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".
