is as if Coca-Cola is occupying 30% of the Wal-Mart store space and they can only sell that product at Wal-Mart (since in this imaginary world, that is the only store)...Wal-Mart has significant power and might possibly try to use that power and charge Coca-Cola for that space (plus the margin they gain from selling the product). In the case of cable, Youtube and Netflix can only sell their service though cable in most of the country and they occupy most of the space (bandwidth).
-levcap65-My overall capex numbers have been too low. In the 4q call they mentioned that capex intensity (as % of revenues)would decline slightly and overall amount would increase (compared to 2017). In my post, I had capex at $8.2bn in 2018...think the figure will be closer to ~$8.8bn...I was too agressive on the capex side and my model was wrong for that reason. Winfrey also stated that capex intensity and total $ amount would decrease in 2019...Proxy numbers made by Charter were too aggresive on the capex side, it seems
-Winbrun-Think recent weakness might be due to rising rates, push into mobile which will once again delay the point at which they reach stable fcf margins, fixed wireless, cord cutters, etc...As I mentioned in the writeup I think 5g and cord cutting are risks, but those have always been present and this hasn´t changed significantly in the past months...Not sure what is driving the move, but think environment hasn´t drastically changed.
|Entry||04/27/2018 09:40 AM|
MarAzul - are you still involved? if so, an update on the situation would be helpful. I understand the quarter was a disappointing but is the stock move an overreaction?Thanks.
|Entry||04/27/2018 11:39 AM|
Yes, unfortunately still in the name. I don´t feel numbers were terrible, but understand inverstors dissapointment. Ebitda growth of 6.5%, HSD adds continue to be strong, mgmt reiterated that capex should trend down starting in 2019, etc...On the negetive side, Video losses were higher than expected and it feels like the environment has worsened...Rutledge even mentioned that the financial impact of losing these subscribers is minimal given how low margins are in the video biz...that was unexpected since he has always pushed video as an important service for Charter...Seems like mobile will pressure margins in the short term...there will be little repurchases this year as they won´t be able to increase leverage...Stock now is trading with low expectations imo ~10x 2019 fcf (and fcf should grow nively from then on)...This idea has not worked as planned (down 25% since published) and I feel sorry fot that.
|Entry||04/27/2018 12:19 PM|
I think a few things may be happening that are contributing to the decline:
1-TMUS/Sprint now may merge---removes Softbank as possible Charter buyer and may be seen as increasing threat in video (Tmus television launching soon-now will have Sprint sub base as well to target). Also, longer term TMUS/Sprint may be viewed as threat in residential broaband if the combined entity tries to enter fixed wireless like T/VZ----TMUS/Sprint will have a strong spectrum portfolio for fixed wireless should fixed wireless become possible. I also think some people believe Malone was in favor of Charter merger with Sprint or TMUS to get nationwide scale in wireless to strengthen the bundle of service Charter could sell.
2-Charter is transitioning to unified platform across all three major assets bases(TWC/Brighthouse/Legacy Charter)--which creates lumpiness in the numbers-that is a short-term issue----Management has been talking about this for some time. But hard to really drive unit growth and reduce churn which so much integration tumult.
3-No buyback left to support the stock-Charter spent a ton last year buying stock (like $13B at $349/share)--probably put on a floor on it (coupled with persistent takeover rumors that began in Jan of 2017 with Verizon---may have backstopped the stock and artificially propped it up above where it would otherwise trade-- Charter management/Liberty did a nice job playing that up all year.
4-Cord-cutting--this is a longer-term problem that is not going away. Charter management publicly stands behind their ability to drive net video adds over time as they improve the service, packaging, and grow into their footprint. I think the consensus is that the linear video business is a deteriorating business that is going to continue to de-rate----which seems reasonable because of the rising cost of the linear bundle + the flood of low-cost stand-alone services coming to market. The de-rating of linear hurts Charter a lot because of the leverage in the business model-and the lack of any offset on the content side (unlike Comcast which arguably has a bit of hedge with NBCU-although that is debatable).
Charter will eventually package and sell OTT services bundled with residential broadband like Comcast is beginning to do with Netflix. Not clear what the economics or defensibility of that business will be; it will probably be lower ARPU but higher margin and it will be the way to stabilize video relationships. Charter is probably not excited about doing that right now because it will cannibalize core big bundle linear video business. Charter also has not gotten behind a smaller OTT bundle like Dish/T/V/TMUS/ are doing will do.
