2023-04-26 06:15:00 ET
Summary
- A contributing factor to Cable One's higher margins is their industry-leading ARPUs.
- Cable One is trading at less than 7.0x LTM EBITDA and less than 9.0x LTM run rate FCF, down from a peak EBITDA multiple of ~21.0x on an NTM basis.
- Fiber competitors have overbuilt ~25% of Cable One's footprint compared to 40%+ for Charter.
- I expect Cable One's multiple to expand back to or above pre-covid levels.
The following segment was excerpted from this fund letter.
Cable One Inc. ( CABO )
Cable One is a rural broadband provider with the majority of its footprint consisting of Coaxial rather than Fiber. For those unfamiliar with Cable One (Sparklight Internet), you can compare them to their larger, more well-known peers like Charter ( CHTR ) (Spectrum) or Comcast ( CMCSA ) (Xfinity).
There are however some important distinctions to make; unlike Charter and Comcast, they started to pivot away from TV subs back in 2013, and thus, their EBITDA margins are higher than the rest of the industry (~53% for CABO versus ~40% for Charter). This is because TV subs are basically a zero-margin business and contributed only ~25% of residential revenue for Cable One in 2022 but ~42% for Charter (lower margin, but still profitable for Charter). Funnily enough, I have been shocked at how often cable bears bring up TV subs as a concern on these names, not realizing they contribute nothing to the bottom line and are just a drag on margins. Another contributing factor to Cable One's higher margins is their industry leading ARPUs (Average revenue per user), which should continue to grow moving forward.
This is easily our most controversial/contrarian position as of writing; just go look at Cable One's, Charter's, Comcast's, or any other cable company's share price over the past two years - most are down 50%+ from the highs. There are several reasons for this; some include but are not limited to, multiple compression after substantial expansion in recent years, interest rates rapidly increasing, and since these names are levered, market participants are more hesitant to own them (4x EBITDA in Cable One's case), Fiber overbuilds increasing, and a new competitor in the form of 5G Fixed Wireless Access "FWA."
The first (multiple expansion) is no longer an issue, as Cable One is trading at less than 7.0x LTM EBITDA and less than 9.0x LTM run rate FCF, down from a peak EBITDA multiple of ~21.0x on an NTM basis. The second is also not a problem, their current blended interest rate is ~3.86%, ~75% of their debt is fixed, and the majority is not maturing until 2028 or later. The third (Fiber) is an overstated risk and has been for a while, and the verdict is still out on the fourth (FWA).
Up until recently, Cable One enjoyed a positive reputation in the market and received a premium multiple thanks to its rural footprint, lower penetration rate, phenomenal management team, and higher margins when compared to its peers. However, due to the emergence of Fixed Wireless Access, its rural footprint is now being perceived as a liability. Below I'll discuss fiber overbuilds and then elaborate on the potential impact FWA is going to have on them.
The cost of fiber overbuilding is substantial, which is why when competitors evaluate potential markets to overbuild, rural markets like most of Cable One's are typically at the bottom of the list if they are considered at all. It just doesn't make economic sense to lay the same amount of fiber in more rural markets when you can pass more homes in a suburban area for the same cost. To further prove this point, fiber competitors have overbuilt ~25% of Cable One's footprint compared to 40%+ for Charter. Regardless, overbuilds are nothing new to any Cable operator, and it takes several years, not weeks, for Fiber to start taking share from Cable, and in markets where Cable and Fiber do compete, they end up splitting the market 50/50. There are various reasons for this, but the primary reason is that, as of today, Coax and Fiber are essentially the same product, with the most significant difference being the symmetrical speeds offered by Fiber (Same upload speeds as download). A very, very, very small portion of broadband consumers need this upload speed, and Coax will soon be capable of offering symmetrical speeds as well as download speeds of 5GBs+ with the rollout of DOCSIS 4.0. Fiber is a superior product undoubtedly, but its advantages as of today (or the next several years, for that matter) aren't material. While Fiber overbuilds were ramping up significantly in recent years for various reasons (including 0% rates), they are now headed in the opposite direction, with essentially every fiber overbuilder cutting their 2023 build estimates significantly because of rising cost and lower IRRs - I don't expect this trend to change anytime soon.
