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CHTR - Charter Communications


Guest JoelS

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There is a good thread on Liberty Media but I thought it would be worth starting a new thread on Charter Communications (if there isn't one already), as a stand alone company or to help analyse the new Liberty tracking stock LBRDA/B which will hold among other things Liberty Media's 27% interest in Charter. So here's my summary, sourced mostly from the company, VIC, interviews, and Brooklyn Investor.. (i'll post up all the sources i've come across at some point)

 

Charter Communications is a provider of cable television, broadband internet and telephone services to 6.8 million Americans in 29 US states. The Company is minority owned and controlled by Liberty Media, the flagship company of John Malone. Liberty Media acquired a 27% stake in Charter in March 2013 at a price of $95.50 per share, and has the right to increase its stake to 35% ownership between now and June 2016 and 40% ownership after June 2016.  John Malone, by all accounts, is recognised as one of the best CEO and capital allocators of the 20th century. Over 25 years at the helm of TCI, Malone compounded capital at a rate of over 30% before selling to AT&T, whose cable assets were later bought by Charter and Comcast. Malone has achieved a similar rate of return with Liberty Media, originally a spin off from TCI. From May of 2006 through the financial crisis to March 2013, Liberty returned 33% per year. The upshot is a compounding rate of return near 30% for nearly 40 years.

 

Cable background

 

Cable is an attractive industry in general. Cable operators have de facto monopolies in that they control the only data connection into the home with enough capacity to serve video, internet and voice simultaneously. Cable provides the highest speeds and will continue to have the highest speed for the least incremental capital. Because data usage is rising exponentially, having the lowest cost basis will become increasingly important. Cable companies are also attractive in that they hold no inventory, have no labour problems and no long term benefit liabilities. The industry norm is two year contracts with annual price increases.

 

JM quote on cable industry:

 

“I used to say in the cable industry that if your interest rate was lower than your growth rate, your present value is infinite. That’s why the cable industry created so many rich guys. It was the combination of tax-sheltered cash-flow growth that was, in effect, growing faster than the interest rate under which you could borrow money. If you do any arithmetic at all, the present value calculation tends toward infinity under that thesis.”

 

Charter

 

In 2009, Charter Communications went bankrupt. The company suffered from over leverage and poor management virtually from the time of its IPO in 1999. Charter was bought out of bankruptcy by distressed debt and private equity interests including Apollo and Oaktree. They sold their stakes in the company to Malone's Liberty at a significant profit. Charter emerged from bankruptcy with reduced debt and an enormous net operating loss position (at 31st dec 2013, loss carry forwards were $8.3 billion) meaning Charter won't pay tax until at least 2018. Protected by these NOL's, Charter's earnings will flow through to free cash flow, allowing share repurchases or acquisitions.

 

Today, Charter is levered 4.8x Ebitda. Historically, cable has been able to support up to 5x ebitda due to the utility-like nature of the business. 95% of Charter's debt is due after 2016, with an average duration of 7.4 years and a weighted average cost of debt of 5.6%.

 

The stock is priced at an EV/Ebitda multiple of about 9.5x. This is higher than peers but arguably justified because the outlook for charter is much better than peers. Tom Rutledge, Charter's CEO since December 2011, is reputedly one of the best operators in the cable business. Rutledge was formerly COO of Cablevision, The US's eighth largest cable operator. Under his leadership, Cablevision achieved some of the best operating metrics in the cable industry, while overseeing a turnaround comparable to Charter. In 2010 Cablevision acquired Bresnan communications, a company which, although much smaller, has similarities to Charter in that both serve mostly rural markets. Rutledge sought to improve Bresnan's EBITDA per serviceable passing (the standard industry metric for measuring the financial performance of a cable company) through a strategy of driving sales and customer service, boosting internet penetration and offering better video products.

In six quarters, EBITDA per serviceable passing at Bresnan rose from $207 to $270.

 

Rutledge's strategy for Charter is very similar to Bresnan's and to help turn around Charter, he recruited almost his entire team from Cablevision. Rutledge's employment agreement also includes 1.3 million share awards vesting over four years. Today, Charter's EBITDA per serviceable passing sits around $220. The best cable companies in the US show a figure of about $450 EBITDA per passing. If Charter can increase EBITDA to approximately $280 - $300 per home passed per year, free cash flow should grow at a decent clip. Combined with repurchasing shares and incremental borrowing, Charter should be able to shrink the equity of the company substantially over the next 2-3 years.

 

John Malone on Charter:

 

"This is a unique opportunity to take this vehicle and grow it; through both superior marketing and promotion, in other words organic growth… which can be exceptionally strong for a number of years… and particularly the rate of growth of free cash flow can be very, very strong, which allows it to then access the leverage market in order to do roll-up transactions, particularly where there are horizontal synergies. So the old TCI formula, horizontal acquisitions, synergies, grow scale and then look to form consortia with other cable companies".

