2023-03-06 13:15:02 ET
Summary
- Charter Communications, Inc. has historically beaten the market.
- I don't think it will continue to do so, and the future is murky given the company's capital position.
- Charter Communications, Inc. stock is a sell today.
Charter Communications, Inc. ( CHTR ) is not a company I was overly excited to cover. The stock has beaten the market over time, and Internet companies in general gain many of the benefits of utilities without quite the same level of regulation like overt price controls.
However, my interactions with the company have been atrocious. I've lived in several locations around the country, and whether it is Charter or Comcast Corporation (NYSE: CMCSA ), I've tried everything to get away from using the company's products due to the shady bundling tactics (my opinion, obviously) and poor customer service. However, DSL Internet over phone lines from the local phone company are a poor substitute. I remember from my earlier days when DSL blew dial-up out of the water, but these days it's difficult to stream a video while doing anything else through a DSL connection.
Alternatively, my experience with AT&T Inc. (NYSE: T ) installing fiber to my last house was truly among the worst interactions I've ever had with a company. They damaged the house, were nearly impossible to get on the phone, put the router in a spot that actually made the internet connectivity worse, and locked us into a contract that I thankfully got out of by moving away. Compared to those issues, today I gladly pay the fixed-rate for cable internet and recognize it may be the least-bad option. Needless to say, I came into writing this article with some preconceived notions about Charter.
FAST Graphs
However, setting those aside, I'm covering the company in part because of its success over time. Internet is effectively a utility, slowly becoming nearly as ingrained in household operations as electricity, sewage, etc. Charter has a significant moat in its operational infrastructure, with massive cash outlays to build its fiber-coax mesh network to around 55M homes.
Because of that moat, the company has managed to easily lap the market over the past 14 or so years.
Charter's footprint is vast, and based solely on area, it continues to grow quickly. As part of various government subsidies, Charter is expanding the network to rural customers (projected to about 1M). The government will end up footing part of the bill, considering its more expensive for cable companies per customer than in more densely populated areas.
Charter also has to continue investment to increase its infrastructure as demands for data grow. The footprint today is almost entirely able to subscribe to 1 GBps speeds. The network architecture operates on fiber to nodes, where coaxial is run to individual homes. Enterprise customers, and the new rural buildout, will run fiber straight to the customer. It's not a cheap endeavor, evidenced by Google's (GOOG) effective exit from the space following significant investments into Google Fiber.
Looking above, the discussion is very technical from the 10-K, but it shows the company's path forward. There will be substantial cash outlays as Charter continues its upgrade cycle to a faster internet architecture. The current plan takes them out to 2025, and the investment really does need to happen. The way I look at it, if Charter stops improving, it will provide an opening for competitors, including the mobile network companies like AT&T to start taking share. As I mentioned above, AT&T is working through its own fiber initiative, and 5G in more densely populated areas has the potential to unseat cable Internet as customers can meet their data needs over mobile networks.
Additionally, Charter's investments into mobile have been a land-grab situation. The company resells Verizon network capacity and is priced very competitively to take share. Charter is attempting to use its in-home WiFi along with a build-out of 500,000 WiFi access points and partnerships with an additional 25M WiFi access points to offload as much traffic as possible off of Verizon's towers. In 2022, Charter added 1.728M mobile lines bringing the total customers to 5.3M. Along with that, mobile costs rose from $2.5B to $3.4B, while revenues rose around 40% from $2.2B to $3B. The initiative appears to be working at least in customer growth, but time will tell how well the company can flex its scale and bundling (my favorite) to actually make this a profitable portion of the business.
One risk that bears watching remains government regulation. Charter takes advantage of some Covid-era internet affordability legislation where the government foots a portion of low-income customers' bills (generally $30). However, a concern to keep in the back of your mind should be what happens if the government decides to set price caps on internet accessibility and turns internet providers into straight utilities like the power companies. Charter attempts to lower prices when it can to grab share, but a key part of the bull thesis is pricing power when Charter decides to expand profitability by hiking prices.
Looking at the business segments, Charter is facing a likely terminal decline in its video operations. Most recently, Video revenue dropped 1%. However, this is milking the last bit out of the segment, as customer count was down 719,000 resulting in $621M in revenues walking out the door. Charter bandaged that loss with $451M improvements in rate and product mix. This will only last so long, and is the likely reason the company is pushing so hard in mobile. The company's joint venture with Comcast on the Xumo player to aggregate streaming platforms, the Spectrum TV app available on Samsung Smart TV's and Rokus, and smart set-top boxes able to stream from various services are ways the company has attempted to staunch the bleeding. However, I'm in a "show me" mentality when it comes to Charter's ability to prevent a decline in Video, overall.
As far as Internet, this is the mainstay of Charter's business. I mentioned some risks above, but the continued build-out and improvements in the infrastructure should keep the company's competitive position intact for the medium-term. The company added 340,000 new internet customers in 2022, and continues to act as price leader to stave off competition. Internet revenues grew 5.3%, which ultimately aided in the overall 4.5% revenue increase for the company. Revenue mix was from product mix and net customer adds. Additionally, SMB's rose on 64,000 new customers, which resulted in a $157M revenue bump.
