Description

“The most hated company in the most hated industry - what could go wrong?”

- Compound248 to Himself, Just Prior to WOW’s Disastrous Q3 Earnings Call

WOW - February 2024

During the golden age of private equity returns, back when we called them “LBOs,” prototypically attractive deals were bought at 6x EBITDA and financed with 4x of leverage. 

Today, in the era of high multiple Private Equity, WideOpenWest trades at 4.1x EV / EBITDA and carries 3.1x turns of net debt - it trades at a distressed valuation but is anything but distressed.

WOW is a cable and fiber overbuilder for sale at an absurd valuation. It is so cheap that, despite owning a modern network, it trades below that of many DSL / copper / LEC players and well below where precedence would indicate any M&A transaction would likely occur. 

While prominent cable companies like Charter are building new network for $1500/home passed and some pure fiber builders like Frontier are claiming to build at $1000-1100/home passed, WOW’s modern network trades in via the stock market for ~$595/home passed, or roughly 4.1x EBITDA (2023E). When WOW opportunistically sold assets in 2021, those were acquired by two different strategic buyers for 11x EBITDA or roughly $1300 and $1600/pass. Today, if WOW garnered $1000/pass, it would be worth ~$13/share.

It trades for $3.50.

WOW is not so hated so much as completely ignored by an uninterested Mr. Market who is understandably shy to buy a cable company when there’s easy money to be made in an AI mania. Most recently scarred by Charter’s disastrous performance, the collective appetite to dive into an obscure cable company is minimal. Worse yet, compared to WOW, Charter stock has had a wonderful last twelve months. 

And yet here we are - WOW is unbelievably cheap.

While its 3.1x of net debt/EBITDA is comparatively moderate (Charter has 4.5x and Altice USA 6.5x - both more than WOW’s total valuation), WOW’s equity stub of ~1x is highly sensitive to any change in multiple. The set-up is absolutely spring-loaded, with a market cap equal to just 2.5 years of (optional) expansion CapEx. Its primary debt is termed out for five years and it has the covenant headroom to recap its entire market cap with room to spare.

By way of comparison, let’s look at CNSL, a legacy copper player undertaking a substantial fiber overbuilding program that it asserts is going worse than planned: at the depths of the summer/fall 2023 market decline CNSL agreed to be acquired by private equity for 9.6x LTM EBITDA. 

Even the shittiest LEC copper companies are regularly acquired for 5-7x EBITDA, while WOW itself sold assets similar to its remaining business at ~11x EBITDA two years ago.

Shitty DSL Companies (from CNSL presentation Oct 2023):

At the CNSL takeout multiple on 2023E EBITDA, WOW would trade for ~$22/share. Today WOW trades closer to $3.50.

The lowest transaction multiple on the sheet is AT&T’s sale to Frontier of its rural wireline business for 4.8x, which would value WOW just under $6.00.

Cable peers trade at huge premiums, with Charter at 6.8x 2023 and Altice USA - which has been shedding subs for two years and is choking on its debt load - at 7.2x. While WOW’s overbuilding business model is arguably inferior to incumbents like Charter and Altice, if it traded a turn below Charter at 6.0x, WOW stock would be near $10.00 - nearly 3x its current price.

But Why?

“You assert it’s cheap, Compound. Sounds great, but there must be a catch.”

Like many cable companies, WOW’s future is selling broadband or “high-speed data” (HSD) subscriptions. As you know, these are considered sticky, recurring, high-margin relationships. It’s that first part that contributes to the nervousness - are the relationships still sticky?

A brief historical digression is required.

In 2021, WOW wisely agreed to sell a large chunk of its cable footprint in parallel transactions to two different buyers for roughly 11x EBITDA ($1.825 billion EV). Those were exceptional sales and are a credit to WOW management and its board for being willing to shrink the company for the right price.

