Description

Summary

John Malone’s Liberty Broadband operates as a holding company focused on North American cable. The company wholly owns GCI, an Alaska-focused broadband provider, and owns a 26% stake in Charter. We believe that Charter is undervalued at today’s prices, and that the LBRD discount that should close over time, offers additional upside. The look-through LBRD FCF yield is 9%, which we view as extremely attractive for this well-positioned, growing, and low-risk business.

Given there have been numerous write-ups and comments on Charter and the cable industry on VIC, we will not go through a detailed outline of the Charter business. Instead, we will focus our thoughts on key competitive topics facing Charter and US cable operators today.  

Company History

March 2013: Malone invested $2.6bn into Charter, entering back into the cable industry

May 2014: Liberty Broadband spun out of Liberty Media

May 2015: Liberty Broadband announced its $5bn investment in connection with Charter’s acquisition of Time Warner and Brighthouse and capped its ownership at 26%

July 2020: GCI sold their broadcast business to solely focus on the core Alaska network

August 2020: Liberty Broadband announced its stock-for-stock acquisition of GCI Liberty

Competitive Issues in Current Environment

Currently, Liberty Broadband owns 26% of Charter Communications, which represents ~90% of the value in LBRD. While Charter has a strong internet business (2^nd largest in the US) that has been growing steadily, their voice and video segments have been declining over time as consumers switch to streaming services and have been reducing their landline usage. That being said, Charter’s mobile business has been rapidly growing and presents a very good opportunity going forward.

A key issue currently is the recent slowdown in broadband net adds growth. We believe there are a few potential contributing factors, including the demand pull forward during the pandemic where the industry saw significant increase in broadband additions as well as from competitive pressures – notably, fixed wireless and/or fiber.

We are less concerned on the competition from fiber. As mentioned in prior write-ups, fiber has rarely had an impact on broadband growth in prior years. While the increased fiber builds are most certainly notable, Charter already faces fiber competition in 38% of its footprint. Fiber competition is not new and should remain manageable. The key question is whether there’s enough juice to squeeze out of the current infrastructure that consumers will not have a preference between fiber and cable in the medium-term future. Charter and others are focused on bringing “symmetrical gigabit” speeds to their network in particular areas where that’s needed, but that will take some time. Over time, the cable industry is focused on building out to DOCSIS 4.0 which should provide significant improvements to current speeds without needing expensive upgrades for the “last mile” connections to consumers. In theory, cable should be able to provide downstream speeds of 10 Gbps and upstream speeds of 6 Gbps – recent lab tests of DOCSIS 4.0 have shown symmetrical speeds in excess of 4 Gbps. While fiber could reach 100 Gbps, we are likely years away from the point that consumers will need that level of speed. And as time goes by, Charter and other cable operators will continue to push fiber deeper into their networks, giving them existing, “future-proofed” infrastructure closer to the homes they serve than other competitors. In the meantime, Charter can selectively use FTTH for greenfield projects and to target areas where they are seeing churn from fiber to further improve their internet speeds. And importantly, return on fiber to the home investments, which some cable executives originally found dubious to begin with, are pressured in the current environment with higher costs (due to inflation), lower labor availability, higher interest rates, and more difficulty in penetration given historically low movements amongst broadband subs (i.e. low churn for both cable and fiber subs).

Fixed wireless is a newer competitive threat that started to emerge over the last couple of years. T-Mobile and Verizon realized that there were areas in their mobile network that were being underutilized so they decided to offer fixed internet to consumers to improve utilization. Verizon has been more cautious in their expansion into FWA to ensure there is no network congestion, but T-Mobile has been much more expansive in this area. They currently have 1mm FWA subscribers and have targets to reach 7 to 8mm by 2025. While the speeds are similar or slightly below cable, the plans are usually offered at a lower price or bundled with other mobile products. In general, T-Mobile has a heavy focus on suburban and rural environments and are stealing subs from cable. However, they have to be careful from deteriorating their mobile product, as mobile offers 30 to 50x more revenue per unit of capacity than fixed wireless with higher margins. Before launching the service, T-Mobile mapped out potential areas across the US where they had excess capacity. Once they reach a certain threshold of fixed wireless subscribers in these areas, T-Mobile plans to stop adding additional subscribers to ensure a strong network. While Charter CEO Tom Rutledge has mentioned there has been no increased churn due to FWA, we believe this is a short-to-medium term risk for Charter, especially as Charter focuses on building out its rural network further. However, we see this as a short-term risk as DOCS 4.0 should improve cable latency and speed to deepen its advantages vs. FWA. The FWA offering may be a nice bridge for a subset of customers, but over time the inferior technology should allow Charter to win back those subs. Moreover, Charter can, and likely already is, combatting the FWA threat by offering better speeds. There is a real argument to be made that Charter should offer higher advertised speeds across price points that would make the product clearly superior to FWA offers. While we believe the FWA risk is real in the intermediate term, we believe longer-term it will be largely a non-issue. It would seem foolish to assume no competitive impact given there of course is a swath of unhappy cable customers, given the NPS scores in this industry are notoriously low. Yet even with some net adds pressure, we believe Charter will be a growing business even if subs grow more slowly or stall briefly while pricing continues to increase.

