Description

Recommendation: long Charter stock with a base case price target of $431 implying 50% upside from current trading levels ($287)

Business Overview: Charter is the 2^nd largest cable company in the US, with more than 32 million customers nationwide. As a cable business, Charter offers broadband, video, voice, and mobile services to customers over a hybrid-fiber coaxial network (“HFC”).

Investment Thesis: Charter recently reported weak 4Q23 results that sent the stock down to 5-yr lows. The enterprise now trades at a multiple of just 6.5x 2024E EBITDA and 6% TTM unlevered free cash flow yield (7% TTM levered cash flow yield to equity). Coming out of 2026, upon which Charter will have completed a network upgrade and expanded its footprint by 8%+, the company should generate $5bn+ of free cash flow. While the next 10-12 months present several headwinds for cable, where the stock trades today is a compelling opportunity to acquire a leading business at a discount to earnings power (at just ~10x fwd cash flow) with the added optionality of success in a nascent mobile business that can return the company to overall ~MSD growth.

Detailed Background and Thesis:

• How We Got Here: there are several debates around cable, both structural and transitory, and we address each below and why we believe it creates an opportunity to own the business at an attractive valuation:
• Structural - Fixed Wireless Competition: early prognostications about Fixed Wireless running out of capacity in 2024 have proven to be incorrect. Our base case is that fixed wireless has taken away the “low-hanging fruit” of cable competitive capture from DSL (~10% of the US broadband market) that used to drive 2-3% of cable broadband growth every year. What Fixed Wireless accomplishes is a bifurcation of the consumer broadband market between price sensitive competition and price-insensitive monopoly; due to the cost limitations of wired networks, we believe the technology will continue to capture industry growth but is uncompetitive playing in Charter’s captive base of customers with double/triple-play products
• Transitory - ACP Expiration: we size the potential ACP topline impact at 1-2% of 2024E growth should the gov’t program go away. We note that this is likely fully priced into the stock with some upside should Congress pass an ACP extension with the March budget (which has looked modestly more likely thanks to sustained cable lobbying efforts).
• Structural - Convergence: at the network level, marginal costs to serve a wired/wireless customer has converged following the technological leap from 4G to 5G (which effectively increased spectral efficiency by 5-10x). In a converged world, we believe Charter offers the best connectivity economics for customers by providing mobile services using their hybrid MVNO / wi-fi offload model. Wi-Fi is essentially the use of unlicensed spectrum to provide in-building wireless services while the MVNO gives Charter access to carrier assets and undercut pricing. We believe that Charter can re-capture their lost broadband growth in mobile as data usage moves further to the edge. While mobile data typically commands lower margins than fixed broadband (due to the lower marginal costs and high customer acquisition costs), it does present a large growth opportunity and therefore we believe fears that cable is in structural decline is overblown
• Transitory - Capital Intensity: cable companies undergo ~5 yr CAPEX cycles as they upgrade networks, pursue edge-outs of existing markets (typically with a level of gov’t subsidy), and retire aging infrastructure. Charter is at the peak of one such CAPEX cycle today upgrading customers to DOCSIS 4.0 speeds and completing RDOF builds. Market fears around fiber competition is likely overblown, as post-upgrade, Charter will have a comparable product with fiber but with the additional benefit of a mobile product which reduces broadband churn when bundled. As capital intensity subsides after 2027, we believe Charter will return $5bn+ of FCF annually to shareholders while remaining an aggregate grower.

Valuation Backup:

• In 2021, Charter’s broadband flywheel was 4% ARPU growth + 5-6% unit growth comprised of 2% footprint expansions and 3% competitive capture from DSL. The company was able to achieve this with a trough capital intensity of ~15% which accounted for a peak 12-13x multiple during the ZIRP era. We now see the flywheel as 2-3% ARPU growth + 2% footprint expansion, with no competitive capture from DSL due to Fixed Wireless/Fiber. The remaining drag from video going away is partially offset by mobile dollars. At a normalized 15% capital intensity (implying CAPEX as 40% of EBITDA) and applying today’s cost of capital, we estimate Charter’s intrinsic value at 7.1x 2024E EBITDA or a ~$157bn EV, implying ~49% upside from current levels

Risks:

• The largest risk to the thesis is carriers either pursuing success-based fixed wireless CAPEX or re-negotiating Charter’s MVNO which will require Charter to become a facilities-based carrier to continue growing – resulting in a lose-lose for all. In our view, the carriers would only rationally pursue this if Fixed Wireless economics exceed the attractiveness of mobile subscriber economics. While many focus on the revenue $/bit being much lower in Fixed Wireless, payback periods are quick due to the low incremental costs to acquire a customer and focusing on revenue $/bit ignores the commoditized and deflationary nature of acquiring the pipes for those bits. While we don’t see the economics making sense in the 5G era, future technology improvements could lead to a break-even point although we see this risk as far-off.
  • On the MVNO, both companies have been mum on the specific terms except saying that it is a perpetual agreement with Verizon with room to wiggle. Verizon could potentially sue Charter to walk away should they lose more subscriber dollars than they gain from wholesaling, but indications are that the relationship between the two remains healthy and most of the Charter adds are coming from less economic prepaid subscribers.
• Near-term results will likely create overhang on the stock and management seems set on pursuing their CAPEX policy, reducing buybacks. As Fixed Wireless competition increases throughout the year, the market may continue to price Charter at a discount to intrinsic value for longer. With Charter’s highly levered balance sheet, the stock is highly sensitive to changes in perceived multiple.

Exhibits:

Catalyst

Catalysts:

• Charter increases mobile disclosure as business hits scale and profitability
• Fixed Wireless capacity begins to exhaust – although very difficult to pinpoint exact timeline – and cable adds stabilize at our projected 2-3% ARPU growth + 2% footprint expansion
• ACP is renewed and market fears around 2024 guide subsides