Description

Megacable (MEGACPO, or “Mega”) is an underleveraged and profitable Mexican cable/FttH company that has been recommended on VIC three times over the years at substantially higher prices. Since the most recent VIC recommendation two years ago, Mega has achieved significant continuing growth in homes passed, video and HSD subscribers, and consolidated EBITDA, while the company’s growth capex plans and recent termination of merger discussions with Televisa’s cable unit (combined with broadly negative investor sentiment toward cable and Mexican equities in general) have disappointed investors looking for a rapid payoff, and the stock price has depreciated significantly to its lowest levels in almost a decade. Mega is now trading at a fraction of the valuations of already bombed-out US peers with much more limited growth prospects, while on the eve of beginning to reap the benefits of its significant recent FttH growth capex.

Entonces y ahora - 2023 edition

To set the stage for how far valuations have fallen, I’ve reproduced the table “Now and then” from miser861’s 2021 writeup, updating with further relevant data from Mega’s recent financials. As you can appreciate, significant continuing growth in homes passed, HSD, video, and telephony subscribers, and consolidated EBITDA have all been accompanied by a steep contraction in Mega’s already low multiples, leaving the stock trading at truly head-scratching levels.

As I’ll expand on below, current EV/EBITDA figures carry the full burden of recent additions to net debt from significant recent growth capex that has yet to fully come online and start generating significant revenues, as well as temporary margin compression from rolling out service to new communities that start from zero market share and will generate much higher revenues and margins in the future than they do today. Despite recent numbers being burdened by growth capex, Megacable is more undervalued than ever based on trailing EV/EBITDA, while giving no credit to the value of imminent future growth.

Recent FttH growth capex - GPON and MEGA 2024

Over the past several years, management has recently completed significant investments in network upgrades replacing legacy coax infrastructure with a fiber global passive optical network (GPON), and is in the middle innings of implementing an aggressive growth capex program called MEGA 2024, aimed at leveraging its construction expertise and low labor costs to rapidly expand its fiber footprint and customer base, through a near-doubling of homes passed and significantly expanded rollout of FttH. In the latest quarter 52% of subscribers received service through FttH, and 65% subscribed to data at speeds of 50 MB/s or more, up from to 56% in 1Q22. During this rollout, equipment from areas now transitioned to FttH has been redeployed to improve the quality of the remaining HFC network, increasing the density of nodes per home passed and bringing fiber closer to homes. This positions Mega’s DOCSIS 3.1 HFC network to readily accommodate growing demand for premium higher-speed data within its remaining footprint, and will allow further areas to be cost-efficiently upgraded with last-mile FttH when needed in future.

Mega has historically earned attractive EBITDA margins building to 47% to 49% in each of the last six years. As recent growth capex has ramped up and services are rolled out to new municipalities which initially start at zero market share, the company has been experiencing negative operating leverage, which will likely continue as the buildout completes then gradually mean-revert as local market share builds. Recent margins also incorporate 6-month promotional rates offered to stimulate growth of the subscriber base in newly served municipalities, which will roll off with time as new markets mature.

Mega has historically operated with very low levels of leverage for its industry, with the founding Bours family often maintaining net debt near zero and paying significant dividends. Management plans to take leverage up from a current ~1X net debt/EBITDA to a maximum 1.5X, perhaps enough to make this writeup ineligible for the coveted "Ft Knox baby" tag(1), but certainly still an exceptionally conservative degree of leverage for a cable company. In recent calls management has estimated a stable level of maintenance capex spend in the high teens or lower, and targeted a return to ~20% in the intermediate term after the MEGA 2024 buildout is complete.

Management, ownership, incentives, and capital allocation

The founding Robinson Bours and Mazon families own a majority of shares, and derive a significant amount of income from Mega dividends rather than salaries. (Of note, the Robinson Bours family are also the controlling shareholders behind 2002 VIC banger Industrias Bachoco, a grade A+ book report that has gone on to compound marvelously.) Upper management are professional cable operating executives who are not family members, and in most cases have been with the company for a decade or more. CEO Enrique Yamuni Robles has led Megacable since its founding in 1982 and owns over 6%. You can review the financials later on in the writeup and draw your own conclusions; I think they have proven to be competent operating executives with a long-term track record of efficiently executing on organic growth within their market.

