With Charter Communications one of our largest holdings (via Liberty Broadband), I've continued to look for reasons why I am wrong about the value of the company. During this ongoing process I've come across a few writeups that advocate selling Charter short. The crux of the bull thesis is cable companies in general will be one of the primary beneficiaries of the increasing consumer demand for greater internet speed and capacity as they are better positioned than the traditional telcos. Charter in particular should be able to derive greater benefits as it will be the acquirer of choice to further roll-up the smaller players in the cable industry and thus create a lot of value from synergies and cost savings.
The crux of the bear case is that equity holders will be threatened by a company with a huge amount of debt along with continually large capex spending, tiny margins, and low EBIT and sales growth. Some say synergies will not amount to as much as the bulls think and an unsustainable debt load will turn equity holders into bag holders for a second time.
My subjective, kneejerk reaction to those who suggest Charter should be shorted is that not one of them has put in the time to understand the history of Charter. All of them also seem to have no respect for who John Malone is and what he has done for himself and other shareholders. Why would Malone and Greg Maffei (and several other excellent investors like Jana and Coatue) invest more money into Charter (at prices that are currently higher than shares are now, I would add) if they didn't expect at least a double-digit return on their money? Malone and/or Maffei have actually said they expect mid-teens returns from this latest investment in Charter. Why would you want to bet against these people?
For the bears who have pointed to huge capex spending and low margins and thus worry about piling on more debt that might be unservicable, they either fail to mention or simply gloss over the fact that Charter has been an undermanaged company for nearly a decade. It's only in the past few years when Charter hired Ruttledge and emerged from bankruptcy have they been spending meaningfully to replace and upgrade their technology and assets to give customers a better, all-digital experience. Capex will decline and margins will be higher in five years than they are now, especially if/when the deal for TWC and Brighthouse goes through.
Most of the synergies will come through greater scale and bargaining power. For example, programming expenses on the video side for Charter and TWC were 5.7 and 8.1 percentage points higher than for Comcast during 2014. If Charter and TWC could reduce programming expenses to 50% of video revenues, they would save about $530 million. Attach a 10x multiple to that and that's $5.3 billion of value. Add Brighthouse into the mix, and the savings and value creation could be slightly higher.
And programming expenses is just one pathway to savings. Having greater geographic scale means they will have more efficient advertising and a lower number of technician truck roll-outs. Reducing corporate headcount is another obvious pathway.
In the end, I see no reason why Charter should not be able to approach the size and profitability of Comcast or even surpass Comcast sometime down the road. I still see no reason why I should not own Charter. I still think people saying Charter is a short are kind of crazy.
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