Billionaire cable titan John Malone is the best known cable entrepreneur in the United States. GCI Liberty (GLIBA), one of his holding companies, owns stakes in several cable assets including Charter Communications (CHTR), Liberty Broadband (LBRDK), and General Communications (GCI). In the last twelve months, US cable companies have performed extremely poorly, with Altice US, Comcast, and Charter falling 47%, 24%, and 29% respectively.
Predicting a US cable recovery, Nitin Sacheti, the Founder and Portfolio Manager of Papyrus Capital, submitted a long report on GLIBA to SumZero earlier this week. His research on GLIBA is grounded in Papyrus' extensive due diligence on the 5G industry. This included discussions with the Chairmen/CEOs of multiple Liberty cable companies (including Malone), senior employees of Dish's wireless and satellite businesses, and a wide variety of experts at trade shows. The publication of his piece was covered in Bloomberg, and less than a week later Goldman Sachs upgraded CHTR to a Buy rating. SumZero sat down with Sacheti to hear his thoughts on GLIBA, 5G, and the future of the US cable industry.
SumZero: What about GLIBA caught your eye as a value investor? What initially sparked your interest in the name?
Nitin Sacheti, Papyrus Capital: As a value investor, I love buying businesses that (1) are run by a great manager with a keen eye for capital allocation, (2) possess secular growth and sustainable free cash flows, i.e. they are good businesses and (3) are trading at low cash earnings per share multiples.
- John Malone is arguably one of the best managers in history, a self-made billionaire, growing Telecommunications Inc. (TCI) from 100k subscribers in 1970 to $55B in 1999 when acquired by AT&T. Tom Rutledge, CEO of Charter Communications (CHTR), is the best executive in cable, having executed a tremendous turnaround at legacy Charter (pre TimeWarner Cable acquisition) after building Cablevision.
- Cable is a great business, offering the only high throughput pipe into the home in which speeds can be increased with limited incremental capital cost, discussed later.
- At about 6.5x 2020 cash EPS (or FCF/share) with 20%+ cash EPS growth and high predictability, the stock is cheap!
We previously owned smaller positions in both LVNTA and GNCMA, the predecessor entities that merged to create GLIBA. However, we significantly increased our position size in May when GLIBA became extremely cheap after an unwarranted sell-off in Charter Communications (CHTR).
SumZero: Could you break out your views of GLIBA’s holdings? Why is pass through ownership in CHTR, LBRDK and GCI preferable than buying them directly?
Sacheti: Billionaire and cable entrepreneur, John Malone made a large investment in CHTR, first in 2013 through one of his holding companies now known as Liberty Broadband (LBRDK) and then through another of his holding companies, Liberty Ventures (LVNTA) in 2015. In Q1 2018, LVNTA bought General Communications, GCI, (previous ticker GNCMA), an Alaskan cable and wireless operator and renamed the business GCI Liberty (GLIBA).
GLIBA owns (1) 5.4m shares of CHTR, the US cable operator with 27m customers, (18% of GLIBA operating NAV), (2) 42.7m shares of LBRDK, a Malone vehicle that owns 54.1m shares of CHTR and no other real assets (38% of GLIBA operating NAV), (3) General Communications (GCI), the aforementioned Alaskan cable/wireless operator covering 99% of the Alaskan population (32% of GLIBA’s operating NAV). (4) Other assets include interests in Lending Tree (TREE), Evite and Giggle (12% of operating NAV).
The result is a business where cable represents 88% of the operating NAV (56% direct/indirect CHTR and 32% GCI). We believe this is preferable to owning CHTR directly because (1) GLIBA trades at a 22% discount to its NAV when inputting current CHTR and LBRDK at market prices and 26% when inputting CHTR at market into LBRDK, too. (2) Related, GLIBA will buy back its own stock, magnifying the degree of the discount which increases our upside potential and (3) in certain scenarios, discussed later, GCI should extract a premium to our value given the synergies in a horizontal merger.
SumZero: Could you walk us through your and Papyrus’ background in 5G/telco research? How did your background play into the research process for this idea and why are you so positive on cable?
Sacheti: I’ve researched mainly tech, media and telecom companies since I began my investment career over 12 years ago. I’ve had extensive conversations over the years with management teams, telecom industry experts, the FCC, lobbyists and engineers through my long investments in cable/telecom, spectrum plays, content, and satellite businesses and my shorts in wireless chipmakers. More recently, we began a research project at Papyrus around 5G and its effects on the industry. We spoke to management teams and industry experts/engineers through our network, at the 5G show, and through the Wireless Research Center. We’ve scoured industry whitepapers from participants on all sides of the debate and we believe that cable offers the best opportunity to invest in the growth of consumer data usage and the shift to 5G.
SumZero: During your research process, you spoke with management at various companies include Dish and Liberty. What are the biggest takeaways from your due diligence?