I have to admit, a big part of me does wish they were plowing their cash into buying back shares hand over fist at these prices rather than into FttH growth capex. But another part of me recognizes that the first part possibly also would've told them this several years ago, back when the market was giving much higher multiples to everyone in cable, and would've ended up throwing pesos into the wind rather than building durable FttH network assets which will likely have very attractive long-term business value that could compound for decades. They have run this business conservatively but effectively while gaining deep familiarity and operating experience with the domestic cable business, and are now executing on a reasonable growth strategy they have planned over many years. I’m coming to believe that these family-controlled situations can often be a significant positive for long-term minority shareholders, since having huge amounts of their personal net worth permanently aligned with long-term business outcomes effectively makes management and the Board into punch-card investors. That said, management has certainly shown a willingness to return cash directly to shareholders via dividends - once the recent growth capex is complete, continued return of Mega’s significant and growing cash flows to shareholders via dividends or buybacks will not reasonably leave the stock continuing to trade at today’s depressed levels.

Televisa merger

In December of last year, Megacable was the subject of a merger approach by Televisa's cable unit (Izzi) which sent the stock higher by nearly 50% from current prices. Televisa stock also climbed significantly, reflecting the potential for significant synergies from combining the companies' footprints (and potential value capture for Televisa from absorbing Mega's underleveraged balance sheet, while cutting back planned growth capex significantly and milking its substantial cash flow). This merger would likely have delivered appealing near term returns (and had proposed that Megacable management would lead the combined entity), but arguably did undervalue the company and give shareholders little credit for the future value of recent GPON and growth capex investments currently underway.  After a substantially higher valuation was demanded by Megacable management, merger negotiations eventually collapsed, taking the share price along with them.

I don’t think it’s likely merger negotiations will restart in the near term - on a recent CC, when asked if they’ve had any further discussion with TV management tersely replied “no”. But this does support that any reasonable estimate of private market value is far above the current market price, and once its bargain-basement multiples have recovered with completion of the MEGA 2024 capex buildout, Megacable could be an ideal candidate for renewed discussions with TV/Izzi or another partner like LILAK.

Growing fundamentals, shrinking valuations 

I’ve attached a link to a comprehensive table (or Megatable, if you will!) summarizing key aspects of the growth and valuation of the business over the past decade, with bulleted commentary on several important takeaways below.

• As was particularly evident during 2020-21, a significant amount of recent growth capex has been deployed to GPON network upgrades and conversion of existing customers to FttH (which would not translate to immediate increases in homes passed or instantaneous improvements in revenue and EBITDA margin, but should result in long-term maintenance capex savings from fiber infrastructure, and significant potential for long-term future growth in higher-margin FttH HSD services going forward).

• Mega also owns a 2300 m² datacenter in Guadalajara and generates a significant and growing share of revenues from its B2B networking, IT, colocation, and cybersecurity businesses, including MetroCarrier, Ho1a Innovación, and MCM Telecom. This revenue stream is in addition to revenues from provision of commercial HSD services reported under the internet segment (for example, FY2022 internet/HSD segment revenues of Mxn$ 8,994,848 MM were comprised of residential HSD revenues of 7,913,789 MM and commercial HSD revenues of 1,081,059 MM). MetroCarrier already has an existing fiber network and local support staff across most major population centers nationwide, creating significant cost advantages for Mega vs newbuild competitors like TotalPlay as it leverages this existing infrastructure in its ongoing last-mile FttH consumer buildout across these areas.

• While marketing departments do their best to make like-for-like comparisons challenging, a look over the rates charged by Mega vs competitors Izzi and TotalPlay (as well as domestic fixed wireless options from AT&T and Telcel) show that Mega generally appears to be fairly consistently the low-cost provider, even while earning industry-leading EBITDA margins. As well as reflecting a positive track record of operating efficiency, this supports some degree of positive economies of scale from Mega’s B2B data businesses.

• Internet and B2B revenues have grown from 35% to 51% of revenues over the last decade, with video declining from 54% to 36%. With that said, Mega’s video segment has actually also continued to add subscribers. Perhaps this creates cognitive dissonance for US cable investors accustomed to viewing cord-cutting and the gradual shift away from lower-margin video toward higher-margin HSD as a wonderful thing, which to some extent it can be. But again, the low costs of Mega's services are much more attractive for consumers than is the case in the US. It was not long ago that a majority of Mexican homes were satellite TV subscribers, creating a reasonable path for Mega’s triple-play video/HSD options (priced dramatically lower than developed markets) to continue to gain market share, a dynamic that’s all but impossible for US peers.