Charter’s Opportunity in Mobile

Charter’s mobile business utilizes MVNO agreements with Verizon to provide mobile service to consumers. The model is powerful as the poor economic areas are passed through to Verizon, while the higher margin areas are serviced by Charter through Spectrum hotspots. Bundling mobile services into their other offerings allows Charter to upsell its customers and add a new revenue stream. We believe the mobile business has a long runway of growth left with only 4% mobile penetration of the 55mm passings. Importantly, Verizon really doesn’t mind so much ceded retail subs for wholesale subs via MVNOs given the wholesale contribution margin is very high. There are limits to this (i.e. Verizon can’t lose 50% of its retail subs), but we believe for quite some time Verizon management will not try to aggressively stem the increase in MVNO subs. And over time this slow flood of cable mobility subs will tie Verizon more closely to Charter, making mutually detrimental competitive behavior less likely.

GCI Overview

Operating an undersea fiber optic cable system linking Alaska to other networks, GCI Holdings focuses on providing wireless, data, video, voice and managed services to residential customers and businesses in Alaska. 60% of their revenue came from data services while 27% was from wireless services in 2021. The business continues to generate strong free cash flow with the goal of continually delevering the business. In 2021, they reduced leverage from 4.0x to 3.0x.

GCI has been suffering some of the same challenges as other telecom providers with video and voice subscribers decreasing over time. However, they have been able to grow their data wireless segment over time due to relatively low competition in Alaska. GCI has been a low growth but stable company for its history, growing revenue at 2% in 2021 with margins steady at 36%.

Management

Charter CEO Tom Rutledge is an excellent cable operator in the industry and has been running the company since 2012. Prior to Charter, he worked at Cablevision as the COO, overseeing the cable television and programming business. He also oversaw the $5bn fiber upgrade and the cable rollout of VoIP. We believe that his involvement in the telecom sector for the past 40+ years gives him the skillset to continue scaling Charter’s business in a cost-effective manner.

LBRD CEO Greg Maffei has been part of the Liberty enterprises since 2005 and has experience with all the previous Liberty transactions. Prior to Liberty, he was the Co-President of Oracle and the CFO of Microsoft. He has been discussed at length on VIC, specifically on the Liberty Sirius message board, and we have nothing further to add.

Financials/Valuation

Charter is a growing business with great margins, resulting in strong cash flow. They usually spend a large portion of their free cash flow to buy back shares. In the first quarter, Charter bought back $3.6bn of shares, retiring 6mm shares out of 173mm of shares. We expect even as growth slows, Charter will continue their large share buyback program.

Based on an SOTP analysis, we calculate a ~17% discount for the NAV of Liberty Broadband vs. its underlying holdings. In prior Liberty entities, this discount has closed through various transactions and we believe there is a possibility of LBRD and Charter eventually merging in the future. We believe this discount offers additional upside to a Charter investment.

At the current share price of LBRDA, the look-through price for Charter is $397. This implies an 8.5x forward multiple or a 9% FCF yield. As Charter buys back more shares, LBRDA is capped at its current ownership percentage at 26% and will have to sell back its shares pro rata to Charter.

Risks

·         FWA / Fiber take share. DSL still has 10% market share. We think the impact of FWA, especially, will have an impact on DSL more than cable since it is simply an inferior type of technology and cannot reach the theoretical speeds fiber and cable can offer. Fiber, on the hand, is very expensive to build-out but offers better speeds currently than cable. However, data points to a lack of consumers switching from fiber to cable as Rutledge recently commented churn is not drastically differently in areas where there’s fiber overbuild.

·         DOCSIS 4.0 upgrade takes longer than expected. Charter is focused on continuously upgrading its network which is important as consumers’ internet usage is only increasing over time. Charter has done these investments in a cost-efficient and timely manner in the past, but we need to see this in the future as well to compete well with fiber.

·         Consumer behavior exiting COVID-19. With consumers staying at home in 2020, industry broadband net adds picked up significantly. We are unsure how much of the current low net adds are driven by competitive pressure vs. demand pull forward. Furthermore, census data showed that Americans are moving to a different home at the lowest rate since 1948, also creating a material headwind towards broadband growth (but also more stickiness for Charter’s existing subs).

Conclusion

In summary, Charter and GCI are high quality, well-managed, and well-positioned businesses. While we acknowledge that FWA offerings may impact net adds growth for a period of time, we don’t believe there will be permanent, meaningful losses of subs. The long-term value of the enterprise should not be dramatically impacted by a temporary slowdown in net adds, and we view the recent significant decline in Charter’s stock price as creating an exceptional opportunity to buy LBRD at a look-through FCF yield of 9%. Our conviction is less around an immediate path back to stronger sub growth, and more around the strong competitive positioning of the company over the next 5-10 years. The forward growth outlook remains solid over the long-term, and an investment in Liberty Broadband is a compelling risk-reward looking over a 5+ year time horizon.

Catalyst

- Continued execution by Charter management

- Share buybacks

- Potential M&A activity between Charter and Liberty Broadband