Description

The investment case for cable companies has been regurgitated countless times over the last decade. I’m not here to convince you of its merits. What I would like to do here is to focus on 2 things: the risks to cable and how they pertain to Cable One (CABO) and CABO’s unconsolidated investments, for which they are clearly not receiving credit. 

Footprint

• CABO’s footprint is unique within the public cable co universe. 

  • Focus on more rural markets, or as they say “small cities & large towns” considered secondary or tertiary markets. 

  • Within their footprint, CABO does not have a competitor capable of offering 100mbps download speeds in ~65% of their markets.

• CABO’s footprint, which has historically been seen as their greatest strength, is now being interpreted as a weakness. 

• Because of their more rural footprint, fiber overbuilds are much less of a worry than that of other Cable Cos footprints. 

• However, the more rural footprint magnifies the 5G risk due to capacity constraints being less of an issue in rural footprints.

  • However, this is a bit of a double edged sword. Rural is better for capacity for 5G, BUT because it is less dense, it is also less efficient for 5G infrastructure. 

5G

• Due to CABO’s more rural footprint, this is the largest perceived risk in most investor’s minds. 

  • However, CABO claims fixed wireless is available in less than 35% of their footprint. 

    • This can be loosely verified and monitored going forward using the FCC map: https://broadbandmap.fcc.gov/provider-detail/fixed?version=jun2022&zoom=5.47&vlon=-93.798604&vlat=32.331773&providers=130183_40_on%2C130403_71_on%2C131425_71_on&br=r&speed=100_20&pct_cvg=0

    • The FCC map suggests to me that the overlap where 100mbps 5G is available is quite a bit lower than 35%. 

• Given all the facts, it seems to me that 5G is a good use case for SOME people and is likely to continue taking net adds for a few years. However, it also has a very limited runway and the service turns very ugly when it gets too saturated. This suggests to me that 5G is an interim technology that will not take major share over the long run.

  • In areas where T-Mobile/Verizon have excess capacity, they will utilize this capacity for fixed wireless home internet. This certainly will be a great option for customers who didn’t have a high speed internet option in the past.

    • Pros of 5G: 

      • It’s typically offered cheaper than other high speed options.

      • It is much easier to set up when compared to cable/fiber where they must run a line to your home. The only setup required is to set up a router. 

    • Cons of 5G:

      • Slower speeds when compared to cable/fiber.

      • Less reliable than cable/fiber.

      • Higher latency than cable/fiber.

      • Network deprioritization during peak times with congestion.

    • Will there be people willing to tolerate these cons for cheaper internet? Sure - anyone who isn’t a heavy user of data and doesn’t care about massive fluctuations of speed but just wants the barebones home connection. However, as will be discussed later, I think this is a rapidly shrinking pool of people. 

  • From a high level, spectrum is going to run out in the next few years. Take a look at the following study that was commissioned by the CTIA (which represents the US wireless communications industry itself - members of the CTIA include AT&T, Verizon, T-Mobile) How Much Licensed Spectrum Is Needed to Meet Future Demands for Network Capacity?.

    • Comparing the network capacity model and projected demand, Brattle Group found that supply will lag demand in just a few years. In 5 years, by the end of 2027, the U.S. is expected to have a capacity deficit of over 10 exabyte/month. In ten years, by 2032, this deficit could grow to approximately 17 exabytes/month.

    • Absent any new spectrum, by 2027, the U.S. is expected to have a spectrum deficit of nearly 400 megahertz. By 2032, this deficit could more than triple to approximately 1,400 megahertz.

    • The report examines potential mechanisms to ease the anticipated spectrum gap. Even accounting for extremely optimistic improvements in spectral efficiency and additional infrastructure deployment, the analysis makes clear that additional 5G-ready spectrum is the only realistic way to meet projected growth in demand.

  • If you take a more narrow POV, 5G is already running into major capacity issues in saturated areas. 

    • Using a simple search at Verizon or T-Mobile ISP forums, you’ll find countless examples of areas where the 5G is unusable.

      • The following I found after browsing reddit for less than a minute: 

      • After 2 years, I left TMHI : r/tmobileisp 

      • 4 month review of Tmobile 5G Home Internet / compare to Verizon & Comcast : r/tmobileisp

      • Verizon 5G EXTREMELY slow

      • Anyone else’s data speeds unusually slow tonight? : r/tmobileisp

      • You’ll find hundreds of threads with a simple search on reddit. The common themes that always pop up: speeds start out great, after a while they run into capacity issues, speeds start to tank during peak times when people actually want to use the internet. It isn’t unusual to see 5G speeds in the low-single-digits-mbps, which is unusable for most current-day applications.  

• 5G also poses an issue in terms of being a financially viable use of spectrum. 