• Over 90% of video subs have been migrated to XView+, Mega’s Android TV-based digital video system that integrates multiple options for consuming linear, streaming and VoD content. Mega also owns a small content production business (PCTV) creating regional news and music programming (including its Meganoticias local news service) that can be tailored to the local and regional markets it serves, and are carried by CHTR and other US cablecos for Mexican-American audiences. Importantly, Mega’s video content is remarkably economical, with the marginal cost of XView+ triple-play (including >80 linear channels, >20k hours of VoD content, and access to Paramount+) coming it at less than a standard subscription to Netflix in the country. It’s possible that many of Mega’s domestic customers find this a convenient way to consume the content they like, and unlike developed peers Mega may continue to see some lower-margin growth from XView+ video, with higher-margin HSD and B2B growth gradually continuing to eclipse this. If further cord-cutting transition to HSD does evolve as it has in the US, Mega’s FttH infrastructure should leave them reasonably well positioned.

• Recent MEGA 2024 growth capex investments grew homes passed by >20% last year, with a resulting tick down in apparent total share of homes passed (taking HSD subscribers from 40% to 35.8% of total homes passed). This has been driven by growth rather than churn, which has remained stable, and resulted in a slight easing of EBITDA margins to 45.7% from recent historical levels near 49% - I expect this trend to continue through completion of the buildout next year, with market share and margins gradually rebuilding to historic levels. Does the recent decline in EBITDA margins mean this business is rapidly falling apart and a sub-4X EV multiple is justified? No, I think it’s a natural consequence of the current expansion, and as newly-entered markets start to mature, even a slight upward inflection of margins toward recent historic norms could rapidly leave this looking remarkably cheap.

While the discount to previous VIC writeups is certainly striking (and considering dividends paid out since 2013, it’s true that total returns have not been quite as dismal as the chart would suggest), taking an even longer-term view of the stock price relative to significant growth in revenues and EBITDA really bring home the extent to which a substantial amount of profitable growth has gone totally unreflected in today’s valuation. 

From 2006-2021 Mega has compounded revenues and EBITDA at a 14-15% CAGR. Today, it can be purchased for barely 15% above post-IPO levels of MXN $37 in 2007.

Does this imply Mega (and perhaps other deep value Mexican equities more broadly) will be a perpetual value trap going forward? Or does it simply go to show that the market narrative has radically shifted, from one that had once perceived Mexico and other BRIC-adjacent emerging markets as appealing growth engines deserving of premium multiples vs stagnant developed markets, to one that foregrounds political risks, gives no credit to growth prospects, and has left Mega (and to some extent Mexican equities overall) deeply unfashionable and neglected?

Is Mexico dying and uninvestable?

If Credit Suisse was too big to fail, Mexico is too big to be a failed state - not only in terms of sheer size (the world’s 14th largest economy and 10th largest population) but its exceptionally close degree of geographic and economic integration with the US. Along with many other emerging markets it does have real issues with crime, corruption and politics that should be recognized as risks. But Mexico is far from becoming Venezuela or Argentina, and its close US economic connections are a unique and powerful long-term structural advantage that appear to be ignored by the equity valuations we’re seeing today.

There have been quite a number of Mexican deep value recommendations on VIC in recent years, several of which appear startlingly cheap against peers in other markets to a degree that’s hard to justify. As referenced in other writeups, even as Mexican equity valuations have been left for dead, supply chain issues and Sino-American political tensions are leading to growing recognition of the value of North American manufacturing. Even during the seemingly perfect storm of a left-of-center populist Mexican president (AMLO) overlapping with a right-wing populist antiglobalist (Trump) in the US, Mexico has remained in the USMCA and US-Mexico trade has grown significantly. Mexico now receives over USD$142 billion annually in direct cash flows from remittances, though its diversified economy makes this a lower share of total GDP than most Latin American countries. Growing North American supply chain integration and family and business ties with 37 million Mexican-Americans are creating increasingly close interdependencies that will not be easily unraveled. USDMXN is at the same levels as 2016, while average daily wages have grown from Mxn$ 300 to Mxn$ 527. 

While one perspective is that Mexico is fated to become a socialist criminal backwater and its domestic equities a permanent value trap, another is that forces including a young and growing population, cheap US natural gas imports, arbitrage of the large current labor cost differential with the US, and an inexhaustible USMCA export market will make Mexico a privileged location for nearshored manufacturing and trade for years to come. If Mexican incomes and land values continue to converge toward developed economies even modestly over time, this could be a remarkable long-term tailwind for owners of valuable low-maintenance domestic FttH infrastructure.

