2023-11-03 11:06:55 ET
Summary
- Altice USA has significantly underperformed its peers and the S&P 500 since going public.
- ATUS faces business challenges due to its declining traditional pay-TV business and competition from fixed wireless access players.
- ATUS has a highly leveraged balance sheet and it is difficult to see how it will be able to refinance its debt given the current interest rate environment.
- ATUS is currently trading at a valuation which is mostly in line with higher quality peers such as CMCSA and CHTR.
- I expect ATUS' challenges to continue and I am initiating coverage with a sell rating.
Altice USA, Inc. ( ATUS ) has been a very disappointing investment for anyone who participated in the company's 2017 IPO . Since then, ATUS has delivered a total return of -90% compared to a total return of 92% delivered by the S&P 500.
In addition to underperforming the S&P 500, ATUS has significantly underperformed peers such as Comcast ( CMCSA ), Charter Communications ( CHTR ), and Cable One, Inc. ( CABO ).
ATUS shares have struggled due to a decline in the traditional pay-TV business, broadband competition from fixed wireless access ("FWA") players such as Verizon ( VZ ) and T-Mobile ( TMUS ), as well as balance sheet concerns related to rising interest rates.
In my view, these challenges are not likely to go away anytime soon and thus ATUS is an unattractive investment at current levels.
Company Overview
ATUS provides broadband communications and video services in the U.S. under the Optimum brand. ATUS delivers broadband, video, and telephony services to ~4.9 million residential and business customers across 21 states. The company's primary markets are the New York metropolitan area and various markets in the south-central U.S.
Residential revenue accounts for ~79% of revenue while Business Services accounts for ~16% of revenue. The remaining revenue comes from other sources including news & advertising, mobile equipment, and other sources.
The residential broadband business accounts for ~52% of residential revenue while Video accounts for ~42% of residential revenue. The telephony and mobile businesses are smaller contributors accounting for ~4% and ~1% of residential revenue respectively.
ATUS is controlled by Patrick Drahi, who also controls Altice Group Lux. Drahi is currently under investigation for alleged corruption in Portugal related to Altice International, which is a separate company from ATUS. However, both firms are under the control of Patrick Drahi.
Business Challenges
As shown by the charts below, ATUS has experienced declining revenue and EBITDA since late 2021. This trend has broadly been the result of pay-TV cord cutting as well as increasing competition from FWA providers which has resulted in negative net broadband additions for the past 7 quarters.
The FWA market has been growing rapidly and is expected to grow at a CAGR of ~38% from 2023-2030. Currently, FWA providers are estimated to be capturing ~90% of all new U.S. broadband customers.
ATUS reported a net loss of 31,000 broadband subscribers in Q3 2023 which compares to a loss of 37,000 broadband subscribers in Q2 2022. While the trend appears to be improving, the reality is that ATUS continues to lose subscribers each quarter.
High Capex Required to Support Network Evolution
ATUS is currently engaged in a massive build out of its Fiber-To-The-Home ("FTTH") network. FTTH offers faster broadband speeds allowing ATUS to deliver multi-gig broadband speeds. The FTTH business has been rapidly growing and now accounts for ~295,000 broadband subscribers.
In order to fund the buildout of the FTTH network, ATUS has been making significant capex investments. Capital intensity, which measures capex as a % of revenue, had been hovering in the low 20% range over the past 5 quarters. The 20% level marks a significant increase from ATUS's historical capital intensity which had been closer to 10%.
However, ATUS has recently slowed the pace of investment. In Q3 2023 capital intensity was 15.2%. Excluding the FTTH build, capital intensity would have been 8.8%. ATUS management has noted that it expects capital spend to come down through the remainder of the year but that FTTH investments remain a priority.
Q3 2023 Results
On November 1, 2023 ATUS reported Q3 2023 results that beat market expectations. ATUS reported EPS of $0.15 per share which beat analyst estimates by $0.08. Revenue came in at $2.32 billion which beat analyst expectations by $30 million.
Residential revenue was down 3.4% on a year-over-year basis driven by losses of higher ARPU video customers over the past year. Residential ARPU was $138.42, down 0.6% on a year-over-year basis. The rate of residential revenue decline improved from -5.7% in Q2 2023 and -5.5% in Q1 2023.
Adj. EBITDA came in at $915.5 million which was a decline of 4.1% on a year-over-year basis.
ATUS shares responded favorably to the new rising ~10% following the news as of this writing.
Highly Levered Balance Sheet
As shown by the chart below, ATUS has a significant amount of debt. Currently, the company has long-term debt of ~$ 25 billion (including debt issued at its Lightpath subsidy.)
