CABO - Cable One

[jmp8822]

 

Also on the horizon, in my view, is enough bandwidth from wireless carriers, (T-mobile, Verizon, etc.) to compete directly with cable companies for my internet service business.

 

Thanks for the anecdote.

 

What do you point to as evidence for the increases in bandwidth to come from wireless carriers?

 

From my layman understanding, wireless carriers could install short-distance towers that could generate 5G speeds, what some have called "wireless broadband". The "last mile" represents half the cost of broadband installation, while these local towers could perhaps cover a neighborhood with an internet connection as fast or near broadband speeds. Clearly, this doesn't yet exist in practice across the U.S., although the possibility strikes me as a large risk to the utility-like model. More players might attempt to gain market share, where they otherwise would not because of the high cost of laying cable/fiber to individual homes.

 

http://www.multichannel.com/news/distribution/verizon-eyes-fixed-wireless-fiber-launch-2017/406624

[dwy000]

If net neutrality goes away (which is increasingly likely with an opponent of it now heading up FCC), you can see a scenario where cable/internet companies charge significantly higher prices for broadband to customers who don't take a double or triple play with them - or more likely put very restrictive volume caps and exclude their own cable/OTT offerings from the cap.  AT&T is currently doing that. 

 

At the end of the day, the cable companies have a cost advantage over the OTT services due to their massive customer base.  By owning both the internet access as well as lower content costs, it's hard to see any OTT provider gaining long term traction.  The only ones who will survive will have unique content not available elsewhere (which is where Netflix and Amazon are hoping to get to).

[Nell-e]

Anyone have updated thoughts on CABO? 

 

https://www.wsj.com/articles/why-you-should-cut-cableand-what-youll-miss-1518627438

 

[dwy000]

The company has a gold plated Board behind it (Tom Gayner, Wally Weitz, a partner from Munger Tolles, etc.) and a strong management team.  But I'm not sure what the game plan is for this company as a standalone business.  Growth is a big question mark - they are walking away from (or have already walked from) the cable side of the business in favor of broadband.  But they took a massive price increase about 18 months ago that makes them really expensive considering they are in one of the poorest regions of the country.  I'm not sure where growth is going to come from and they still have the headwind of declining TV customers.  I guess you could treat it like a cash flowing bond and hope for price increases.

 

In my opinion the company should be sold to Charter or Comcast who can be much more efficient with it given their scale.  But they more they dissipate the cable customer base and price themselves at the top of the broadband market, the less rationale for a buyer.  I don't see what the end game is here.

[Nell-e]

Here are my pros for CABO:

 

1) They pay really high taxes and all of their profits are US based.

2) Proliferation and improvement in quality of streaming services like YouTube Red, Sony Vue, Sling, etc. so potentially their cable customers switch from low margin cable package to the high speed internet package.

3) TV's being sold these days are 4K ready.  4K content takes more bandwidth.

 

Just my 2 cents.

[dwy000]

Taxes are meaningful here so it's a good point.  Although I would look at that as a one-off win (and not company specific).

 

On streaming, I guess it's a question of all in cost and margin.  Cabo got out of cable tv because they were being squeezed by broadcasters and cable channels on price increases.  This is the place that a Charter or Comcast could operate much more efficiently.  Cabo is already priced at the higher end of the broadband spectrum ($65.74 per residential data user vs. $61.89 for Comcast) which, given the economic areas they operate in, I can't imagine there's much pricing left to take there.  They only added 1% organically to the broadband customer base thru 3Q vs 5% for Comcast so they may be at the pricing peak before losing customers altogether.  There were articles at the end of 2017 where the other cable companies were complaining that Cabo's pricing actions were going to put pressure on the regulators to regulate pricing across the industry. 

 

4K - if you have cable you don't really have to worry about it.

 

I haven't read thru the report recently but I also think that one of the ways Cabo is getting add'l price increases is by capping the amount of data you get for your monthly fee.  That's just a price increase in another form that will disproportionately hit the streaming customers. 