FWA can be thought of as a permanent 5G hotspot in your home. The technology is inferior to both Fiber and HFC (Hybrid Fiber-Coaxial) and can experience frequent dropouts. In addition, its speeds can start off well but slow down significantly as more people join the network, and during times of heavy use, FWA is deprioritized by carriers who prioritize their mobile customers. While it is true that FWA providers like T-Mobile have gained a substantial number of FWA customers in recent quarters (~500k every quarter for the past three), I don't anticipate that they will continue to add subscribers at this pace. Moreover, I believe it is unlikely that FWA poses a greater threat to Cable Companies than Fiber does.
As previously mentioned, Cable One's footprint was once regarded favorably because they were less vulnerable to Fiber overbuilds. However, that same footprint is now seen as a disadvantage due to the perception that FWA is a threat to rural markets. I don't necessarily agree with this notion, and Cable One's typical market isn't in the middle of nowhere, with approximately 60,000 homes passed on average. These are not the same types of "rural" markets that would justify FWA deployment. The impact of FWA on a particular area or market depends on several factors. In urban areas, the presence of more infrastructure, such as towers, allows for the deployment of more mid/high-band spectrum, which provides higher speeds but covers a smaller area. However, urban areas also mean there are more users on the network, resulting in capacity constraints (This constraint is why when spectrum comes up for auction, mobile carriers bid it up substantially - they can't create more of it). Conversely, in rural areas, there may be a lack of infrastructure and lower bands may be required to cover the area needed, resulting in slower speeds but wider coverage. In certain cases, rural areas might have extra spectrum due to fewer customers, but this could also result in slower speeds if it's a lower band covering a wide area. To sum up, FWA has both pros and cons in rural and urban areas, so I do not believe that rural broadband providers are at a disadvantage compared to their urban counterparts. Customer demand comes from both rural and urban areas. For instance, T-Mobile states that around two-thirds of their FWA additions come from their top one hundred largest markets, while the remaining one-third is from smaller markets and rural areas. It should be noted that T-Mobile is not deploying 5G small-cell radios specifically for FWA. Instead, they offer this service only in areas where they have extra capacity in their networks. FWA customers typically consume ten times more data than mobile users, resulting in lower returns on their investment and, as a result, are given lower priority during times of peak usage.
To save time, let me conclude with some final remarks on FWA. Customers seem to be less satisfied with the service than before. A quick glance at the T-Mobile ISP subreddit reveals numerous negative reviews, where people frequently report speeds below 100 Mbps. A year ago, the same subreddit was full of positive feedback, but today, positive reviews are often met with comments such as "Come back to us in six months when more users join the network." Moreover, the price of FWA, which is around $50 per month for non-bundled T-Mobile customers, is not much cheaper than coaxial or fiber internet. Finally, it is worth noting that the former chairman of the FCC, who approved millimeter-wave technology for 5G FWA, described it as an "interim technology."
As of writing, Cable One is currently trading at ~7.0x LTM EBITDA (for clarity, we do give them credit for the book value of their investments, which I believe to be conservative and think these assets are likely worth more than they are listed on the balance sheet for), and 9.0x our run-rate FCF estimate before accounting for their investments - if you tack them on at book, you're at ~6.5x. These multiples seem far too low for a business that still has an essential monopoly in 65% of its markets while providing what is practically a necessity today (home internet). If the FWA risk proves to be overblown, I expect Cable One's multiple to expand back to or above pre-covid levels, which on LTM numbers today gives us an incredible upside opportunity.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Atai Capital - Cable One: Most Contrarian But With Incredible Upside