Charter's EBITDA margins are still depressed relative to mature competitors (Cabo/Altice) that are focused on driving price in residential HSD data business----Charter has been more in investing/growth mode. The residential HSD data business has little marginal cost at scale so that business is going to be very high margin (maybe over 50%). If Charter can get to a $20B revenue internet business in a few years with 50% margin---$10B in EBITDA on a non-cyclical essential service with good visibility-could potentially get a high multiple. I think the problem with that is that there may be a concern that Charter is going to be overly dependent on residential broadband for its economics---and therefore you have to be sure that Fixed wireless/FTTH are not replacements-and nobody really can say for sure how the threat will evolve (its possible that Charter's backhaul, wi-fi network, and infrastructure get more valuable in 5G fixed world).
The other concern is that the business will need to keep raising prices to grow because the video subs are going to decline and residential internet unit growth growth is ultimately constrained by the size of the footprint. The combination of dependency on one business (HSD) + lack of unit growth gets a lower multiple--particularly when it is hard to handicap the threats that could emerge in residential broadband.
The bull case is that Charter is going to have the best infrastructure for all essential bandwidth intensive applications into the home-that business is going to grow for many years-and there is unit growth and pricing power left in that business because Charter is underpenetrated in its footprint and there will be a lot of innovation. What you are seeing in the stock today/recently is a combination of 1) rotation out by all investors expecting a deal/2) short-term/catalyst driven investors selling because no near-term catalyst; 3) fatigue selling in a difficult market; 4) cord-cutting fear over the whole sector 5) fixed wireless competitive threat selling
Bull case also is that the free cash flow should accelerate a lot after this year---to the point where it could get to ~$30/share in earnings power 2020--depending on pace of buybacks and capital intensity. As Charter improves its infrastructure and scale, it will cement its dominance in residential HSD--which will cause a structurally higher multiple re-rating because as the pipe gets faster and more value-added services in the home are created and bundled with Charter's HSD service---Charter becomes harder to dislodge. At 17x 2020 FCF of $30/share ~$500/share-great return on the current stock price.
|Subject||Re: Re: Update?|
|Entry||04/27/2018 12:25 PM|
Thanks for the reply. 2 questions:
1) How do you get to $25/sh fcf in 2019 from $10/sh fcf in 2017? Seems like a real stretch....I assume some of the delta is tax-related but what are the main operating drivers vs consensus?
2) Do you think malone is more amendable to a sale now? But not sure who the right buyer is per your note....a lot of "funny money" players.
|Subject||Re: Re: Re: Update?|
|Entry||04/27/2018 12:44 PM|
1) See MarAzul write-up--I agree with the model
2) I think Malone has always been in favor of a sale--from the outside, it seemed that the resistance may have been from Rutledge. Rutledge has a ton of stock that vests at like $540-so clearly he benefits from the stock going higher and Rutledge is the best cable operator in the business.
I agree with you on the "funny money" players-the numbers being thrown around were a little crazy. The only company mentioned that probably could actually do it is Verizon--and it would have to come with a lot of stock. I think Malone likes the idea of wireless/wired converging and would be open to any deal that creates more value than he believes that Charter can create alone.
|Subject||Re: Re: Re: Update?|
|Entry||04/27/2018 12:51 PM|
I would add one thing--the competitors for these businesses--whether it is selling video, selling digital/premium advertising, or selling connectivity services, are the largest, most dominant companies in the world (Amazon/Google/Apple/Facebook). If you are Charter or Verizon, and you have a declining/mature core franchise that drives a lot of your valuation and generates a lot of your cash flow, and you see the size and ambition of the tech giants, and those tech giants are building their businesses on your connectivity platform while at the same time competing with you and beating you and creating a lot of value in the stock market, at some point, you would have to believe there is going to be a response that involves these companies getting scale in new large growth categories, or consolidating scale to protect their existing franchises.
|Subject||Re: Re: Update?|
|Entry||04/27/2018 12:56 PM|
17x FCF in 2020 feels like a stretch, given the dynamic of increasing competition for the core of that FCF (resi HSD). Obviously, if you're right on $30 of FCF, you make money at 9x FCF (vs. $259 last trade). My guess is what's happening here is not so much a re-rating on today's earnings, but a re-rating on terminal multiple in 3-5 years, which is flowing back through to today's stock price. Whether correct or not, Mr. Market is becoming less confident in the stability of those long term cash flows and doesn't want to put a big multiple on an uncertain future competitive environment.