[dwy000]

Sorry, I phrased my point really poorly.  Essentially, Cabo is already the high cost provider in one of the poorest areas of the country.  They have almost no organic customer growth and limited acquisition opportunities in the space.  The video business will continue to wither and die (and this is a scale business).  I don't know where growth is going to come from going fwd.

[Nell-e]

Appreciate the feedback, dwy000.  I think I get what you're saying.

 

1) The tax cut will be a windfall in perpetuity (unless congress raises it again) so it shouldn't be considered a one time gain. 

2) As far as CABO charging customers high prices in less affluent areas, I'll propose an alternative view of the situation.  If you live in Manhattan and the cable companies try to screw you on pricing, one might go completely mobile and spend less time watching TV.  For people who live in poorer areas, there may be fewer entertainment options.  My guess is that Game of Thrones, Netflix, or gaming on Playstation is a higher priority to this demographic and they're more attached to internet/TV shows.

3) The thinking goes that the cable business will die but customers will convert to high speed internet/Playstation Vue/Netflix bundle where customers get same channels but CABO gets higher margins.  Customers will probably pay around same price as Triple play bundle but will have more flexibility in choosing channels i.e.  ditch ESPN.  CAPEX spending falls, internet usage goes up via 4K content, plus more business users join.

 

 

 

 

 

 

 

 

 

[Txvestor]

FWIW. Lou Simpson of SQ advisors, added a bunch of shares to make this an 8.2% position in his portfolio.

[dwy000]

Appreciate the feedback, dwy000.  I think I get what you're saying.

 

1) The tax cut will be a windfall in perpetuity (unless congress raises it again) so it shouldn't be considered a one time gain. 

2) As far as CABO charging customers high prices in less affluent areas, I'll propose an alternative view of the situation.  If you live in Manhattan and the cable companies try to screw you on pricing, one might go completely mobile and spend less time watching TV.  For people who live in poorer areas, there may be fewer entertainment options.  My guess is that Game of Thrones, Netflix, or gaming on Playstation is a higher priority to this demographic and they're more attached to internet/TV shows.

3) The thinking goes that the cable business will die but customers will convert to high speed internet/Playstation Vue/Netflix bundle where customers get same channels but CABO gets higher margins.  Customers will probably pay around same price as Triple play bundle but will have more flexibility in choosing channels i.e.  ditch ESPN.  CAPEX spending falls, internet usage goes up via 4K content, plus more business users join.

 

 

 

 

 

 

 

 

 

 

On the tax cut - by one time,.i.meant that everyone's model will adjust for it upfront (on a discounted cash flow.basis).  The cash will definitely be annual. 

 

On pricing, that may end up.being the case.  But the customer base is already stagnating so im not sure how much juice is left in that lemon and they probably don't have the scale to add products to the suite like the other cable providers (wireless, home security, etc).  Dunno. 

 

John Malone and Tom Rutledge very aptly have described this as a business of scale.  You have largely fixed infrastructure costs and you put as much volume thru it as possible.  Cabo is subscale in a consolidating business.  It will always be more valuable in the hands of a large player who can operate.more efficiently.  The end game is likely a sale to one of them but all the actions they are taking today are in the other direction. 

 

Again, gold plated mgmt so maybe they see something else there.  I'm always happy to be wrong on a name I don't own.

[Spekulatius]

End game for CABO has to be a sellout. Watch for management incentives to do so.

[vince]

End game for CABO has to be a sellout. Watch for management incentives to do so.

 

I'm not so sure Cabo MUST sell.  I agree that it's likely but their strategy is working beautifully.  They are proving that they don't need to focus on video to be successful and in fact may be proving that the business is better off, over time, without.  The main argument in the industry is that a bundle with video lowers churn.  Cabo disagrees and claims people that take larger bundles are less likely to churn.  Very interesting that they claim churn has not increased as more of their customers take broadband internet as a single product.  Notably, their ebitda margins are approaching 50% as growth in broadband customers has started to overshadow the loss of video revenue.  Would be great if you could put forth your reasons for thinking they have to sellout.