The proceeds of the sales were earmarked for three activities:

1. Debt paydown - WOW reduced its leverage profile to <2.5x
2. Share buybacks
3. New-build expansion (primarily fiber)

Obviously, the company is quite happy to have de-levered. And while the share buybacks look expensive in retrospect, in real-time, buying shares at 6-7x EBITDA didn’t seem crazy. 

As to #3, the new-build (aka, “Market Expansion”) efforts are finally ramping up. The first half of 2023 was a substantial “prep” period. Beginning in the second half of 2023 and continuing through 2027, WOW intends to operate at a pace that builds and delivers ~400,000 new passings (80-90k per year). This substantial Market Expansion investment may be attractive, but is likely to cost $110+ million per year, consuming more than all of WOW’s free cash flow for the next several years. Of course, it should also drive growth in HSD subscribers, HSD revenue, and EBITDA.

That brings us back to the 2023 earnings guide.

At the start of the year, WOW management “back halfed” the guide, based on a belief it would deliver a large part of 2023’s guided 50,000 expansion passings by early-Q4. Delivering early in the quarter was key to the guide, as that would allow WOW time to market those new passings to potential customers, signing them up in time for a hoped-for substantial Q4 impact (the biggest acquisition period for new passings is the first two months after going live).

Further, on its Q1 and Q2 calls, management described improving trends in its legacy base and limited competitive pressure from fixed wireless (FWA) offerings, such as those T-Mobile and Verizon have popularized. WOW’s 2023 guide extrapolated this, assuming customer losses in its legacy-base would continue to improve in the second half.

The combination of expected improvements in legacy losses and a large positive impact from its Market Expansion drove a guide for meaningful positive HSD net adds in Q4. That would come to haunt them.

Given the competitive pressure other cable companies were seeing from FWA and WOW’s existing footprint declines, the market was already somewhat skeptical of its second-half guide. But Mr. Market was not expecting what WOW announced with its Q3 earnings call, when it announced >4,000 HSD losses and pulled guidance. 

Management identified four surprise headwinds:

1. Its summertime price increase led to bigger-than-expected churn (the churn impact also showed up a month later than expected, which contributed to poor mid-Q3 communication by the company);
2. FWA-related competitive pressures were substantial;
3. A large portion of its expected Q3 and Q4 passings were running a month or two behind schedule, which would push a meaningful part of the expected new-customer ramp out of Q4 and into Q1
4. Management flagged that it had a high number of 12-month promos rolling off in Q3 and Q4; it worried churn from those would echo the summertime price increase.

The Q3 result was a surprise 4,000+ broadband sub decline (vs. ~breakeven guidance given in August) on a 500,000 sub base. Worse, on the call, CEO Teresa Elder said Q4's HSD sub losses could be “triple” Q3’s losses. Horrible in any event, but absolutely disastrous compared to the expected growth of perhaps 10,000 net adds implied in prior guidance. Depending on how many expansion adds WOW expects in Q4, the “triple” guidance implies ~17,000 HSD sub losses on the legacy base, which is >1% PER MONTH. Truly atrocious.

The market rightly freaked out, sending the stock -65% in a day, to <4x 2023E EV / Adj EBITDA.

Which brings us to today. I want to dig in on a few points about the opportunity worth noting. In order, I’ll discuss:

• Expansion CapEx
• Not All Customers are Created Equal
• HSD Revenue Still Grows
• Kitchen Sink
• Q1 is Here

Expansion CapEx: WOW’s overall market cap is ~$295 million. We expect WOW to spend that amount on just expansion CapEx over the next two and a half years. While WOW’s core business is shrinking, we believe it could choose to accept that challenge, slash its expansion aspirations, and return the entire market capital to shareholders from free cash flow in just a few years. 

As an aside, given its covenant headroom, WOW could theoretically recap its current business, return the entire market cap in cash, and still be less-levered than many larger peers (cable and fiber overbuilders).