 

 

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EBITDA per passing is an interesting statistic.  When comparing to GNCMA (more than $ 600 EBITDA per  passing), there seems to be a lot more of potential improvement at Charter. So price/EBITDA is lower at GNCMA but potential is a lot higher at CHTR.

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where is the upside? If they increase to 300, then it still trades at like 12-14x FCF with current revenue? If it increases to 375 then it trades at 6.75x FCF. How can you assess the chance they will succeed at this? Seems like alot of the improvement is already priced in?

 

Also is attaining GCI's level not a bit unrealistic, and isn't their cost structure different with higher cap exp?

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Oh, the pain!  I bought CHTR warrants post-reorganization for ~6, then sold a couple months later for no explicable reason.  Every time I see a CHTR thread or message, it opens up the wound again.  Quick - bury this thread!  ;)

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where is the upside? If they increase to 300, then it still trades at like 12-14x FCF with current revenue? If it increases to 375 then it trades at 6.75x FCF. How can you assess the chance they will succeed at this? Seems like alot of the improvement is already priced in?

 

Also is attaining GCI's level not a bit unrealistic, and isn't their cost structure different with higher cap exp?

 

Attaining GCI's passing figure seems out of reach, at least for the next few years. Getting to $300, on the other hand, doesn't seem so unrealistic. Most of the upside in EBITDA would come from increasing internet penetration in its footprint.. In 2013, Charter provided internet to just over 32% of customers v competitors Time Warner, Comcast and Cablevision all over 36%. (50%+ for Cablevision).

 

If they can get to $300 per passing at year end 2015, it depends on your assumptions of course, but from 1. 2014 free cash flow, 2. 2015 free cash flow and 3. incremental borrowing to keep leverage at 4.5x ebitda, you end up with c $5bn of cash for Mr Malone and Mr Maffei to use for whatever purpose they deem appropriate.

 

The current market cap is c $13.1bn. So the free cash looks good in comparison.

 

 

 

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What would cap exp be compared to depreciation?

 

Because here is what I get. 300$ per passing is 36% higher right? So 36% more ebitda. they had 2.8b$ ebitda in 2013. So x  = 3.8bn$ in ebitda now. - 1.8bn$ in depreciation (how much cap exp is that in reality?, and will this be  higher or lower?) - 850 in interest is 1.15 bn$ in FCF, not counting in taxes. with a market cap of 13 bn$ that doesnt look v cheap?

 

Also if you think they can get more debt, then you are saying i should buy liberty media? Is that FCF for liberty media? I dont get that part.

 

Did I do the FCF calculation right?

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What would cap exp be compared to depreciation?

 

Because here is what I get. 300$ per passing is 36% higher right? So 36% more ebitda. they had 2.8b$ ebitda in 2013. So x  = 3.8bn$ in ebitda now. - 1.8bn$ in depreciation (how much cap exp is that in reality?, and will this be  higher or lower?) - 850 in interest is 1.15 bn$ in FCF, not counting in taxes. with a market cap of 13 bn$ that doesnt look v cheap?

 

Also if you think they can get more debt, then you are saying i should buy liberty media? Is that FCF for liberty media? I dont get that part.

 

Did I do the FCF calculation right?

 

We're in about the same ballpark. So using your figure of 3.8bn, and keeping leverage at 4.5 v 4.8 today (for charter, not liberty) you add about 3.1bn to debt. Maintenance capex should come down as a percentage of revenues in 2015, when the c400m attributed to the digital rollout ends. So you get capital coming down per customer. I think the cash flow yield might be closer to 10% in 2015 - more like 1.3 - 1.4bn.. But that's subjective.

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Charter Communications has filed legal documents contesting the proposed $42.5bn merger between Time Warner Cable and Comcast, claiming that the deal has been subject to a “flawed process”.

 

In a filing with the Securities and Exchange Commission on Thursday night, Charter, a cable operator, outlined a series of complaints against the structuring of the deal, with a particular focus on proposed divestitures and the lack of a break-up fee.

 

“TWC’s process for negotiating and approving the merger was flawed because of the failure of the TWC board of directors to consider and investigate alternatives to the proposed Comcast merger,” the document reads.

 

“In particular, the TWC board simply refused to meaningfully engage with Charter regarding a potential business combination even after deciding to pursue a transaction with Comcast

 

http://www.ft.com/intl/cms/s/0/4279ccc4-b671-11e3-b230-00144feabdc0.html#axzz2xHQ55UlE

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  • 3 weeks later...

Haven't look at this yet but just thinking out loud here:

 

If you assume that "internal/organic growth can be exceptionally strong for a number of years" is possible in combination with increased EBITDA per passing to $300 by the end of 2015/2016 you would get much much higher EBITDA in only a few years. If internal growth is 10%/year* you'd get near $5B EBITDA in 2016! Sure, that would be a very bullish outcome but also one where you could see a double from the current market cap, if not more.

 

(*likely way too aggressive ;))

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very bad blood now between malone and roberts. I don't suspect charter now has the inside track on divestitures. so I guess the strategy is to go "all in".

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  • 2 weeks later...