Future conditions will most likely lie somewhere in between the rose-colored and apocalyptic scenarios, and I’m not interested in paying for optimistic beliefs. What interests me is that the market narratives of 2007 and 2013 saw only the potential of the positive statements above, while the narrative of 2023 sees only the negative, leaving Mega shares at levels that price in a dramatic near-term deterioration in its business which doesn’t actually seem to be occurring. I’m honestly not smart enough to know how geopolitical forces will play out over decades, which is why it feels good to pay deep value multiples for situations that could reasonably have quite positive future outcomes that everyone’s currently neglecting.

Is cable dying and uninvestable?

I read with interest the VIC discussion thread on AIFL’s recent recommendation of CABO, and in parts it got almost as salty as a good Michelada. It’s not only the market narrative on Mexico that has changed for the worse, but the market narrative on cable, with each of these revaluation trends dragging Mega’s multiples down along with them.

As jso1123 aptly put it during a relatively less salty part of the thread: "For sure, cable stocks did really well when they were perceived to be monopolies with pricing power and the U.S. was 75% internet penetrated going to 90-95%.  They grew broadband subs +5% per year, raised price 4%, [grew] revenue 9% organically with 75%+ incrementals aided by negative mix-shift from low-margin video to high-margin broadband.  EBITDA margins expanded nicely.  EPS grew faster due to levered share shrink.

Then technology changed and the monopolies were disrupted - in early 2021, two things happened:  1) fixed-wireless broadband emerged and began taking a lot of market share;  2) wireline companies said cable had pushed price enough and cost had come down enough that fiber overbuilding made economic sense and announced large overbuilding plans, and investors at that time agreed on the positive ROI and fed them capital to do it.  So cable multiples started falling and the stocks did poorly as multiples got killed and estimates for EPS growth decelerated due to the slow down in sub adds.“

These changes in market perceptions and multiples arguably do seem rational in light of the evolving trends and information available at the time, and would’ve been hard to confidently predict going forward. But the laws of physics and the needs of humans may have changed less dramatically than short-term views about business value, particularly if these views are colored more by occurrences in developed markets in the recent past than what will realistically happen in Mexico in the future. There’s still a very reasonable case for the long-term value of HFC and particularly FttH assets, based on their very long usable life, low ongoing maintenance costs, and very high ultimate data capacity per subscriber relative to wireless, coax, or DSL alternatives. 

It seemed so much simpler back when everyone agreed cable was a wonderful business, when 14X EV/EBITDA seemed like such a steal. If only we could somehow go back in time, to a place as yet untouched by relentless overbuilds, to those halcyon days when pricing and penetration were low and growing, when the potential for subscriber growth seemed limitless. And pay a price that seemed to presuppose the worst of all possible worlds..

Is Mexican cable dying and uninvestable? (A Venn diagram of hated investment themes)

The market’s concurrent aversions to Mexico and cable have combined to send Mega’s multiples to unprecedented levels of cheapness. Is this likely to be justified, and what could the US market dynamics described above imply for an EM cableco that may effectively be at a much earlier stage of this cycle?

As laid out in AIFL’s recent CABO writeup, from Jan 2022 onwards:

• CABO had 8k net adds or .9% overall growth in HSD customers

• Charter had 420k net adds or 1.4% overall growth in HSD customers 

• Comcast had 255k net adds or .8% overall growth in HSD customers

• Altice had 122k net losses or -2.6% overall decline in HSD customers

Current multiples (which do look attractive, and have come down significantly) stand at:

• CABO with credit for investments EV/EBITDA - 6.7x

• CABO without credit for investments EV/EBITDA - 7.8x

• CHTR EV/EBITDA - 6.7x

• ATUS EV/EBITDA - 7.0x

• CMCSA EV/EBITDA - 6.9x

If you’d like, you can use information in the Megatable above to build out an elaborate model that incorporates detailed projections about telephony churn rates in Mexico in 2026, etc. (See, I’m almost as generous as Cathie Wood with her open source model of TSLA!) But I’m not going to do that. Instead, I’m going to stodgily point out that in comparison to the multiples above, Mega has a trailing EV/EBITDA of around 3.9x, and has compounded EBITDA at a 14-15% CAGR since 2006 and achieved between +5% and +40% annual growth in HSD customers in each of the past ten years, largely before seeing the impact of its significant recent FttH growth capex investments.