We don’t expect it will do either of these, but it highlights how cheap the company is. I remember 16 months ago when META traded at $90, one framing was, "Meta is trading at just 12x Reality Labs Cash Burn." Obviously WOW is no Meta, but knowing that it trades at 2.5x its Expansion Burn both de-risks the downside and highlights the upside.

Not All Customers are Created Equal: While WOW’s Q3 HSD ARPU was $72, that is an average, whereas the elevated churn skewed heavily to low-value subs. We don’t know what portion of WOW’s sub-base was on 200 mbps or lower speed plans, but we believe over half of the elevated churn was in this cohort. 

The below screenshot is the rate card WOW offered for its cable (not fiber) markets during Q4 (as discussed below, as of recently, this is not the current rate card):

The bulk of WOW’s surprise churn was from its lowest tier customers (200 mbps and below - the $24.99 and $19.99 promo tiers). We believe the cost to acquire, serve, and retain these customers likely meant those subs were nominally profitable, if at all, during the initial 12-month promo period. While having an entry-level tier is important to building a funnel for upgrades over time, losing those customers has limited impact on current cash profitability. As we discuss below, WOW subsequently eliminated the bottom tier as a go-forward offering, which hints at our point about those being unprofitable subs. Depending on what you think the variable monthly cost of support and operations are, it wouldn't surprise us if one $50 customer was worth three or more $25 customers on an EBITDA contribution basis.

HSD Revenue Still Grows: Even with the elevated churn, we believe the price hike WOW took in July likely netted ~$15mm of incremental run-rate annual revenue. While Q4 HSD revenue may be down vs. Q3, we still expect it to be nicely positive YoY.

Kitchen Sink: When Charter recently announced its poor Q4, we understand WOW management conveyed that Charter “belatedly” took its medicine, whereas WOW took its own back in Q3. We believe Teresa intended for her “triple” guidance to be downside guidance.

We also know that ~25,000 of 2023's 50,000 guide for passings were complete by Q3’s report, with many of those delivering late in Q3. That left the balance of the 50,000 target for Q4, most of which we believe were delivered mid to late in the fourth quarter. 

Q1 is Here: While Q4 was likely had quite severe subscriber losses, we know that part of the shortfall is in part driven by brief delays in bringing to market some of the 25,000 homes it expected to pass in Q4. On recent calls, WOW indicated it was seeing penetration as high as 30% in the first 30 days post-activation. If we assume WOW was expecting to sign up 5,000 of those passes as customers in Q4, but, due to delays, could only sign 2,000, it pushes an extra 3,000 into January. CEO Teresa Elder has also indicated that “internal” projections were originally for more than 25,000 passes in Q4, the overage of which likely now slipped to early Q1, pushing more “bonus” gross adds into early 2024.

In the three quarters preceding Q3 2023, WOW lost 7,500, 3,800, and 2,700 legacy base customers in Q4 2022, Q1 2023, and Q2 2023, respectively. Now that the pricing and promo churn-spikes have passed, let’s posit that in Q1 2024, the legacy churn settles part-way back down to a still high 7,500 for Q1 2024 (or 2,500/month). An added sweetener is that in January, T-Mobile announced $10/month increases to its FWA plans, incrementally reducing competitive intensity.

As you can see in the Bloomberg screenshot below, the market is expecting WOW to have Q1 HSD subscriber losses of 6,000 and an associated QoQ decline in HSD revenue. We believe HSD revenue could grow in Q1 and it’s possible there is actual HSD subscriber growth.

When WOW announces Q4 earnings, it’s plausible it simultaneously gives a sneak-peak into January trends and announces positive January net adds (or close to it), which nobody expects, comprised of something like 2,500 legacy losses in January, but 3,000+ expansion adds.

Further, with a substantial number of the gross adds coming from its fiber markets and its higher-tier cable offerings, we know the ARPU of the gross adds skews high while the associated service costs skew low (especially for fiber). Combined with the opposite for its churning customers (ARPU skews low), it creates the potential for stronger-than-expected HSD revenue and EBITDA in Q1.