To be confident that it deserves a high terminal multiple, you have to believe that consumer demand for both high data intensity and delivery quality is going to keep skyrocketing. If getting 100-500 mbps with some issues when it rains is going to be "good enough", then the cable advantage is going to continually erode, because lots of other technologies are coming after that speed range and quality. However, if consumers are going to need 1G+ with high implied SLAs, then these cash flows are going to be long lived. The questions become: 1) do you want to own a bet on consumer data consumption needs continuing to skyrocket?; and 2) is Charter the best risk/reward to make that bet? Hard to say. It's certainly not a bad bet, and somewhere around these prices, you are probably close to getting paid enough to take the risk (i.e., maybe a good bet).
IMO, Comcast's current cash flow stream is even more vulnerable given much higher HSD ARPUs they are taking today, perhaps part of why they are trying to diversify?...
|Subject||Re: Re: Re: Re: Update?|
|Entry||04/27/2018 12:59 PM|
Thanks WinBrun. Can you expand on the fixed wireless competitive threat? How credible is it as a replacement for intensive bandwidth applications and how do you see it evolving over the next few years?
|Subject||Re: Re: Re: Re: Re: Re: Update?|
|Entry||05/02/2018 05:11 PM|
My view on cable competitive edge, 5G, cord cutting, CHTR operational opportunity, and capex. I’d be very interested in why this might be wrong
• The cable business tends toward monopoly due to a high fixed cost structure relative to the size of the market. The cable business cartoon economics are for a market with $100 of revenue (excludes variable programming cost pass through in video revenue) there are roughly $50 of fixed costs. Therefore, there is no incentive for a second entrant in a market because 2 players in a market wouldn’t make economic returns on capital (each player with $50 revenues and $50 costs).
• A good video of John Malone describing this industry structure can be found here at minute 26:50
• This is further evidenced by Verizon’s wireline segment, which had FY17 pre-tax returns on capital of 1% ($380MM/$41,351)
• This also means that a “third pipe” from a municipality, Google Fiber, etc that tries to cherry pick incumbent cable profit centers (high incomes/population density) will also be unsuccessful
• Cable’s hybrid fiber coax architecture has capacity of approximately 800 MHz of spectrum in its pipes. Under DOCSIS 3.1, the efficiency of that spectrum is 12 bps/Hz using 4096-QAM, which results in approximately 10 Gbps of capacity. This 10 Gbps of capacity is shared on average between 500 homes per node (per Rutledge on Q4 FY16 call) and currently provides for 20 Mbps per home. Nodes can be split at a cost of approximately $2,500 per node, which is equivalent to $5 /home passed. If Charter wanted to go from 500 homes/node to 31 homes/node it would cost approximately $1 billion (50MM homes passed x $5/home passed x 4 node splits) and result in +300 Mbps per home of capacity.
• First, the economics of Fiber to the Home (“FTTH”) consist of Fiber to the Node (“FTTN”) and then a “fiber drop” from the node to the home. FTTN per home passed is approximately $1,200 (although this can be +2x in rural areas) and the fiber drop is approximately $800 of labor and CPE. For Fios, this results in approximately $3,800 of capital per connected subscriber ($1,200/40% Fios penetration + $800) or $1,500 per home passed ($1,200 + $800 x 40% Fios penetration). The economics of 5G fixed wireless consist of FTTN and then a 5G FWA cell site, which is essentially “wireless drop” instead of a “fiber drop”.
• 5G technology needs to be segmented into spectrum below and above 6 GHz (above being mmWave spectrum) due to the vastly different propagation and economics.
o Sub 6 GHz economics
As seen in article below, the 4 carriers each have approximately 150 MHz of spectrum below 6 GHz between them. Assuming 6 bps/Hz 5G spectral efficiency (equivalent to DOCSIS 3.0 @256-QAM) that results in each telco having approximately 900 Mbps of capacity. There are approximately 300k cell sites and 135MM homes in the U.S. (each carrier with roughly 450 homes/node equivalent), which results in the carriers being able to deliver capacity per home of 2Mbps (900/450).
