Short This "Overvalued, Unfocused Cable Operator on Acquisition Spree"

By: SumZero Staff | Published: May 22, 2015 | Be the First to Comment

Full chtr 8ce72ff23c
By Jonathunder (Own work) [GFDL 1.2 (http://www.gnu.org/licenses/old-licenses/fdl-1.2.html)], via Wikimedia Commons

Thesis
•There is a huge trend towards consolidation in the cable industry right now
•Investors are rewarding companies for transactions in the space
•CHTR has been rewarded handsomely for Bright House Networks acquisition, as well as recent growth
•But the company has not been able to generate free cash flow, and we do not foresee that changing
•As interest rates rise, highly levered companies (like CHTR) will get slammed
•Consolidation is masking the most important trend in the cable and Pay-TV industries: cord cutting
•CHTR’s valuation is widely out of touch with company and industry fundamentals, and represents a great short opportunity

"The industry in which we operate is highly competitive and has become more so in recent years. In some instances, we compete against companies with fewer regulatory burdens, better access to financing, greater personnel resources, greater resources for marketing, greater and more favorable brand name recognition, and long- established relationships with regulatory authorities and customers. Increasing consolidation in the cable industry and the repeal of certain ownership rules have provided additional benefits to certain of our competitors, either through access to financing, resources, or efficiencies of scale."
(CHTR 2014 10-K)

Company Overview

Cable, Internet, Land-line Provider
•Provides cable television and video subscription, high speed internet, and telephone services

•Over 5.9 million customers in 29 states (Dec 31, 2014)
-4.2 million residential video customers
-4.8 million residential Internet customers
-2.4 million residential voice service customers
-619,000 commercial primary service unites

•4th largest cable provider by revenues (behind Comcast, Time Warner Cable, and Cox Communications)
•10th largest telephone provider
•Founded in 1999 / Headquartered in Stamford, CT

INDUSTRY
Changes & Developments
•PayTVmodel under fire: customers moving away from paid content

•Netflix and other online services: Dish Network’s Sling TV offers about 20 channels for $20 a month
-Cheaper and cutting costs for the essentials

•Industry showing signs of decline
-CHTR’s number of subscribers fell a second straight year in 2014 by 176,000 and 251,000 in 2013

Consolidation
•Evolution of the industry has less to do with consolidation through M&A (although this may help with negotiations with content providers)
•Focus shifts to the growth of the customer experience in general
•Cable tv providers are offering their own streaming services which might be an example of cannibalism
•Plays in to the bundling trend

INDUSTRY HEADWINDS
1.Shrinking video market share
•Services like HBO GO, Netflix, Hulueat away at cable TV business
•Increasingly, young people entering the market choose to forgo subscribing to cable TV services altogether, relying on streaming services instead
•“Cord cutting”

2.Unfriendly regulation
•Net neutrality ruling cuts into profits from paid prioritization and butting costs through throttling
•Shows that the public and FCC do not support cable companies/are willing to work against them

3.Competitive pressures
•Google Fiber has already pressured rivals Time Warner Cable and Comcast to provide free internet speed boosts and upgrade infrastructure at the cost of profit margins. Charter will have to follow suit in order to compete
•Trend towards bundling favors telecom providers like AT&T and VZ with wireless subscribers over content-driven and internet providers like CHTR
•Saturation in the American market à CHTR does not have much presence internationally

Why CHTR is so overvalued
1. Merger between Comcast and Time Warner Cable
•CHTR will purchase assets from Comcast, but it will need to borrow $7 billion additional in debt
•In hot M&A market, companies have been rewarded for acquisitions
•Consolidation is a big trend for media à Street believes CHTR is the main vehicle for consolidation

2. Street has focused on revenue and subscriber growth
•But thin margins have not allowed this growth to flow down to net income
•Mergers have focused on revenue and subscriber growth

3. Focus on consolidation in the cable industry rather than investing in streaming technologies
•Cord cutting is becoming more prevalent in the industry, similar to changes the newspaper industry went through
•Rather than consolidation, cable companies should use extra cash to acquire technology and deliver their content
•Should look at companies like Hulu