  • According to T-Mobile, the average monthly data usage for a FWA customer is 478GB. 

  • Also according to T-Mobile, the average monthly data usage for an unlimited wireless customer is 31.4GB. 

  • So according to T-Mobile’s own disclosures, an FWA customer consumes 15X more data than an unlimited wireless customer. 

  • When considering the ARPU for a wireless customer is somewhere around $50/month and T-Mobile charges anywhere from $30-50/month for 5G home internet, it’s clear that wireless customers are much more economically viable than FWA customers.

  • As spectrum capacity becomes more strained, who do you think wireless companies are going to prioritize: serving 15 unlimited wireless customers or 1 FWA customer? 

• Data consumption has been increasing exponentially for the past decade, which seems poised to continue. 

  • According to Cable One, their average customer used 202GB/month in 2017 which increased to 547GB/month by 2021. 

  • Not only does the world continue to evolve with more applications consuming larger amounts of data, but as the population ages an increasingly larger portion of the population will convert to data users. 

  • The average customer is likely set to surpass 1TB/month at some point in the next 5 years.

  • If 5G networks are struggling with current user data needs, how are they to keep up with the exponential growth of data consumption? 

• Cable One has achieved positive net adds for the past 2 years DESPITE T-Mobile adding over 3 million customers and Verizon adding over 1 million customers.

  • Yes, adds have materially slowed down. To me, this suggests that while FWA is in fact taking some net adds from cable, it is likely taking the majority of its net adds from inferior technologies like DSL and satellite. 

    • This would make sense as FWA is focused on the lower end of the market - an inferior offering for cheaper prices. CABO, on the other hand, is focused on the higher end of the market - customers seeking out the highest speeds available in their area. 

• As I will touch on later, Cable One refuses to consider an MVNO mostly because wireless reliability in their footprint is quite bad. If wireless carriers cannot even offer reliable cell service in their footprint, how are they supposed to offer FWA which is much more sensitive to reliability? 

Fiber

• Opposite to 5G, due to CABO’s rural footprint, fiber is conceived as less of a threat to their business.

  • Due to the lower population density in their footprint, fiber is much more expensive to overbuild and therefore less economically viable. 

  • CABO claims fiber competitors are available in ~25% of their footprint which is 10-20% less than their large cable competitors (Charter, Comcast, Altice). 

    • According to the FCC map, I think the number is quite a bit lower than that, but CABO’s management is always very conservative with their claims. Third-party research tends to put the number at 10-15% fiber overlap for CABO vs 30-40% for Comcast, Charter, and Altice. 

    • This number has come up from low-single-digits in the last decade. However, there are nuances here. If you look at the areas that have been overbuilt, the low hanging fruit has been picked (meaning the more dense areas). Most of what is left is very rural where it will never be economically viable to fiber overbuild. 

      • Each of CABO’s 5 largest markets have ALREADY been overbuilt by fiber:

      • Boise, Idaho: overbuilt by Lumen. 

      • Gulfport, Mississippi: overbuilt by AT&T. 

      • Prescott, Arizona: overbuilt by Lumen. 

      • Idaho Falls, Idaho: overbuilt by Lumen. 

      • Fargo, North Dakota: overbuilt by Lumen.

      • However, if you look at CABO’s smaller, more rural markets, there is very little overbuilding and there will likely continue to be very little overbuilding.  

      • Take the following examples. These are just random Cable One markets picked off a map:

      • Franklin County, IL (88 people/sq mi), Navajo County, AZ (11 people/sq mi), Greer County, OK (8.5 people/sq mi), West Point, NE (3.5k population), Parsons, KS (9.6k population)

      • For each of the above locations, the only competitors are copper, satellite, and 5G. There are zero gig options overlapping CABO’s footprint in any of these markets. These locations are not unique within CABO’s footprint - in fact, it is the norm. 

  • I think a good resource to listen to here is the Yet Another Value Podcast with Julia Laulis, CABO’s CEO (Hi Mr. Walker). An exciting time in the Cable Business with Cable One Julia Laulis (NYSE: $CABO) 

    • According to Julia, their competition with fiber is much more rational than what is perceived by investors. 

    • Julia claims that even in markets where they’re overbuilt by fiber, if CABO is the better operator, they still end up growing in terms of units and arpu. In 2022, CABO’s arpu actually GREW in competitive markets.    

  • According to history, market share in markets with a cable player and a fiber player tend to work out to 50/50. So even if they were to get massively overbuilt (they won’t), it wouldn’t be a death sentence for Cable One. 

Lack of an MVNO

• Over the past few years, the hot new product in cable has been a mobile offering via an MVNO. 

  • This has been highly publicized at Charter/Comcast.

    • Comcast & Charter have each added ~6million lines in the ~5 years since launching their mobile products. 