Wireless operators could split number of cell sites (nodes), but it would cost the industry about $7.5 billion annually assuming $25k/site/year to double cell sites (see American Tower “Introduction to the Tower Industry & American Tower”) and only increase capacity to 4 Mbps per home. Spectrum below 6 GHz is supply-constrained, although there is a chance that the FCC will release some 3.7-4.2 GHz spectrum.
This limited capacity relative to cable’s current +20 Mbps is why 80% of mobile data is over a wireline Wi-Fi connection. Also, it is important to note the difference in cost to split nodes: one-time $2,500 cost for cable and annual $25,000 for wireless. This is a key difference in the economics of cable vs wireless; the incremental cost to upgrading wireless capacity (splitting nodes/cell sites) is about 100x more expensive than cable. Randall Stephenson once described the wireless business by saying “it’s a variable cost model. Every additional megabyte you use in this network, I have to invest capital”. Or as Motorola Mobility Chairman/CEO Sanjay Jha put it “I don’t think there’s any other industry positioned to replace that broadband connection. It costs 30-100 times more to deliver data via wireless than through a broadband pipe. This notion that you can deliver all your broadband needs through 4G is not physically or economically possible.”
o mmWave 5G Fixed Wireless Access (“FWA”) economics
The FCC has now made available approximately 12 GHz of mmWave spectrum. Due to the low propagation characteristics the average efficiency of this spectrum is estimated to be 3 bps/Hz using 5G (for example, at 70 GHz, which is 7 of the 12 GHz, the efficiency drops to 0 bps/Hz if there is a pine tree between cell site and receiver).
We estimate that an average 5G FWA cell site costs approximately $40k, which capitalizes the incremental annual power costs vs FTTH and appears to be quite conservative (in CableLabs report below they estimate to be $75k, which is also what Crown Castle and Zayo estimate). This $40k cost implies that it could become economical for a telco to do a 5G FWA drop vs a fiber drop if they can get more than 50 subscribers per site ($40k 5G FWA drop divided by $800 fiber drop). However, the mmWave spectrum used in FWA has low propagation/penetration and therefore a usable, reliable range of approximately 200 meters. Therefore, FWA utility is limited to high population density areas where there are +50 subscribers within 200 meters.
Based on page 30 of AMT’s “Introduction to the Tower Industry & American Tower”, which shows population density/sq km, and assuming a FWA 5G cell radius of 200 meters (roughly 8 cell sites/sq km; 1,000m^2 / π200m^2 = 8), then almost 85% of the U.S. population cannot be served by a 5G FWA connection as there needs to be +50 subscribers within 200 meter radius (85th percentile population density of 2,900 pop/sq km divided by average household size of 2.75 people = 1,050 homes/sq km; 1,050 homes/sq km divided by 8 cell sites/sq km = 133 homes within 200 meter 5G cell radius; 133 homes x 40% Fios penetration = 53 subscribers, which is equal to the +50 subscriber breakeven for 5G wireless drop vs fiber drop; anything below this 85% percentile uneconomical). This is somewhat more bearish than Verizon’s estimation that 25% of population could be served by 5G fixed wireless mentioned in November 2017. Also, worth noting is that this math uses Fios penetration of 40% and NOT the 20-30% penetration that Verizon estimates for 5G FWA. See presentation below:
If Verizon were to spend +$30B to build out 5G FWA to 20% of the country (midpoint of my and Verizon’s estimate of addressable market) and achieved its 25% penetration, it would only reduce cable’s broadband penetration of homes passed by at most 4% (20% addressable market X 25% penetration X 87% occupancy of homes passed X 90% steady state broadband penetration). Also, the capital costs per home passed and operating costs of 5G FWA vs FTTH are basically identical and at 25% penetration they likely wouldn’t be profitable as Fios at 40% penetration only has a 1% ROC.
Worth noting, Verizon is the only telco that is pursuing 5G fixed wireless; the other telcos don’t believe it is economical. Even if the Sprint/T-mobile deal goes through, given their greater scale, they have said specifically when asked on the 4/29/18 call they would not pursue 5G FWA.