[rogermunibond]

There are quite a few small cable companies that just chug along.  No one's paying a premium to roll them up.

 

https://decisiondata.org/list-of-cable-providers/

[Munger_Disciple]

Looks like CABO is currently trading at 15 times EBITDA! Granted their EBITDA margins are 48% because of HSD focus but still seems very richly valued relative to all the other US cable companies. They acquired several companies recently for cash (as opposed to richly valued stock) which might indicate that the sellers didn't want their stock. Any thoughts?

[wabuffo]

Looks like CABO is currently trading at 15 times EBITDA! Granted their EBITDA margins are 48% because of HSD focus but still seems very richly valued relative to all the other US cable companies. They acquired several companies recently for cash (as opposed to richly valued stock) which might indicate that the sellers didn't want their stock. Any thoughts?

 

They appear richly valued because they are following the Malone Cable Cowboys playbook - they are growing rapidly by acquisition of other small rural cablecos.  In addition to the acquirees' net income, CABO is creating significant operational synergies that increase the value of each acquisition. 

 

They don't offer stock in their deals because they prefer using debt.  They want to increase the ROE of their acquisitions in this manner.  That's not to say they might not issue equity if it makes sense in the future.  They have stopped repurchasing their stock in the latest quarter (last purchases were near $900 per share) - so perhaps they may use stock as currency in future deals if they feel it is overvalued. 

 

wabuffo

[Munger_Disciple]

 

They appear richly valued because they are following the Malone Cable Cowboys playbook - they are growing rapidly by acquisition of other small rural cablecos.  In addition to the acquirees' net income, CABO is creating significant operational synergies that increase the value of each acquisition. 

 

They don't offer stock in their deals because they prefer using debt.  They want to increase the ROE of their acquisitions in this manner.  That's not to say they might not issue equity if it makes sense in the future.  They have stopped repurchasing their stock in the latest quarter (last purchases were near $900 per share) - so perhaps they may use stock as currency in future deals if they feel it is overvalued. 

 

 

I agree with your comments regarding the Malone playbook and the use of debt. But the acquisition multiples they are paying appear to be in the 11-12 multiple range (not real cheap), which due to synergies and tax benefits will be a few turns lower. They are also investing additional capex in the acquired properties. In addition, they appear to charge more for their HSD than Charter so there is not a lot of hidden pricing power.

 

Given all this, I have trouble justifying the 15 multiple even if I give extra benefit to CABO for future roll-ups. Recently Lou Simpson unloaded his entire stake in CABO although that might be related to him unwinding his advisory business. Still, he could have distributed the stock to clients (if he thought it was reasonably valued) in stead of selling out. I would appreciate your thoughts on the valuation of CABO.

 

-MD

 

[wabuffo]

I have trouble justifying the 15 multiple even if I give extra benefit to CABO for future roll-ups.

 

Munger_Disciple, I'm not arguing that at current prices, this isn't more than fully valued.  I have a slight nit with the 15x EV/EBITDA multiple, though.  It doesn't factor in their two latest acquisitions.  Its probably closer to a 14x EV/EBITDA multiple once these acquisitions are fully integrated.

 

If you look at the NewWave acquisition they made in Jan. 2017, they paid $735m (using $650m of debt).  They acquired a business with annual EBITDA of $54.5m.  Operational synergies were around $27m.  That's a multiple of 9x. Not expensive, IMO.  I'll use this to estimate the EBITDA added by their two recent acquisitions.

 

Clearwave was acquired for $357m in November 2018 and Fidelity Communications for $526m (which was announced in April but has not closed yet).  If CABO is still paying 9x (with synergies) - these two buys will add another $100m EBITDA to the current run rate of $540m EBITDA.  (note - that may be conservative, on the Q1 CC, the CEO said that Clearwave had higher EBITDA margins than CABO. implied the same for Fidelity on the Q2 call)  Regardless, add in around $450m additional debt for Fidelity that's not on the balance sheet yet, and I get a 14x multiple.