Sacheti: Our due diligence lead us to the following takeaways:
- Cable offers the only pipe into the home in which speeds can be increased with limited incremental capital cost to meet growing bandwidth demands.
- Cable should have a large role in 5G infrastructure. As CHTR CEO, Tom Rutledge has said, 5G is mainly a standard for smaller antennas, meaning densifying networks through small cells will increase wireless speeds. However, the small cells must connect to wired infrastructure to handle the backhaul (i.e. data goes from our cellphone to a small cell which connects to coaxial cable that transmits the information to/from the datacenter). As experts at the 5G show said, we will need extensive terrestrial networks to backhaul 5G data and cable is the sleeping giant in infrastructure with the first and middle mile rights to fulfill that demand.
- The timing of wireless 5G rollout is somewhat a chicken and egg situation. The cost to build massive MIMO antennas and densify networks with small cells is very expensive for carriers currently in a pricing war. However, if consolidation occurs and they spend sooner to upgrade their networks to 5G, we could see an acceleration in new, productivity enhancing wireless applications including drones, autonomous cars, the connected internet of things…etc. That said, at this point, timing of an urban rollout (i.e. NFL cities) is anyone’s guess as to whether it occurs in 2021 or 2024+.
- We should expect a spectrum crunch in 5G.That said, it’ll likely happen in only larger NFL cities with higher population densities and in spectrum bands 3.5GHz and below, where propagation and in-building penetration is higher. As discussed below, we will likely not see a crunch in millimeter wave spectrum at 28GHz+.
SumZero: What is your view on the long-term headwinds in the US cable industry? Why is ‘cord-cutting’ and the rise of competitors like Netflix not an existential threat to the industry?
As mentioned above, we believe cable has few substitutes and offers the only pipe that can fulfill higher broadband speeds.
- Fiber-to-the-home (FTTH) is uneconomical at a $3,200 cost to pass a customer which generates only $120 in monthly service revenue. This is why Verizon’s pre-tax returns in their wireline business (which houses FioS) is only 1%. No one will likely spend hundreds of billions to connect fiber at a 0% return.
- DSL with vectoring offers speeds that max at 30Mbps (well below what’s needed for streaming even a couple 4K televisions)
- Fixed wireless broadband on millimeter wave spectrum is economical only where about 100+ homes are located in a 2,000 foot radius with direct line of sight to each home (since the wireless signal cannot pass through trees or any other objects)
- Cable, on the other hand, can increase speeds from 20Mbps to 300Mbps at a cost of $20/home with speeds of 1Gbps easily achievable. It’s really the only option and should continue to enjoy some pricing power.
While consumers are cutting the cord because of robust offerings by Netflix and Amazon, the loss of a video subscriber has a minimal effect on cable’s free cash flow. A CHTR video customer has an $84 monthly ARPU but only a $33 gross profit per subscriber given the content costs they must pay the networks. This video sub has only about a $15 EBITDA contribution due to higher call center support required to service a video customer. Also, due to the high capital costs of set-top-boxes for video subscribers, free cash flows per video subscriber are only about $3. This $3/sub/month is easily offset by broadband price increases and subscriber growth. As discussed above, we believe the cable pipe is the only way customers, even those who have cut the cord, can achieve the 1 Gbps speeds required for 4K, AR/VR…etc in the home.
SumZero: What do you see as the long-term future of Verizon’s fixed wireless broadband’s purported ability to offer gigabit internet without digging home fiber connections?
Sacheti: As Dr. Malone has said, if a truck drives through the signal, you lose the connection. Our cell phones can ‘talk’ to towers through buildings, but that’s partly because they use low-band spectrum (700MHz), which has a much longer wavelength, allowing for greater distances and less interference, while millimeter wave spectrum at a 55x higher frequency has much shorter wavelengths that prohibit it from travelling through objects/obstacles. Various industry experts and T-Mobile (who has a vested interest in wireless broadband working) have confirmed that Verizon began testing in two cities, Boston and Sacramento. They started in Boston because it is densely populated (but they could still get the service working only in the South End). T-Mobile has said, topologically, Sacramento is considered ‘a midwestern city’ in the west, meaning the flat terrain results in some success in fixed wireless but, in reality, the offering has limited national viability.
CableLabs estimates the capitalization cost of a cell site at about $75k. With fiber costing $800/home connected to the node, the cell site would have to connect to at least 100 homes to make fixed wireless economical ($75,000/100=$750 for a fixed wireless connection vs. $800 for a fiber (FTTH) passing to the home).
As discussed above, since a millimeter wave tower covers only 2,000 feet with direct line of sight required, we estimate a very small addressable market where 100+ households live in a 2,000 foot radius WITH direct line of sight to the small cell, and again, this equals the cost of FTTH, which is also uneconomical.