What do you mean with 'going all in' wellmont? TIA

 

Apparently the "bad blood" was just for show. It appears that Malone was using the threat of making himself into a real nuisance and object to the Comcast/TWC deal, in the hopes that he could get something for charter. So he was "all in" in acting like a total jerk. He also knew that comcast wanted to swap subscribers with charter in LA. So being a jerk got comcast to the table.

 

And it looks like it worked. Malone knew he had lost TWC. But he got almost as good a deal with this 3 stage agreement. The original plan was for chtr to buy twc and split some of it with comcast. The only change is that comcast is buying twc and will split some with charter. The end result is comcast gets more subs and charter less than the original proposal. But this deal will work for both companies. If charter also bags COX and or CVC down the road, there will essentially be a duopoly in cable. And that could bode well for DTV/DISH.

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  • 3 months later...

Such a complicated valuation on the deal! Anyone care to venture a guess what will be the market cap of the new charter? There could be opportunities in all these spinoffs and new company formation! I would like to see what's the valuation on single customer?

 

Ex:  New Charter will have 5.7M in legacy & 1/3(2.5M) in the spinco?? On a ownership basis, new charter will have 6.5M customers??

 

Proforma debt - $21.8 B

Current market cap - $16B??

EV - $38B

 

Each customer is valued @ $38B/6.5M(both legacy and spinco ownership) --> $5846???

 

Can someone verify the math above?? Something is wrong i guess!

 

 

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The value for Charter should be even more than that (whatever number you use per subscriber) because they are getting a revenue share fee for managing the new entity.  That's huge - it's a fee on the entire business so they are in effect paying themselves for their 1/3'd share but getting fees on the other 2/3's.  That revenue/fee should drop pretty squarely to the bottom line.

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This is my first post on CoB.  Charter is intriguing, and I've just started trying to understand it to get a better handle on what LMCA pre-spin is worth.  Here is my stab at valuing Charter pro-forma for the Comcast transaction.  Welcome your thoughts / improvements:

 

2014 Charter Enterprise Value

+ 5.4m video subscribers = $5.7b revenue (+1.4m acquired)

+ 5.1m internet subscribers = $2.5b revenue

+ 2.5m voice subscribers = $0.7b revenue

+ 0.6m commercial subscribers = $0.9b revenue

+ 2.5m SpinCo video managed subscribers = $0.1b revenue (4.25% on revenue of SpinCo subscribers)

+ Other revenue = $0.5b

= $10.5b total revenue

 

x 36.0% Adj. EBITDA margin (historical 35%-37%)

= $3.8b Adj. EBITDA

 

x 9.5 EBITDA multiple (accounts for growth)

= $36.1b enterprise value

 

+ 33% stake in SpinCo = $2.1b equity value

- $21.8b debt (5.7x leverage)

= $16.4b equity value

 

/ 0.1b diluted shares

= $153 per share

 

Charter is currently trading around this value, suggesting upside of improved ARPU, margins and future capital allocation actions by Malone or Rutledge is not fully priced into the current price.  Charter could potentially be worth 25% more is one assumes improved ARPU and margins as a result of economies of scale. 

 

What do you think?

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Hey there, welcome to the Board!

 

I think your analysis is pretty correct.  The only things I'd question are: a) the managed subs should have much, much higher margins since that is just a management fee and wouldn't have any of the associated costs of revenue;  b) for the SpinCo ownership, you show $2.1bn of enterprice value and $21bnof debt - not sure that math works but the $16bn remaining value is probably right.

 

I can't recall but I thought they were also purchasing some 2M subs from Comcast to get them to a total managed base of about 9-9.5M subs.

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Yes, thanks for taking a look at these estimates.  I agree that most of the revenue from the managed subs would drop to profit, especially since some costs will be reimbursed by the SpinCo.  Also, the way I presented the SpinCo equity value and CHTR debt is confusing.  They are not related, just grouped together to get to CHTR equity value.

 

I like the CHTR story.  Must believe that the economics of the business will improve to resemble leaders like CVC and Malone and Rutlege will make shareholder friendly capital allocation decisions.  Resembles the FIATY thesis (but probably with fewer upside options...).

 

Look forward to the dialogue on the board!

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  • 4 weeks later...

 

Thanks for the transcript.

 

I must be a little slow, because it took this transcript to help me figure out why the GreatLand deal was such a good deal for Charter. They get to offload some of their costs (R&D, marketing, etc.) onto GreatLand, and this helps Charter by increasing Charter's margins while at the same time they benefit off the revenue share on GreatLand. It's pure margin for them.

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Thanks for the transcript.

 

I must be a little slow, because it took this transcript to help me figure out why the GreatLand deal was such a good deal for Charter. They get to offload some of their costs (R&D, marketing, etc.) onto GreatLand, and this helps Charter by increasing Charter's margins while at the same time they benefit off the revenue share on GreatLand. It's pure margin for them.

 

It's more than just margin expansion. The customer trade with Time Warner is very beneficial. And not to mention the possibility of acquiring GreatLand when the opportunity arises.

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