  • Even smaller competitors have followed suit, with WOW! beginning to offer mobile in 2022 via an MVNO with Reach Mobile.  

  • There is sound reasoning behind a mobile offering as it should theoretically reduce churn and the financials are beginning to look more and more compelling. 

• Management has reasons as to why it doesn’t make sense to them. While these reasons are somewhat rational, I don’t entirely agree. 

  • Their first pushback is always that customers are not asking them for mobile. I think this is a poor argument. Customers don’t know what they want until you offer it to them. I also don’t think it was customers that were pushing Comcast or Charter to offer mobile. 

  • Mobile reliability in their footprint is apparently very poor, which I believe is the better argument against offering mobile.

    • They do not want the reputation of poor service attached to their brand. Reasonable. 

    • However, everything is relative so even if their service would be poor, all the competitors would be as well. 

  • CABO does not have the leverage to get terms like the Charters/Comcasts of the world. Yet another reasonable argument. 

• At the end of the day, there are pros and cons to both sides, but I don’t think it drastically moves the investment case in either direction. I would like to see CABO pursue an MVNO but understand their rationale behind avoiding it.

 Equity Investments

• CABO’s unconsolidated investments are a big part of what sets them apart from their publicly traded peers. 

• The strategy appears to be to take minority investments in smaller, rural broadband players, monitor the operations for a few years before ultimately acquiring the remaining equity interests once they’re convinced of the investment merits. 

• Ignoring these investments, CABO trades roughly inline with peer multiples. 

  • However, CABO’s equity investments total $1.2B on a company with a $3.5B market cap. 

  • CABO’s equity investments generate $724mm in annual revenue & $348mm in annual EBITDA vs $1.7B/$900mm in revenue/EBITDA for the entire company.

  • When accounting for these investments, CABO is cheaper than peers while operating in a higher quality footprint.

  • Hence, It seems rather clear to me that CABO is not receiving credit for these unconsolidated investments.

• The KPIs at these investments have been highly outperforming those of public cable cos since the deterioration of cable co fundamentals post-2021.

  • From Jan 2022 onwards, consider the following high-speed data net adds for each of the public cable cos: 

  • Unconsolidated investments had 55k net adds or 12% overall growth in HSD customers.

  • CABO had 8k net adds or .9% overall growth in HSD customers.

  • Charter had 420k net adds or 1.4% overall growth in HSD customers. 

  • Comcast had 255k net adds or .8% overall growth in HSD customers.

  • Altice had 122k net losses or -2.6% overall decline in HSD customers.

• While CABO holds 10 unconsolidated investments, over 80% of the valuation comes from 2 investments. Unfortunately, CABO does not give a ton of granular detail about each specific investment, but does give quite a lot of detail about their investments as a whole.

  • I will dig a bit further into their 2 largest investments (MBI & Clearwave) below. 

• Regarding the overall financials of their investments, here is what CABO has given us: 

  • In 2022 (2021 numbers in brackets), their unconsolidated investments generated revenue of $724mm ($600mm), EBITDA of $348mm ($280mm), HSD customers of 454k (390k). Obviously these investments have not received the memo regarding the national slowdown in the broadband business.

• Given CABO’s history with minority investments as well as the structure of MBI & Clearwave, I find it highly likely that CABO will acquire most of the remaining equity interests in their current unconsolidated investments at some point in the next 5 years.

  • MBI call option in 2023 and put option in 2025.

  • Exit process for Clearwave may be initiated by either CABO or the investment partners on the 7th anniversary of the formation of the venture.

MBI:

• $569mm carrying value vs $1,186 for the entire investment portfolio (48%).

• Acquired a 45% stake for $574mm in Nov 2020 with the right to purchase the remaining interests in MBI at a predetermined multiple of earnings in 2023.

  • The acquisition was financed via notes due 2030 fixed at 4%. 

  • Management has already stated that they will not exercise their right to purchase the remaining interests due to multiples coming down around the space since the acquisition. They have better uses of capital and they know it.

• MBI is a typical broadband network, which provides service under the “Vyve Broadband” name. At time of purchase, MBI had 630,000 passings and was capable of delivering gig speeds across its entire footprint. 

• MBI, like CABO, is focused on rural markets, concentrated in middle america with most of its customers being in the Texas/Oklahoma/Kansas area. 

• At the time of purchase (FY2020), MBI had 31.5% penetration (201k HSD customers vs 638k passings) and $258mm in annual revenue. 

  • By FY2021, annual revenue had reached $295mm.

  • Unfortunately we do not have specific financials past this point. 

• EBITDA margins at MBI are presumably in the mid-high 40s (if not over 50%) given CABO tells us that their investments as a whole have a 48% EBITDA margin and MBI makes up the largest chunk of their investments (MBI makes up nearly 50% of the revenue of their investments).

