As Charter Communications (NASDAQ:CHTR) celebrates its 30th anniversary, it is an opportune time to reflect on how the industry has evolved, how its Spectrum brand became the United States’ second largest cable operator (behind Comcast) with 32.2m customers and whether the value proposition still resonates with customers as strongly as in the past.
History of US Cable
Cable systems were invented in the late 1940s and were used to bring television to local communities. One of the first major brands was NewChannels which was established in 1964 by Newhouse. Warner Cable was formed in 1973 by Warner Communications and Newhouse formed a second cable company, MetroVision in 1979. In 1989 Warner Communications and Time merged to form Time Warner with a subscriber base at the time of over 5.5m.
Charter Communications CATV systems was founded in 1979 by Charles Leonard as a Michigan-based cable TV operator and at the time of garnering approximately 7,900 homes merged with Spectrum Communications in 1982 to form Charter Systems. Charter was then consolidated through a series of mergers and acquisitions by former executives of Cencom Cable TV. Serendipitously, the cable companies were able to use their infrastructure systems, comprising hybrid coaxial cable, to carry data to facilitate internet broadband with relatively minor investment requirements. This placed the cable companies at a huge competitive advantage versus new providers seeking to enter the broadband market. Over the ensuing years, Charter invested to enhance the speed of its network at fairly low incremental costs to preserve its dominant market position.
Bankruptcy & Rolling-up the Sector
Having rolled up several cable companies during the 1990s, Charter went public in November 1999 with 3.9m customers.
Several debt-funded acquisitions followed during the 2000s but by the end of the decade the business became over-extended and had racked up debts of $21.7bn. Charter, which at the time was controlled by former Microsoft founder Paul Allen, filed for bankruptcy in the midst of the Great Recession of 2009. The ensuing financial restructuring eliminated $8bn of debt in exchange for ownership in the new company and emerged with $13 billion in new debt. By November 2009, Charter emerged from Chapter 11 and re-listed on the Nasdaq in 2010. In 2011 Allen retired as chairman and was replaced in the following year by Tom Rutledge who was appointed President and Chief Executive Officer.
Aided by a prolonged period of low cost capital, in the ensuing decade, Charter rolled up the sector, acquiring Optimum West from Cablevision in 2013 for $1.6bn, Time Warner Cable for $55.0bn and Bright House Networks for $10.4bn in 2016.
Provision of Mobile Service
Over the last year the housing market has been up-ended by the surge of Federal Funds rate to 5.25% which has led the 30-year US mortgage rate to recently reach a two-decade high of 8%. As a result, housing transactions have fallen precipitously as mortgage holders are highly dis-incentivized to relinquish their existing loans. As Charter tends to benefit when US homes are acquired and households move, earnings have been subdued. Costs have also been elevated as Charter has focused on adding a mobile service to its core offering. Having conquered cable TV and broadband internet, Rutledge is attempting to disrupt incumbent mobile telecom providers by bundling Spectrum internet with an unlimited mobile line for starting price of $49.99 per month.
In recent years a large capital expenditure program was initiated to ensure the business remains on a stable growth trajectory. Federal, State and local government subsidies have been secured to lay cable in rural areas whilst wi-fi hot spots have been erected to reduce its dependency on Verizon which is obligated to allow Charter to utilize its network. Across its established end-markets, Charter has been upgrading its network to offer download speeds of 5 Gps across the majority of its territory at a cost of only $100 per passing. With the advent of the Internet of Things, homes are becoming more connected and sensor-driven, which will inevitably lead households to consume more bandwidth.
Charter Broadband Expansion
Charter Broadband Expansion (Charter Investor Relations)
Earnings from internet and mobile services may be obfuscated by higher operating expenditure but other yardsticks show favorable trends. Broadband subscriber growth is out-pacing competitors and the company is raising the monthly price of its spectrum internet service by $5 though customers on a direct debit can avoid the hike, thereby incentivizing the establishment of a subscription. In Q2 2022 the business lost 21,000 residential and business broadband customers. A year later, the company added 77,000 new customers despite the soft housing market.
Across its mobile service, the company added 648,000 new lines across residential and small business customers and is now providing a total of 6.62 million lines. Cross-selling and bundling is driving mobile adoption. Over 11% of broadband customers have added a mobile line, a level that is expected to grow meaningfully in upcoming years. Users can link their phones to the Spectrum mobile network using wi-fi spots that Charter and Comcast share. By reducing the dependency on Verizon’s network through a mobile virtual network operator agreement, mobile pricing will become even more competitive.
Risks are Manageable
Whilst some naysayers view fibre-to-the-home as a threat, in reality it is extremely expensive to install and cable has successfully out-competed fibre for many years. A weaker housing market poses a headwind to net new subscribers but, as evidenced, CHTR is weathering the downturn well.
There has been a concern that fixed wireless broadband (FWB) offered by the telecommunications providers will meaningfully increase the competitive intensity of the industry. This fear is overstated as FWB suffers from both demand and supply limitations which ensures that the technology will only be adopted by a small user base. Over time these users will likely migrate to cable or fibre as consumers’ speed requirements exceed those that FWB can provide.
Whilst CHTR is highly geared with $98bn of debt, over 90% matures beyond 2025 and the weighted acreage cost of 5.2% is stretched over an average weighted 13 year maturity window. Management has set a target total leverage range of 4-4.5x EBITDA and interest in the second quarter accounted for 22.3% of adjusted EBITDA.
Supportive Valuation
During 2021-22, Charter shares lost half their value as the market fretted over rising cost of debt and the potential for mobile operators to offer internet wi-fi to customers. Yet Charter has steadfast continued to increase sales and is set to deliver EPS of $38 in FY2024, which puts the shares on a derisory 11.4x P/E multiple – a far shadow of the 24x P/E multiple reached during 2021.
Summary
Charter holds a regional monopoly in the majority of its footprint and offers high speeds of bandwidth at competitive prices. Fixed wireless broadband was once perceived as a threat but in reality network capacity has been quickly absorbed and it is an inferior product in terms of speed and bandwidth. Where it has proven suitable has been select rural areas where there is excess capacity. Fiber-to-the-home has been attempted many times, not least by Alphabet, but it is costly and time-consuming and few have been able to generate a return in excess of the cost of capital. With a strong recurring revenue base and capital intensity set to diminish in coming years, CHTR’s free cash flow generation will be used to contain debt and fund buy-backs. Given an attractive headline valuation, the shares are recommended for purchase.
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