 

The market seems to like the acceleration in the pace of tuck-in acquisitions and may be giving the stock a little premium for the non-dilutive growth in earnings because they are using debt (and not common stock).

 

I wouldn't buy it at current prices - but I'm not selling my position either.

 

wabuffo

[Munger_Disciple]

wabuffo,

 

Thanks for your thoughts. I do think CABO has excellent management in place, and a good shareholder base with the Graham family. Regarding the EBITDA multiple, I did not take into account Fidelity acquisition that hasn't closed yet. I took the Q2 EBITDA and multiplied by 4 to get annualized EBITDA multiple of 15 but it does include the Clearwave acquisition which closed in January 2019. However the synergies from Clearwave are not reflected in this yet, so you are correct that the multiple is closer to 14 once both deals are closed and synergies are achieved.

 

-MD

[Spos]

CABO also has significantly lower penetration for internet (~32%) than Charter and Comcast (~50%).  With presumably a better competitive position as a rural provider, they should have a longer runway for growth, justifying some premium valuation to the larger players.

[Munger_Disciple]

CABO also has significantly lower penetration for internet (~32%) than Charter and Comcast (~50%).  With presumably a better competitive position as a rural provider, they should have a longer runway for growth, justifying some premium valuation to the larger players.

 

Yes the penetration is lower but CABO's organic HSD sub growth is not that different from Charter. I think CABO is a high quality company which is consolidating other rural cable cos but its valuation is unappealing to me given that Charter is much cheaper and has untapped HSD pricing power.  Plus MVNO option gives more customer stickiness.

[Spos]

I am not saying the current valuation premium is justified.  I own this and am debating selling.  But I do think some valuation premium is warranted due to the penetration issue and rural footprint.

 

The similar subscriber growth rate to CHTR concerned me too.  With the lower penetration, you would think CABO's growth rate would be faster, but it hasn't been the case.  I think part of it has been their focus of going away from promotional pricing whereas CHTR's strategy has been to offer lower prices.  But I do feel that their growth rate should be a little faster.  Not sure why it's not.

 

 

 

 

 

 

[Munger_Disciple]

One can argue how much premium for CABO is really justified relative to Charter. CABO uses debt to acquire small rural cable cos @11-12X multiple which after tax savings and synergies comes to 9X multiple. Charter uses debt to buyback its own stock @8-9X multiple with no risk (of acquisitions). Charter will increase HSD prices and narrow the gap with Comcast/CABO HSD rates over time which means that they are really paying a lower "look-thru" multiple than the headline number for own shares on a normalized basis.

[HopeIsNotAStrategy]

I'd argue CHTR should have a higher multiple than CABO. CABO's thesis is that internet is a better business and more profitable. They've abandoned selling TV because it's breakeven at best and they suggest internet only generates more FCF than internet and TV. If you believe CABO is right, you're likely better off buying CHTR. There's nothing that prevents CHTR from replicating CABO's strategy. In that case, you're paying a lower multiple for CHTR with significantly more FCF upside as they shed the TV business. Also, cable is a scale game and CHTR is significantly larger than CABO

[rogermunibond]

My guess is that OTT streaming defections may eventually reduce the content provider power over cable bundles (especially Disney/ESPN) and that such will reduce minimum carriage clauses and allow cablecos to reprice thin tiers to be competitive with OTT streaming bundles.

 

CABO still does sell cableTV  - it just prices it accordingly and if a subscriber is still willing to pay for the convenience etc. they still provide it.

 

 

[dwy000]

CABO has dropped entire packages wholesale from their offerings (eg they don't offer any Viacom channels) even if you want them.

 

The issue I've always had with CABO is that they have some of the highest internet prices in the country and operate in the lowest income region of the country.  Even the other ISP's have chastised them for their broadband pricing because it is making the industry a target for pricing regulation - especially in regions where there is only one effective provider.

 

I'm not sure how many small, regional cablecos are left out there.  I would have thought the Charter/Comcase/Altices of the world would have swept them up pretty efficiently by now.

 

CABO seems like a play on raising broadband pricing.  Might be very effective to a point.