  • With some of their other investments being very immature with lower margin profiles, it is likely that MBI’s margins are higher than the group as whole.

• As for the negatives, multiples in the space have decreased sharply since CABO’s acquisition of MBI and CABO carries MBI at cost, hence the carrying value is likely much higher than deserved (MBI also carries very high leverage which magnifies this). I believe it is much more likely that MBI is worth $200-300mm currently. However, I do believe MBI is a good asset and financial results have been solid. 

Clearwave Fiber:

• $395mm carrying value vs $1,186 for the entire investment portfolio (33%).

• Clearwave is an entity that holds CABO’s subsidiary Clearwave Communications as well as fiber assets that came from another acquisition (Hargray Communications). Its purpose is to invest heavily in FTTP in adjacent areas to its current network. Unsurprisingly, Clearwave is also focused on rural markets in both southern Illinois and Georgia. 

  • In the areas I’ve been able to diligence, Clearwave seems to be the only competitor in most of this footprint to offer gig speeds (no cable OR fiber competitors). They compete mostly with 5G, copper, and satellite.

• CABO owns ~58% of Clearwave. The venture was created via the following contributions:

  • In return for 58% equity interest, CABO contributed 8.7k residential data customers (.9% of its overall residential HSD customers) to the entity.

  • The other minority investors made a $320mm equity investment to fund the buildout of its fiber network.

  • In essence, Clearwave is a startup with aggressive fiber passing plans. CABO contributed an established foundation of a footprint but no cash, while the minority investors contributed significant cash in order to finance the buildout of its fiber network. 

• Clearwave has over 4,300 fiber route miles.

• 15k HSD customers, 74k passings (20% penetration), and $59mm in revenue for FY2021.

• Essentially what you have with Clearwave is a startup shell with $320mm in cash, likely in the neighborhood of 130k fiber passings currently, with plans to pass ~500k homes in southern Illinois and Georgia areas with minimal to zero high-speed competition.

• It’s anyone’s guess what this is ultimately worth, but it seems safe to say that the book value of $395mm is likely very conservative. 

Valuation

I think any discussion about valuation needs to begin with unconsolidated investments and how to treat them because it changes the numbers quite a bit. So - why do I think the public markets aren’t giving CABO credit for its unconsolidated investments? Well, CABO has traded at a large premium to peers even since it was spun off in 2015… and rightfully so. Compared to peers, it has a better footprint, higher margins, better avenues to deploy capital at high rates of return, higher returns on capital, and very solid management (arguably the best in the business). However, CABO is currently trading at a discount to peers when including investments at book value. It is anybody’s guess as to why that is the case, but I do have a few theories of my own.

What I do know is that all of CABO’s investments are carried at cost on the balance sheet. Even though multiples have come down across the space, underlying results at their investments have been phenomenal. 2 things here - the strong fundamental results have likely gone a long way in offsetting any multiple decrease and the strong results also support a much higher multiple than what public peers are currently getting. With that in mind, my thoughts are to ding the investments for ~$300mm for MBI due to the leverage at the asset, bringing its carrying value to ~$269mm from $569mm. This brings the overall portfolio to $886mm from $1,186mm, which I believe is conservative even despite the devaluation of the space. 

CABO with credit for investments EV/EBITDA - 6.7x

CABO without credit for investments EV/EBITDA - 7.8x

CHTR EV/EBITDA - 6.7x

ATUS EV/EBITDA - 7.0x

CMCSA EV/EBITDA - 6.9x

It is important to keep in mind here - the only clean public comp to CABO is CHTR which I find to be a highly attractive investment in its own right (as CHTR is suffering from many of the same negative narratives as CABO). So if CABO looks attractive when compared to CHTR, that’s saying something to me.

As for CABO, it currently trades for a 9% FCF yield when ignoring investments or a 12% FCF yield when considering investments. Both strike me as far too low for a business of this quality, so a simple reversion to the mean seems likely to me.

However, this isn’t just a reversion to the mean story for me. Over the next 7 years, I expect a few things to happen - CABO will likely consolidate all of its current investments, net adds will tick back up as 5G runs out of steam, and CABO will continue to opportunistically repurchase shares. If all of these happen, EBITDA will likely be nearing $2B by 2030, FCF will likely be in the $800mm range, and if the multiple stays constant, shares outstanding will likely decrease by ~30%. This would put FCF/share at $171/share from $52/share today. Value that how you will, but I think it’s clear that any sort of reasonable valuation scenario returns anywhere from 2-5x from this point. Hence, I don’t think a reversion to the mean valuation-wise is necessary for this investment to work - only patience is required.

Catalyst

- Net adds pick up after 5G runs out of steam

- CABO consolidates its equity investments