For more information on 5G FWA, a very good engineering report titled “Can a Fixed Wireless Last 100m Connection Really Compete with a Wired Connection and Will 5G Really Enable this Opportunity?” can be found here:
• It is also worth noting that even if telcos wanted to make value destructive/low ROI fiber or 5G FWA investments, they largely lack the firepower to do so as they have high leverage and limited free cash flow due to large dividend commitments. See page 14 of Deloitte report below:
Cord Cutting Is Not Material To Profitability
• We estimate a video variable profit/sub/month of $10-15 based on $80 ARPU less $50 programming less $15 variable costs ($9 CPE and truck rolls, customer service, marketing, and other). See page 16 from 2015 Cable One analyst day and page 7 2017 investor presentation for video EBITDA mix.
• If consumer cuts the cord, $10-15 increased standalone broadband price offsets lost cord cutting profit, which is willing to pay for due to increasing utility of the broadband product (consumer now needs high speed internet to watch Netflix, etc for +3 hours/day vs previously surfing the web), increased capacity to pay as consumer saves money going from expensive big bundle to $10 Netflix or Amazon Prime, and industry structure (Fios profitability would decline by -$700MM and result in negative ROC). See fiercetelecom article below showing difference in standalone vs bundled broadband price at cable primary competitor AT&T.
• DOCSIS 3.1 with 10 Gbps capacity has significantly delayed the need for laying fiber deeper. Arris has an engineering report that shows when segmenting the customer base by capacity demands, 99% of cable subscribers will have adequate capacity until 2033. During that time, technologies like 65536-QAM could further increase spectral efficiency and delay fiber buildouts. While not exact, pages 6-9 of Arris’s engineering report “Future Directions For Fiber Deep HFC Deployments” shows that large fiber capex by cable is well beyond the investment horizon and likely +15 years away. Even if capex were to come sooner, given the industry structure, it would likely be NPV neutral at a minimum. If 10 years from now Charter has 30MM broadband subs and had to drop fiber into the home it would cost about $24B (30 X 800), which discounted to today at 8% on 272MM shares equates to $40/share assuming they do not earn a return on that capital.
• We estimate Charter capex in particular will fall to approximately $7B in 2019, which is based on Comcast’s current levels of capex applied to Charter’s smaller footprint.
T-mobile/Sprint blue sky scenario; low cost way for cable to get into wireless business?
• What may end up happening, given prior US regulators focus on ensuring 4 wireless players, is Sprint/TMUS are allowed to merge, but are forced to divest assets that would ensure a viable 4th players. The only potential buyer would be cable (CMCSA and CHTR form a wireless JV, which they have already done on a mobile operating platform recently) and they would be able to buy a profitable wireless asset at a discount due to a forced seller, and that would give them a low cost way of getting into the wireless business. Trump wins in having a 3rd scaled operator (S/TMUS) wanted to invest in 5G and ‘not losing the 5G race to the Chinese’ (whatever that means), consumer wins by having 4 competitors and therefore no pricing increases from collusion between 3 players, and cable wins by buying a profitable wireless business at a discount that will reduce churn/opex in their cable business and can be scaled through cross selling to existing customers.
|Subject||Re: Re: Re: Re: Re: Re: Re: Update?|
|Entry||05/02/2018 05:25 PM|
Why doesn't cable just come out and say 5G, cord cutting, etc, doesnt matter?
"Monopolists lie to protect themselves. They know that bragging about their great monopoly invites being audited, scrutinized, and attacked. Since they very much want their monopoly profits to continue unmolested, they tend to do whatever they can to conceal their monopoly—usually by exaggerating the power of their (nonexistent) competition."
|Entry||05/02/2018 11:16 PM|
I think cable presents an unique "blue collar" problem that is very difficult for silicon valley to address. Silicon Valley is very good at addressing problems that can be solved through algorithms that can be implemented through apps, smart phones, and adapted and gain scale rapidly. Cable's entrenched position is that it will require a lot of blue collar labor + local political wins + local marekt share gains in order to overcome. Also the gains will be done one at a time rather than massively adapted overnight. I think these dynamics are particularly difficult for Tech to solve. In terms of develping a solution that somehow bypass all the physical digging, trenching, and installing of many nodes, small cells, etc requires breaking the laws of physics of electromagnetic waves as I know it. I think that the enemy at the gate has a harder and bigger wall to scale.