SumZero: What are the three scenarios in your analysis and which do you think is most likely? Why?
Sacheti: We believe that over the next two years, as CHTR executes on the upgrade to its cable infrastructure to improve speeds, the decline in capital intensity and growth in broadband subscribers should result in $39 in 2020 cash EPS or free cash flow per share. My three scenarios for value realization include the following:
(1) Organic Growth: Over the next 2-3 years, market fears over cord-cutting and fixed wireless substitution subside as subscribers and cash EPS grow, resulting in $470/CHTR share (12x 2020 cash EPS of $39) and GLIBA also trades up to its NAV with just a 15% holding company discount or $80/share, offering 80%+ upside.
(2) Stock for Stock Transaction: Malone initiates a stock for stock transaction much like he did with Liberty Entertainment/DTV in 2009, where he swaps his LBRDK stock for CHTR stock (collapsing the holding company discount) and receives a premium for his GLIBA stock because of the synergy value GCI offers CHTR, resulting in a $100/share price target for GLIBA or 125%+ upside.
(3) Third Party Acquisition of CHTR/LBRDK/GLIBA: A third party, likely a wireless player, acquires the companies to transition from a triple (home phone, video, broadband) to a quad play operator (+wireless phone) which should increase profitability by reducing customer churn. We also believe that Malone sees this value and wants to participate in the long-term upside of a combined CHTR/wireless operator. The disparate footprint at GCI but overlapping service (cable and wireless) means it is a natural fit for VZ/CHTR. We believe Malone fit GCI into GLIBA so that VZ buys GLIBA along with LBRDK in a CHTR merger, rather than paying Malone cash for his GLIBA stake. This allows Malone to participate in pro-forma VZ/CHTR through all his indirect holdings, tax-efficiently. We also believe that buying CHTR gives VZ substantial synergies in 5G given the onerous costs of backhauling from small cells, as previously discussed. Even if VZ pays $500/CHTR share, the synergies could yield $8-9 in PF VZ FCF/share, resulting in a potential 100% upside beyond our CHTR/GLIBA upside (12x $8.50 in VZ 2021 FCF/share) or 206% upside over the next 2-3 years.
While I can’t handicap the likelihood of each scenario, I’m certainly hoping for (3)!
SumZero: What catalysts should investors pay attention to as this thesis plays out?
Sacheti: Investors should pay attention to CHTR’s earnings growth, Verizon’s fixed wireless broadband trials and the game theory/permutations of media mergers that may be announced in the near future.
SumZero: What are the implications of the T/TWX merger on GLIBA? What are the deal’s implications on the broader cable market?
Sacheti: While the T/TWX deal is mainly a vertical merger and an acquisition of CHTR/GLIBA by a wireless operator would be viewed as horizontal, I think the closing of the TWX deal should result in the resumption of conversations between other parties that might have been previously tabled due to TWX uncertainty. Such deals could accelerate the timing of 5G buildouts.
SumZero: What is the biggest risk to your thesis? What could go most wrong?
Sacheti: We view the greatest risk here as a large rise in interest rates that would result in future refinancings at higher rates, impairing levered free cash flow. However, we believe management has done a very good job terming out maturities to 2023+ and fixing coupons. The second major risk we feel could limit upside is a change in the regulatory landscape. If the government capped broadband pricing growth as they do utilities, free cash flow growth could be limited. That said, given the reinvestment required to keep increasing speeds to keep up with technology change, we think this is also unlikely.
SumZero: How negatively would a regulatory overhaul of the broadband market impact the stock?
Sacheti: While I believe a regulatory overhaul would limit free cash flow growth, I hope the government can fathom just how large of an investment 5G requires. The only way we can compete against a command economy like China which undertook a massive government sponsored FTTH build and will likely do the same for 5G is to encourage capital expenditure by making the capital investment worthwhile for the telco/cable companies. That doesn’t happen when the government controls pricing. CHTR has spent $7-9bln/year in capital costs to upgrade its plant. Given the productivity increases that high-speed broadband yields, that’s hugely valuable to US GDP growth and our ability to compete against China. We need a superior cable pipe to backhaul 5G and the best way to do that is by encouraging investment and horizontal mergers with synergies so that we can actually get the network built soon and foster the next set of productivity enhancing business models (aforementioned drones, autonomous cars, IOT) that work only on a 5G network.
The last thing we want is a European situation where onerous government telecom regulation resulted in poor investment, decrepit copper pipes and low high-speed internet penetration. This limits information flow, education and productivity.
SumZero: Where else do you see value in the market today? Where else do you focus your research?
Sacheti: In sticking with the broadband theme, we also see value in Charlie Ergen’s Echostar Corp. (SATS) where we believe a rational duopoly in satellite broadband in rural areas means continued secular growth and good capital allocation by a quality management team.