Description

Cogeco Communications (CCA.TO) is a Canadian HQ cable company with significant operations in the United States currently trading at a very reasonable valuation. The company is controlled by the Audem family through their holding company Cogeco (CGO:TO), which owns 11.7% of the equity and 71.8% of the votes. Through their actions and due diligence, I can attest I am comfortable with them as managers. Furthermore, this is by far the bulk of their net worth – I estimate >90%.

The company is comprised of two segments – Cogeco Connexion consisting of their assets in rural Quebec and Ontario (~60% of cash flow) and Atlantic Broadband which is predominately a rural operator in the United States with significant assets in South Florida. Atlantic Broadband is 21% owned by Caisse de Depot as described below. 

Cogeco today has 50m shares and the stock trades at C$92 (all figures below presented in Canadian $) for a market cap of $4.6bn. There is $3.0bn of pro forma debt, $500m of cash and an NOL worth $500m for an enterprise value of $6.6bn. In 2019, full consolidated EBITDA was $1bn, or 6.6x. Capital expenditures were slightly elevated at 20% of revenues resulting in EBITDA – Actual CapX of $760m and a multiple of 8.7x. 

Cogeco Connexion:

The Canadian assets cover 1.8m households and 150k businesses. They are concentrated outside of Montreal and Toronto in rural Quebec and Ontario and are the second largest operator in the region. In these markets, they often have no competition given the dispersed and remote communities served. As of the most recent quarter, they served 795k internet users, 646k video users and 378k telephone users.

The business has been very steady with EBITDA margins in the low 50% range and top line flat to low single digits. A couple of important initiatives they are making are as follows:

• Rolling out IPTV in August this year (will reduce capx from 18.7% to ~15% or less post roll out)

• Looking to launch a wireless carrier to reduce churn. Waiting for new regs from government

• Able to increase prices annually given lack of competition 

This is a relatively simple business and I won’t overcomplicate it. One final point is that they have a very good reputation within their communities.  

Atlantic Broadband: 

Atlantic was built through a series of acquisitions, the most significant of which was Metrocast which was completed in early 2018 for $1.7bn. To fund the deal and avoid over levering, the balance Cogeco sold 21% of the segment to the Caisse de Depot (the largest pension fund in Quebec). There are no required distributions to Caisse and as a pension fund they can hold these assets indefinitely. Finally, do not underestimate the importance of the pension fund in supporting a local entrepreneur (the Audem family). All numbers in this section assume 100% consolidation.

Atlantic is really two businesses – South Florida and Rural America. Pennsylvania represents 33% of subs, Florida 25%, Maine, New Hampshire, and Connecticut 10% each with the balance in states along the East Coast. The total footprint covers 880k households and 185k businesses. Internet service users are 451k, video 309k, and telephone connections 143k.

South Florida consists of Miami Beach and additional communities up the I95. They provide broadband to gated communities and high rise towers where they get long-term contracts with earnings visibility. Contract terms are typically 5-10 years with paybacks of 3-4 according to management. The business is growing quickly given population expansion.

Rural America consists of small cities such as Bradford/Warren, PA and King George, VA. The most important point is that 82% of their competitors are DSL providers whereby Atlantics’ broadband is heavily advantaged.

Overall, the US business is growing 5-6% per year through a combination of price increases and customer growth. They see very little churn, particularly in the rural communities. Finally, they want to grow this business through M&A (for example, in late December they acquired Thames in CT for $50m which is adjacent to an existing asset) but prices have been too high.

Financials/Valuation:

My simplified valuation model is below. I think the Canadian assets are worth between 8 and 12x operating free cash flow while the US assets which are growing slightly quicker deserve a 1pt expansion in multiple. My target price for Cogeco is $116, representing 27% upside.

With respect to actual free cash flow the company has guided to $476-505m in 2020. The math is as follows:

Pretax Income ~$475m

Actual Cash Taxes ~($50m)

D&A ~ $500m

CapX ~ ($450m)

Actual FCF = $475m or $9.50 per share. However, recall that includes 100% of Atlantic and if you adjust for the 21% owned by Caisse that would reduce free cash flow by ~$0.80 per share to $8.70. 

Capital Allocation: The company is committed to doing more M&A, and with $500m of cash on the balance sheet and a strong financial backer in the Caisse, should be able to take advantage of recent market events. In addition, they pay out a dividend of $2.40 a share and have a $200mm buyback authorization in place.

Catalyst

Inexpensive valuation

Capital deployment