Over the last 12 months, ATUS has generated Adj. EBITDA of ~$3.62 billion and thus its gross leverage ratio is currently ~6.9x on a trailing basis. ATUS has just $268 million in cash so the net leverage ratio is ~6.8x on a trailing basis.
Clearly, ATUS is a highly levered company. S&P recently downgraded the company to B from B+ in March 2023. Moody's downgraded ATUS to B3 from B1 in July 2023. Both ratings represent junk credit ratings.
In addition to being highly levered on a standalone basis, ATUS is currently significantly more levered than its peer such as Comcast ((CMCSA)), Charter ((CHTR)), and Cable One ((CABO)).
ATUS high level of leverage is particularly problematic given the current interest rate environment. 80% of ATUS's debt is fixed rate debt. This is a positive in that the company has been shielded to a large extent from rising interest rates. However, upon maturity all of this debt will need to be refinanced at higher rates. The current weighted average cost of debt ("WACD") is 6.1%. Given the rise of interest rates and deterioration of the ATUS credit story, if the company is able to refinance existing debt I believe it will be at much higher rates than the company is currently paying and thus significant higher interest expense. Highest interest expense will be problematic for ATUS given its current challenges in driving profitability as well as high capex requirements for the FTTH build.
Valuation
ATUS has received a valuation grade of B+ from Seeking Alpha quant scores. I don't agree, and believe the valuation is not attractive.
While ATUS is trading at a substantial discount to the S&P 500 (~8x forward earnings vs ~17x forward earnings), I do not find this valuation attractive given the business and balance sheet challenges that ATUS faces.
ATUS is trading at ~8x forward earnings and at a forward EV / EBITDA of ~7.4x. Comparably, high quality peers such as CMCSA and CHTR trade at ~9.8x and ~10.7x forward earnings. Moreover, CMCSA and CHTR trade at just ~7x and 7.4x forward EV/ EBITDA ratios.
Given the challenging balance sheet that ATUS currently has, I believe the company should trade at a substantial discount to peers such as CMCSA and CHTR.
While ATUS appears to be trading cheap relative to its own valuation history, I believe this is warranted given the deterioration of the business over the past 2 years and increased balance sheet challenges due to rising rates.
Risks To My View
One risk to my view is that ATUS becomes an acquisition target. In early 2023 rumors circulated that CMCSA was interested in acquiring ATUS. However, due to its large scale it is difficult to see a major player such as CHTR, CMCSA, or TMUS getting regulatory approval for a deal. Additionally, given ATUS's troubled balance sheet competitors may just wait to see if ATUS is unable to refinance existing debt and is forced to enter a bankruptcy process. Competitors would be able to bid for ATUS in that forum and likely pay a significantly lower price.
Another risk to my view is that interest rates come down and relieve pressure on ATUS's balance sheet. While a significant drop in interest rates does not seem likely right now, it is possible that rates fall prior to the maturity of a large part of ATUS's existing debt. Lower interest rates may allow ATUS to refinance debt. That said, I think any drop in interest rates is likely to be prompted by a significant economic downturn. While the broadband business is likely to remain resilient, the pay-TV business may suffer as cord cutting accelerates. An accelerated drop off in the pay-TV business would serve as an additional challenge to ATUS.
Finally, another potential risk to my bearish view is that ATUS strikes an out of court restructuring agreement with bondholders resulting in a more sustainable balance sheet. I view this as relatively unlikely currently as bondholders do not have much to gain. I think an out of court restructuring would only occur in a way which would be highly dilutive to existing shareholders and effectively hand over control of the company to bondholders.
Conclusion
ATUS is a company that has failed to deliver strong results for shareholders historically. The company faces a very challenging operating environment characterized by a high degree of competition from emerging FWA providers, a secular trend towards cord cutting, and high capital investments required to keep pace with industry trends towards faster connection speeds.
In addition to facing a challenging business environment, ATUS also faces substantial challenges due to its highly levered balance sheet. It is difficult to see how ATUS can refinance its existing debt load given the current interest rate environment. ATUS is significantly more levered than its peers and both Moody's and S&P have downgraded ATUS credit rating to junk status.
Despite the business and balance sheet challenges facing the company, ATUS does not appear to be trading at a major discount relative to higher quality peers such as CMCSA and CHTR. I believe ATUS should trade at a significant discount.
While ATUS shares are trading at just ~$3 and have already fallen substantially, I believe they will continue moving lower. Thus, I am initiating ATUS with a sell rating.
For further details see:
Altice USA: Business And Balance Sheet Challenges Set To Persist