US peers do look attractive if you believe the narrative that owning HFC/fiber assets will continue to be a reasonably attractive business over the long term. Mega is getting close to the point where you aren’t really paying to believe much of anything in particular. Based on management’s track record, I do think it’s reasonable that recent FttH growth capex investments should prove quite attractive over the long term. If recent capex gradually translates to further growth in subscribers and an increase in EBITDA margin toward historic levels as penetration builds, even modest EBITDA growth from the current base will leave this trading at truly unsustainable levels, and things could work out quite swimmingly indeed. If growth were to slow significantly from the levels achieved over the past 15 years, or even stagnate entirely with recent growth capex amounting to lighting pesos on fire, the margin of safety at this bombed-out valuation is deep enough for things to work out reasonably well.

Cara yo gano, cruz no pierdo mucho.

But maybe this all goes out the window if a future fixed wireless apocalypse entirely reverses past trends and causes the business to rapidly fall apart? At these multiples I’m not so quick to believe that uncritically, and my subconscious has constructed a comforting counter-narrative designed to lull me into a blissful state of bagholder complacency. You see, a fascinating fact about Mexican demographics (known only to a select few geography nerds and cable value stock googlers) is that due to geographic and economic factors unique to the country, the Mexican population is highly urbanized for a developing country, and will likely continue to become more so. Over half of Mexicans live in a narrow mountainous strip of central Mexico (including Mexico City and the surrounding Mega strongholds of Puebla, Jalisco, and Veracruz), where the highland terrain supports a relatively mild and livable temperate climate for Central America. In the north, where much of the Chihuahuan and Sonoran deserts are effectively wilderness, population growth is becoming increasingly concentrated in growing industrial towns such as Tijuana, Chihuahua, Monterrey, and Ciudad Juárez, with maquiladora manufacturing bases closely integrated economically with US communities across the border.

This is relevant because the long-term strategic attractiveness of FttH infrastructure is particularly compelling in areas of high population density, where fiber has an intrinsic long-term advantage vs other options such as DSL, HFC and fixed wireless, which have hard physical limits to the bandwidth they can deliver to a large population. Offerings from AT&T and Telcel are available and could make sense for rural areas with few inhabitants and few other alternatives, but do not appear significantly more economical than Mega in the areas it serves.

The long-term advantages of fiber will gradually become more and more prominent as the amount of bandwidth demand (overall and per consumer) continues to increase. In a global inflationary environment, taking advantage of low labor costs to deploy an extensive fiber network with an indefinite useful lifespan and low sustaining capex needs is an investment I’m happy to be a part of, particularly at these extreme valuations.

Conclusion

“There is a limit to how cheap Megacable can get”, wrote miser861 two years ago. Is there indeed? Seemingly we have somehow not yet plumbed the depths to which multiples can sink. But a sub-4 EV/EBITDA multiple on an underleveraged, profitable and growing fiber-rich cableco is getting to the point where the sheer quantities of cash flow will begin to exert a gravitational pull.

Is today the absolute bottom? Perhaps, perhaps not. Management will be continuing to plow growth capex into MEGA 2024 through the end of next year, with the rapid growth in homes passed likely to weigh on average local market share and margins at least through 1H2024 before inflecting upward. Señor Mercado could easily recoil in horror and disappointment, as he apparently has following each of the past 3 recommendations on VIC.

But with every day that passes, more fiber in the ground (and, one hopes, continuation of management’s >15-year track record of executing on profitable domestic growth) will relentlessly accrue to the long-term benefit of patient shareholders. One morning in the not too distant future, Sr Mercado will wake up and realize Mega is trading at under 3.5X EV/EBITDA with an underleveraged balanced sheet, while at the earliest stages of a positive inflection in margins, EBITDA and free cash flow that could likely continue for years to come. Until that day, I’ll be reinvesting my 7% dividend, and looking forward to reading the fifth consecutive VIC recommendation in another few years at 2X EBIT, michelada in hand and forehead vein pulsing with frustration.

Footnotes

1. It is still eligible for “2nd grade book report”, if the urge strikes you.

Catalyst

• Buildout of MEGA 2024 growth capex program results in continued subscriber growth
• EBITDA margins inflect upwards towards historic levels as local market share builds
• Long-term benefits of GPON/FttH fiber investments create scope for future growth in HSD/B2B revenues and decreased sustaining capex needs
• Growing cash flows sufficient to rapidly pay down modest ~1.5X leverage post-MEGA 2024 buildout and return cash to shareholders
• Long-term oriented founding family ownership
• >7% dividend yield
• Insane valuations stimulate 5th consecutive VIC writeup in another several years
• Increasingly attractive as takeover/merger target