If the company hints at either of those, we believe WOW could see a breathtaking re-rating upward.

Video:

WOW describes its traditional cable TV video business as “slightly accretive” to overall company profits, with that remaining modest profitability rapidly eroding. Of course, many customers value access to the bundle, even if the explicit video portion is only modestly profitable for WOW. As a result, most cable operators are nervous to exit the video business and risk inducing associated HSD churn. 

Anticipating this, several years ago, WOW ceased promoting its video bundle, beginning a slow-motion CABO-style pivot from bundled cable TV provider to a single-play focused broadband / HSD company. This transition is well underway, though WOW has not yet forced a full break from bundling linear video for its existing video customers. 

Last spring, the company announced it would no longer offer new subscribers a cable TV video bundle, instead partnering with YouTubeTV as a preferred linear streaming partner. WOW customers who sign up for YTTV via WOW receive a discounted price and WOW receives a monthly payment from YouTube (which it books in “Other Revenue”). 

I think it’s safe to assume that WOW will force the transition of its remaining video base sometime in the next few years, though I do not expect it in 2024 as WOW is highly sensitive to associated HSD churn.

Competition and Positioning:

Possible Green Shoot: In the past month, WOW updated its HSD plans, offering simpler, cleaner, and reduced promotional behavior. Read into that what you will, but eliminating promotions is not the behavior of a company desperately willing to do anything for a subscriber. Quite the opposite.

Below are two screenshots for WOW’s cable markets: first from mid-January and the second recently in February. Again, these are for WOW’s cable markets, which is where its churn issue resides (its fiber markets are priced at a premium to this, on a download speed basis).

OLD - WOW January Cable:

NEW - WOW February Cable:

Quick observations before we relate this to the competition: 

• Simplified pricing
  • No more 12-month promo followed by a big step-up in month 13
  • No more add-on fees for equipment
• WOW has eliminated promotional gift cards at all but the highest-priced level
• Eliminated lowest-end entry level (where I suspect unit profitability was poor and churn was high)
• Faster speeds for the two remaining entry-level plans
• For $5/month, you can now choose to lock-in your price forever (at a given speed)
• While the new offering “looks” like higher pricing for the bottom three tiers, it also provides faster speeds for two of those and eliminates the large price increase in month 13 

It’s worth zooming in on the $30 and $45/month plans - those are highly affordable and both are faster than FWA’s expected speeds. We will dig into FWA more in a moment, but first, let’s see how WOW prices against the primary companies it overbuilds: Charter (dba Spectrum) and Comcast (dba Xfinity).

Charter’s single-play internet plans are much more expensive than WOW - roughly $20/month more expensive for similar plans.

Spectrum (Charter) February Cable:

To be fair to Charter, its primary marketing focus is “Spectrum One” (not shown above), which bundles a free mobile phone line into these same packages, before resetting prices +$30/month in month 13.

For Comcast, it can be a bit hard to compare to WOW, as Comcast prices Xfinity differently in different regions (presumably based on competitive intensity). If we take Comcast’s lowest price region, you can see that WOW is equal or better value across the board (in Comcast’s other markets, its tiers are priced ~$10 higher than below). Comcast also has mobile line bundles that help make it more competitive than these single-play offerings.

Xfinity (Comcast) February Cable - Lowest Priced Region:

All of this is to say that for single-play broadband, WOW is generally cheaper (often by a lot) and has a simpler, easier-to-understand offering.

FWA Competition:

Competition from Fixed Wireless Access, which is a stationary 5G technology, has disrupted the cable growth algorithm and caused existential worry amongst the investor class. FWA is an easy-to-install, affordable product that delivers reasonable speeds. Per T-Mobile’s website, FWA speeds are “typically” between 72 and 245 Mbps.