Looking at expenses, programming costs have declined, which is good to see considering the decline in Video revenues. Cost to service customers rose on workforce and fuel costs by $379M, and I discussed Mobile costs previously, which mainly rose on customer acquisition.
The company reports adjusted EBITDA, everyone's favorite metric, so I wanted to walk through it quickly. Adjusted EBITDA rose around 5% on the full year in 2022. However, net income is only around 1/3 of that number. D&A is an expected write-off, but notice the company's interest expenses (also expected considering the I in EBITDA). Between interest expense and stock-based compensation, the company took a $5B hit to its net income. I know why the company likes the EBITDA metric. For a company carrying a debt load like Charter's, removing interest expense has a nice cleansing effect on the company's reported profitability.
Buybacks
So, where did the debt come from? I have some ideas, and it's not just capital expenditures. Charter has gone nuts with share buybacks. The company's mega-merger with Time Warner cable and Bright House in 2016 resulted in the huge spike you see below. However, since then the company has cannibalized around 149M shares. Breaking it down a little:
-In 2022, the company repurchased 14.5M shares for $7.1B. This was greater than free cash flow, and the average purchase price was around $489.65. This is well above the current share price.
-In 2021, the company repurchased 15.9M shares for a total of $10.9B. Again, greater than free cash flow, with the average purchase price at $685.53. Yikes, the current share price is around $370.
Debt-fueled buybacks are a plague just as much as massive stock-based compensation for the high flyers. The company's debt load has ballooned to $97.4B, which I'll discuss more below. Charter's management took a flamethrower to shareholder value with these buybacks over the past 2 years.
Unsurprisingly, the returns on invested capital are abysmal. I look at companies with an eye to finding those top-tier compounders. Charter's share price has gotten crushed over the past year or two, and I wanted to find a company on temporary hard times while still set to compound away for years to come.
What I've found is a company with one segment in terminal decline, a segment in land-grab mode growing unprofitably, with a management team dead set on blowing money with share buybacks and a balance sheet loaded down with a huge debt load and tons of goodwill from its previous mega-merger. This metric alone is typically enough to keep me from investing in a company, but I'll keep moving along for the sake of a complete view of the company.
Cash Flows
Given the capital expenditure discussion above, it's no surprise free cash flow growth has not been incredible. What doesn't help on the graph above is the scale it has to show considering the long-term debt load ($6B versus $97B). However, free cash flow is not bad considering the company's current market cap. The yield is currently sitting around 9%, showing just how far the share price has been crushed.
At $97.6B against a market cap of around $55B, we are looking at a debt load that could easily remove the company's ability to flexibly operate as they move forward. The core internet offering requires continual investment, and the company has plans for massive cash outlays over the next 3 years. The other segments of the business can't pick up the slack.
In 2022, $9.4B in capital expenditures included net $553M in debt issuance, and 2021 had $7.6B in capital expenditures with $80M of that in new debt. This year, management is projecting $6.5-6.8B in capex, with $4B spent on line extensions. With that, free cash flow is expected to decline this next year.
Charter is carrying $645M in cash on hand, with $4B remaining on its revolver. $70.7B of the company's debt is investment-grade, with $26.7B in high-yield debt.
I won't proclaim upcoming insolvency considering the predictable recurring revenue stream the company gets from its utility offering. However, as I mentioned above, interest expense is beginning to have a real impact on the business. At $4.5B last year, we are seeing a company that has hamstrung itself with bad debt, used in many cases to repurchase overly expensive stock. This is an example of the type of company on the precipice. They could make some moves here and continue to outperform the market, but I wouldn't bet on it.
Valuation
Looking at the company's valuation, the company appears cheap against adjusted earnings. Earnings growth has been outstanding from a small base.
The adjusted EPS yield is an incredible 8.5% today, and analyst estimates show a return to 47X earnings would yield around 85% annualized total returns. This is how I always set the graphs up when looking at a company, but recognize a return to that valuation is almost assuredly not going to happen any time soon. There's too much uncertainty in the company's business. However, if the company executes a turnaround, there's a huge amount of space above for multiple expansion.
Looking at free cash flow, growth was solid, and is expected to start growing again following the most recent round of capex investments. The company appears cheap against its free cash flow generation.
Based on a return to the company's average multiple of 20X free cash flow, an investment today could yield around 25%.
I've shown a model case for when the valuation graphs don't work all that well, but I wanted to include them to show what's being priced into the business currently. Charter is at the tipping point. If the company is successful in mobile and fends off competition in Internet, I could see it outperforming, but that's likely still years away. Today, I see it as a value trap.
To break it all down, Charter Communications, Inc. operates a utility without the price-controls many utilities face. The company has historically fended off competition and maintains a strong moat based on the network infrastructure. However, poorly executed debt-fueled buybacks, abysmal returns on capital, a massive debt load, declining video business, unprofitable but growing mobile business, and upcoming cash outlays make Charter Communications, Inc. a sell for me. I wouldn't hold on here to see how it goes, but that could work out well over the long term. Comcast is likely a better option, but there's plenty of other fish in the sea besides these 2 companies.
For further details see:
The Decline Of Charter Communications