Thesis
Charter Communications (NASDAQ:CHTR) is a cable telecommunications company based in the United States that provides cable broadcasting, internet, voice, and mass media services. The first-quarter results were broadly in line with expectations, but the outlook appears to be positive, with management expressing confidence in underlying broadband trends. I believe the long-term equity story for CHTR is still the penetration story, with inflation-like pricing improvements. The stock valuation has also suffered over the last two years, falling from 12x EBITDA to 7x EBITDA today, which is near its all-time low over the last ten years. I believe the valuation does not reflect the current state of the business, which is much larger than it was in 2016 (similar valuation at the time) and has a lower leverage ratio. As a result, I recommend a buy rating.
1Q23 results highlight
CHTR reported $13.65 billion in revenue, $5.35 billion in adjusted EBITDA, 680,000 in wireless net additions, and 76,000 in broadband additions. The residential Internet net adds accounted for 67,000 of the total broadband. While the 67,000 is down from the previous quarter, I still think it’s a solid showing when compared to Comcast (CMCSA). Residential Internet revenue grew 4.9% to $5.7 billion, mainly drive by pricing of 4% growth.
Broadband adds
When compared to competitors like CMCSA, I think the reported broadband adds metrics look pretty good, indicating that CHTR is expanding its market share. The 67k net additions at CHTR stand in stark contrast to the 5k reported by CMCSA. I believe this strong relative performance is a result of CHTR investment strategy of expanding its footprint in the rural areas, which contributed 17k net adds in 1Q23. Initially, when CHTR announced the winning of RDOF subsidies, I had mixed feeling about this investment as it meant higher CAPEX and lower FCF for the coming years, especially when there was not much information. I strongly believe that revealing the contribution of rural areas is of utmost significance. This disclosure allows investors to accurately assess the potential profitability and success of their investments. As per the disclosed information (finally), it has been revealed that CHTR has successfully activated approximately 170,000 rural homes for sale since commencing construction last year. Additionally, it has achieved a penetration rate of around 30% (percentage of activated homes compared to the total number of homes passed) in 1Q23. With the current momentum, I expect penetration to continue to rise, and management seems to agree; they plan to reach 40% penetration of new rural passings within 6 months. Suppose CHTR can hit its FY23 guidance of adding 300k of rural homes, that would generate ~$360 million of revenue. I believe achieving this guidance would strongly contribute to the equity story of CHTR growing penetration. By then, investors would be more likely to buy into this story and expect meaningful contribution to FY24 results. The combination of this should drive valuation and stock price momentum upwards. That said, I acknowledge it might be too early to judge performance as it is still a small sample size. ARPU and retention rate might be lower than expected. Nonetheless, this is an area to monitor.
Pricing upside
Broadband average revenue per user (ARPU) grew by 4% year over year (y/y), which was faster than the 2.8% growth seen in 4Q22. The price hikes this quarter for broadband and video bundles are likely responsible for the improvement. I anticipate ARPU tailwinds to last throughout 2Q23, which will mitigate seasonality. Overall, I think the fact that CHTR was able to successfully implement price hikes despite increased competition is indicative of a healthy broadband market and CHTR’s continued pricing power.
Valuation
The last time CHTR traded at 7x forward EBITDA was in 2016, when it quickly re-rated back to the average of 10x. For two reasons, I believe valuation has remained at this level. To begin with, interest rates are much higher today, and CHTR has a lot of debt, which has impacted valuation from cost of capital and earnings. Second, slower broadband speeds add. Third, the rural expansion investment program reduced investors’ expectations for higher FCF returns due to increased CAPEX. However, the company is much larger today, with 2x the EBITDA, a much lower leverage ratio (4.65x 6.43x), and a rural expansion strategy that appears to be working well so far. Assuming the new normalized multiple is somewhere between the current valuation and the average of 10x, 8.5x, I believe CHTR’s upside is quite appealing. Applying 8.5x EBITDA to the consensus FY24 EBITDA results in a $195 billion EV, or a $647 share price (before share buybacks).
Conclusion
CHTR has shown healthy performance in 1Q23. I believe its focus on expanding broadband services, particularly in rural areas, has led to market share growth. In addition, the disclosed information about activated rural homes and penetration rates have provided crucial insights to assess the profitability and progress of that investment. Finally, CHTR’s ability to implement price increases and its favorable valuation make it an appealing investment in my view.
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