T-Mobile and Verizon have each been adding 400-500k subs per quarter, with AT&T 50-100k. Much ink has been spilled about why it’s not economic for the mobile players to overload their precious wireless spectrum with home broadband, but the fact is they are doing and winning huge volumes of customers. 

Facing a competitive loss of nearly one million FWA broadband subs per quarter, the overall cable industry has gone negative HSD adds. As alluded to above, T-Mo has widely communicated that it has network capacity limitations on how many subscribers it can handle without eating into the golden goose, which is wireless mobile (T-Mo charges perhaps 20x more per bit of data consumed by mobile customers vs. FWA customers). It expects to near its capacity next year and recently raised prices for new FWA customers by $10/month, presumably in an attempt to slow growth and get more return from its spectrum investment.

T-Mobile’s Recent FWA Pricing Card (February):

A few things jump out:

1. Each of these looked a lot cheaper $10 ago
2. T-Mo’s unbundled home internet plan (on the right) is $60. Keep in mind T-Mobile will throttle your speeds if you are a big data user and charges $35 for installation. That is dramatically inferior to WOW’s offerings
3. Even T-Mobile’s best Magenta Max plan at $40, which requires a T-Mo mobile subscription is not obviously cheaper or better than WOW’s $30 for 300mbps (give T-Mo credit for $17 worth of ad-tier Netflix and AppleTV+, but you receive slower speeds and a lower quality connectivity experience).

Fiber Overbuilding:

Unlike its cable peers, WOW rarely faces a fiber overbuilder. 

But why? 

In its cable markets, WOW itself is the overbuilder (nobody can justify overbuilding in an already overbuilt market).

Along those lines, WOW is building greenfield fiber (rather than “cable”), generally in markets that don’t have an overbuilder or are new (and unaddressed). This has allowed WOW to gain tremendous penetration on its initial expansion builds. WOW prices its fiber offerings at a premium to its cable pricing plans.

WOW February Fiber:

This premium pricing is important to keep in mind - WOW is adding fiber customers at a rapid clip and more than 80% of new broadband-only customers (cable + fiber) take 500 mbps and above (>90% of all new connects are broadband only, the balance bundle a home landline phone). 

This rapid expansion that skews toward premium offerings and a general focus on more premium gross adds is going to drive HSD ARPU and contribution profit higher in the coming quarters. While some of that is driven by the price increase last summer, the bulk will be driven by product mix as customers demand more and more speed.

This reinforces the point that even as lower-value customers churn out, higher-value customers are landing in. One $50 HSD customer is likely more valuable than two $30 customers, given cost to serve, capital to activate, and opex associated with service. The company would prefer winning all three customers, but from a purely economic standpoint, it’s important to bear in mind not all customers are equally valuable.

Management and Capital Allocation:

As mentioned, in June 2021, WOW’s current management and Board announced a deal to sell five different geographies to two buyers for roughly $1.8B at 11x EBITDA (which was a 3-turn premium to WOW’s trading price at the time). It earmarked the proceeds for a combination of de-levering, shareholder returns (via buyback), and expansion CapEx.

A year later, in mid-2022, the company was rumored to be entirely for sale, but the combination of the cable industry slowdown and rising rates led to an industry-wide de-rating that served to pause the process.

WOW stock peaked near $24 in 2021 and saw $23 in May 2022, before taking the staircase to hell for much of the last 20 months.

CEO Teresa Elder owns roughly 1.7 million shares (~2% of the company) and has substantial unvested shares, many of which are at risk of forfeiture, given the company’s current underperforming stock and the likelihood of missing financial targets.

It should be noted that, on a change of control, Elder would receive a $5 million cash payout (equal to 2.5 years expected pay) and vesting of all unvested shares, which could be worth many millions (depending on a deal price). She is 62 years old.