4. Strong fourth quarter
•Beat on revenue, increased video, internet, commercial, and advertising segments

•Won’t pay taxes until 2020 because of net operating losses
-Mitigates some advantage of high debt load

•Has been one of the only cable companies able to grow in the past year
•Wall Street has focused on high revenue and subscriber growth
•Market believes in the strategic focus of the acquisitions, but the cable industry is dying
•Stock price has appreciated in the past year
•The street believes that CHTR is the natural vehicle of consolidation b/c Comcast will not be able to acquire anything else of size

Proposed Acquisition of Bright House Networks
•In late March, Charter announced a $10.4 Billion agreement to acquire Bright House Networks, its competitor and the 6th largest cable operator in the U.S.
•With this proposed acquisition, Charter would become the second largest cable provider, with 10 million video subscribers
•Proceedings hinge on the approval of the Comcast-Time Warner Merger, adding some uncertainty
•The deal has already been priced in – share price rose $10 after the announcement and is now around $187, as compared to its Mar. 27th price of $180
•If either deal fails to go through, share price will likely fall

TRADING COMPS
•Margins look like an integrated telecom services, but it is really a cable and Pay-TV company, has no dividend
•High EBIDTA growth, the reason it is highly valued
•But it is extremely highly levered, makes it more risky especially in an economic downturn
•Overvalued on every metric
•Risks are that its growth continues, there will be a multiple re-rating but we can still lose if the growth continues
•Capex is 70% of EBITDA for CHTR – numbers are even worse when looking at FCF

CATALYSTS
1. Troubles around acquisitions
–If the Bright House merger falls through, the stock price will take a hit; stock price spiked after the merger was announced
–Failure to realize significant synergies predicted by investment bankers
–Comcast merger with TWC falls through à CHTR loses right to acquire Comcast cable systems and equity interest in spun-off entity
–http://www.bloomberg.com/news/articles/2015-04-17/comcast-deal-collapse-would-kill-other-mergers-in-domino-effect
–High costs around integration of Comcast’s assets if merger does go through

2. Further regulation in the space
–Recent net neutrality announcement is bad for cable companies
–Many side effects of treating broadband like a utility (higher fees for consumers)
–Has prompted consolidation in the space, but will lead to increased competition

3. Leverage
–Since CHTR’s 2010 bankruptcy, its debt load has increased every year
–Current ratio of 0.2x, Debt/EBITDA of 6.7x
–Rising interest rate environment increases risk that CHTR won’t be able to service its debt
–Higher debt loads from acquiring Comcast’s assets
–Just raised another $1.9 billion in in unsecured notes to pay back earlier-maturing notes

4. Decrease in EBIT due to “cord cutting” (Digitalsmiths report)
–Pay TV consumers are more likely than ever to cut their chords (Digitalsmiths)
–78.7% of consumers watch less than 10 channels
–1.5 million Americans plan to ditch pay-TV

RISKS
1.The company hardly generates any cash and does not pay a dividend. Thus, the cost of holding a short position is small
•The long case doesn’t even project increased cash flow and appreciation of the stock price until 2016, when synergies are fully realized

2. Company beating estimates is always a risk, but probability is low given expectations are already so high
•John Malone and Liberty Media took a recent stake in CHTR, Wall Street has faith in the management team
•Optimistic guidance going forward (decreasing CapEx by $500 million is almost unheard of in the cable space)

3. The risk of the stock going up if the company announces an acquisition it touts as accretive and synergistic is a real risk, as the stocks of acquirers have been generally been positively rewarded of late
•Bright House is the sixth-largest US provider, and Charter says the merged company would become the second biggest cable operator by customer volume if the deal successfully closes
•They will control 10 million subscribers
•Provides Comcast with financial and tax benefits and strategic flexibilities
•While an acquisition of any company cannot be ruled out, CHTR already has a substantial amount of debt, so it would be hard to make any acquisition accretive even with low interest rates
•Stock price increased ~7% when news of the merger became public

4. They have a solid management team– it is risky betting against good management
•CEO Tom Rutledge turned Cablevision around and is implementing the same playbook at CHTR – upgrade the network, simplify pricing, writing out costs from the system

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