Description

Megacable has been written up here twice. Each of these writeups provides great background and other information, and is highly recommended reading. While subscribers, revenue, and EBITDA have improved every year, the stock price is lower today than at the time of these writeups by Par03 in 2017 and goirish in 2019. As a result the valuation is compellingly cheap now, and already reflects a significant discount for any real or perceived threats facing the company. 

Then and Now

 Main Thesis

The cable and broadband industries have created very significant shareholder wealth in the US and elsewhere, and continue to do so. As demand for high speed internet increases in Mexico, the benefits of Megacable’s newly improved network should become apparent and allow the company to increase earnings as well as cash flows. Capex is peaking out as the company completes its network evolution, and will decline as a percent of revenue in the foreseeable future. Higher cash flows on decreasing capital intensity, combined with higher dividends and potential for M&A, should cause the multiple to move higher and narrow down the valuation gap with US peers. 

Operating Metrics

Even as the stock has treaded water, operating metrics have continued to improve. Homes passed and network kilometers continue to increase. Bundling continues to drive RGU’s per Unique, which reached 2.46 in June 2021. Broadband subscribers increased 13% yoy and 2% sequentially in Q2, and internet penetration at ~40% of homes passed leaves room to grow even as homes passed grow in low single digits.

Bundling and ARPUs through the cycle

The company’s focus is on triple play and higher, with X-view streaming, HD and Mobile now forming important building blocks of the bundles on offer. One disappointment thus far has been pricing - ARPUs haven't really gained traction in a long time, despite meaningful improvements in these offerings from Megacable. Part of the reason is having to offer compelling bundles to upgrade legacy video subs into the triple play. However, that should change and APRUs should increase once the improved network’s advantage becomes clear in tandem with subscribers’ increasing need for high speed internet.

Video has historically dominated the economic pie for cable companies in Mexico. With cord cutting and streaming, that is set to change. In 2020, for the first time internet subs outnumbered video subs for Megacable. While historically it hasn’t been possible to raise prices on video subs given alternatives that subscribers could churn away to, it would be a mistake to model that same trend far into the future. As the likes of Charter/Spectrum have shown in the US, high speed internet is an entirely different game and price rises will eventually follow.

To obtain a sense of where Megacable is in the cycle, consider that until June 2020 only 35% of subs were receiving speeds of 30 megs or had fiber services. With the rollout of the network evolution discussed below, in June 2021 that number reached 60% and continues to grow. This is laying the groundwork for meaningful speed and price increases in future.

Some Risks

Risks are mostly already priced in, IMHO. As mentioned in the previous writeups, these risks include regulation, FX exposure, political risk, and the widely known risk of America Movil getting a pay TV license that will enable it to create bundles. While this license may be closer now, most of the Telmex network is still copper with all the disadvantages that come with ADSL. Another competitor worth mentioning is TotalPlay, the cable company owned by billionaire Ricardo Salinas. While TotalPlay has historically not competed in Megacable’s markets, it continues to grow fast and poses an increasing threat. 

GPON and Capex

Looking to the future and in order to address these competitive threats, Megacable has embarked upon a meaningful upgrade of its network. The company is currently spending over 30% of revenue as capex, with most of the money going to convert a significant portion of its network to a Gigabit Passive Optical Network (GPON) that will provide long term benefits.

They have already migrated 500,000 of the 1.3 million planned subs onto GPON, as they roll it out to 12 cities. Hence 40% of the planned GPON project is done, with completion by the end of this year. They intend to take some of the displaced HFC network and redeploy it to other markets. They’re spending $400 million on capex this year, and this is currently putting a dent in free cash flow.

Until last year, Megacable had maintained that capex would come down significantly following the end of the GPON project at the end of 2021. More recently the company has stated that capex will continue at a higher level and they will continue to roll out upgrades to more cities. Capex ran at a high 33.5% of revenue in 2021Q2. The company is now guiding to capex declining to mid 20’s% of revenue by 2024 and low 20% by 2026. This target of ~20% was supposed to be reached earlier, and the delay seems to be part of the reason for the severely depressed stock. The majority of capex will be for GPON. No doubt these network evolution announcements also serve as signalling to competitors eyeing Megacable’s markets. 

FCF inflection coming

With EBITDA margins running in the healthy 50% range, once GPON is complete and capex comes down to low 20% of revenue, free cash flow should improve significantly. As demand for speeds increases, the GPON network which will be capable of 500 Mbps to 1 Gbps should be seen as differentiated and begin to fetch higher ARPUs even as expenses stay relatively flat. Low maintenance capex thereafter should cause FCF to inflect upwards.

This upgraded network should provide a moat worth a higher multiple than the old network. Looking out a couple of years, it is not difficult to see 30+ billion of revenue, 15+ billion of EBITDA and only 6 billion of capex once the GPON upgrade is finally behind them. Approaching 10 billion in EBITDA - Capex, the stock could double from here even in the absence of significant M&A or stock buybacks. Potential M&A could accelerate the upside. There is still a compelling case for combining with Televisa’s cable subs, especially since that company is now separating out and contributing its content assets into the new Televisa-Univision. Liberty Latin America remains another potential M&A candidate, since Mexico should be a valuable addition to their portfolio. 

Catalyst

As stated above, the valuation in terms of EV/LTM EBITDA has come down from 9.7x to 6.3x to the current 5.5x. Unfortunately we don’t have stock buybacks as a big catalyst, but there is still a limit to how cheap Megacable can get. M&A remains a potential catalyst. If M&A does not occur, time will be the catalyst. As capex declines and higher speeds translate to traction in pricing, dividend payouts could increase sharply forcing the stock to be revalued. Meanwhile we already get paid a 3.75% dividend yield to wait, one suspects not for too long.