Private Equity Owners:

Private equity firm Crestview Partners owns 38% and arguably has de facto control, with four of nine board members, including the Chairman, Jeff Marcus (himself a former cable operator from the Cable Cowboy era, a former Charter director, and friend of John Malone). Crestview has been invested in WOW for over eight years and is underwater on its investment, after at one point being up roughly 4x. The fund that Crestview used to invest is nine years old, making it a motivated, but not forced, seller in the coming years.

I believe the most likely outcome is WOW gets sold. Probably to another PE firm or PE-controlled operator.

Debt:

WOW has roughly 3.1x of Q3’23 Net Debt / 2023E Adj EBITDA. As I’ve discussed ad nauseum, the entire business trades for ~4.1x.

Interestingly, WOW’s debt covenants allow it to borrow up to 5.0x on a secured basis and 6.5x on an unsecured basis. The keen observer would note that, in theory, WOW could borrow multiples of its market cap without triggering a covenant (which would simply require WOW to not borrow any additional capital).

Risks:

• Churn remains elevated
• Market expansion investments are a poor use of capital
• Entire broadband industry faces existential FWA competition risk
• Modest leverage ratios balloon as more debt used to fund expansion and existing business deteriorates
• SBC - if the company continues to hand out a similar dollar value of SBC as it has in the past, the lower share price will drive dilution much higher
• Potential acquirer pool may be limited due to antitrust risk and many strategics dealing with their own operating challenges
• Take-under by 38% shareholder Crestview
• ACP - WOW has provided no indication of its reliance on FCC ACP subsidy funding, which could further spike churn if the plan is not re-funded this spring

Summary:

WOW trades at a distressed price but is not distressed:

• Public LBO: It is a Golden Age LBO, but available in public markets. 4.1x adj EBITDA with 3.1x net debt. Legacy business is free cash flow positive.

• Could Quickly Cash Flow its Market Cap: The market cap is 2.5 years of planned Expansion CapEx (which could theoretically be dialed down or turned off).

• Industry is Cheap: The entire cable industry is trading at decade+ low multiples, as fears of saturation and competition are depressing Mr. Market.

• Healthy Balance Sheet: WOW’s primary debt is a term loan with nearly five years remaining to maturity.

• Motivated Owners: 38% owner is a private equity firm that has been involved for eight years from a nine-year-old fund.

• Shareholder Friendly History: WOW management and board have shown a willingness to make value-accretive decisions, even if they shrink the business.

• M&A: WOW attempted to sell the whole business two years ago, before cable valuations plummeted and interest rates rose, spiking the process. The ultimate outcome here is likely a sale of the business.

• Unit Economics: Market misunderstands that not all subscribers are created equal: WOW is losing low-value subs while adding high-value subs,

• Variant Perception: Market expects declining HSD subs in Q1 and Q2, even as WOW is likely past its peak churn and is currently selling into a huge set of newly built home-passings: WOW may actually add net HSD subs in Q1.

• Spring Loaded: Current valuation assumes horrific operational performance. Anything less than horrible (such as “merely bad”) could create massive price movement since small changes in sentiment will have a big impact on equity valuation

• Asymmetric Setup: Distressed price but non-distressed operations and plenty of toggles to highlight equity value (change in capital allocation priorities such as reducing optional expansion CapEx, sale of assets, sale of business, levered recap, etc.).

[End]

End Notes:

* I am using management’s definition of adjustments for things like Adjusted EBITDA. Management adjustments match the terms in the credit agreement.

Disclaimer:

ALL INVESTMENTS INVOLVE THE RISK OF LOSS, this one most certainly included. This write-up involves substantial judgment. The author offers many opinions around subjective topics such as valuation, opportunity, and risk that are not meant as fact. Please do your own diligence and do not rely on this write-up for any information. Never trust anonymous internet personas. If you buy this stock on the basis of this write-up, you are self-loathing and should be prepared to lose your entire investment.

Catalyst

Return to HSD net add growth

Change in capital allocation priorities

Sale of the company