I do agree with you that video sub loss will be inevitable and likely not as smooth as the CHTR management has indicated. Although the cost of video content is highly variable, at some point you start to get into the fixed cost category. There will likely be hiccups in the transformation. I believe Rutledge or Malone once mentioned that selling video allows the Cable companies to argue against regulation as they are content provide rather than an utility provider. He mentioned something about dumb pipe inviting regulation.
|Entry||05/03/2018 10:08 AM|
Re: cord cutting. Pretty smooth results for Cable One; excluding NewWave acquisiton, legacy Cable One video subs were down -12% and EBITDA was up 10%.
Also, google has stopped its fixed wireless and fiber plans
|Subject||Re: Re: competition|
|Entry||05/03/2018 01:55 PM|
I think this is a decent summary. I was bearish on cable, and was short ATUS on the IPO (I think I even posted that). I am not so bearish down here, but I am not long. I think the accelerating video losses are an issue and yes they will eat into fixed cots and even (wait for it) cause some broadband losses.
|Subject||Re: Re: Re: competition|
|Entry||05/04/2018 03:57 PM|
I cut my cord years ago. We replaced it with Netflix and a receiver. But I can’t imagine not having broadband at home. Okay I admit I do a good part of my investing work at home. But it is impossible for me to not have broadband. Frankly Spectrum can triple my price and I will still pay it. I think Maslow pyramid has been flipped upside down. Food is not the most basic necessity, it’s broadband. I highly believe that ppl will still move to broadband plus some skinny OTT package whether it’s local sports, Disney, Netflix, or UFC. The issue was never that people don’t wang content. The issue was not having to subsidize ESPN for their ransom like charges and keeping up with the Katrashians. It was always about being able to pay a la carts for the content that you want. People are discovering that bundling does make the bundle cheaper. It seems like we keep getting back to the fact that you need the broadband.
Lets not act like people don’t watch porn.
|Subject||Re: Re: Re: Re: competition|
|Entry||05/04/2018 04:50 PM|
Agree with everything you said Rulon. But isn't the point that Charter's broadband could be at risk? 1) Because of 5G (I admit no one really knows what is happening here) and 2) Verizon and AT&T fiber build out in overlapping regions. I thought those two things are the real LT secular threats to Charter's business if they come to fruition.
Video subs seem inconsequential to the story (low to no FCF) outside of the fact that they lower the value of the bundle Charter offers and incentives customers to drop broadband if they drop video and go to a mobile broadband only solution (if that's possible with 5G).
|Entry||06/06/2018 04:22 PM|
From Google's Milo Medin at Workshop on Internet Economics 2017. Verizon hasnt "already densified and can now offer 5G fixed wireless at low incremental cost to 25% of the country" as they claim. Theyre going to need 10-15x the number of cell sites to do 5G fixed wireless, which will cost them $30-35B of incremental capex for a project that is incapable of making money because it will be a third pipe. VZ also lacks firepower to make that investment because it is an overlevered and declining business and its $8B of after dividend FCF will have to go to debt pay down
"To explore the feasibility of wireless deployments, Google has analyzed street view data to identify potential 5G base stations, considering height, location, trees, and vegetation to generate a projected coverage map. They used a simulation of part of a major city with a 3.5Ghz spectrum service to deliver a 1Gbps 5G service, and found that strategic deployment of 92 poles could provide service to 93% of residences. But because 3.5Ghz spectrum (and lower) bands are so scare, they explored the potential viability of the deployment of the recently hyped option of millimeter wave services for a retail 5G service offering in the 28Ghz bands (Verizon's mmWave bands). The same deployment simulation in these higher frequency bands found a requirement for 1,400 poles, and yielded an acceptable level of service to only 82% of residences. That’s a lot of poles, requiring a lot of power, and hundreds of billions of dollars of investment for each individual service provider with exclusive use spectrum allocations."
In terms of macro cells one can look at revenue breakdown from public tower co's to estimate cell sites
Also, Verizon has roughly the same amount of small cells as AT&T and pro forma S/TMUS (see page 4)