CABO - Cable One

[Munger_Disciple]

Maybe you've done that and concluded 10x EBITDA is rich (if so, I take back the "arbitrary" comment and we can agree to disagree)

 

I have looked at CABO in depth along with several other companies in the cable space, and concluded that I would rather own others given the current valuations.

 

To each his own

 

 

[Packer16]

Isn't an issue with CABO that at a 4% (3.7% by my calcs) DFFCF/EV, that any debt rate above 4% becomes dilutive & thus leverage is of little use here and you are dependent upon the growth to grow value?  The company may not go bust but at a 3.7% FCF yield there is a good amount of growth in the number already. 

 

If we look at Cogeco as another mid sized cable co, they currently have a FCF yield of 5.3% Comcast is 5.7%.  At the current price, CABO has grow 2% more implied growth forever than Comcast.  That is baked in so any appreciation is making a bet that CABO can grow unlevered CF by more than 2% greater than Comcast.  I agree there is some Alaska risk with GNCMA (which will reduce the historical CF growth of 10% per year) but with CABO IMO you have more pricing risk.

 

Packer

[cmlber]

Isn't an issue with CABO that at a 4% (3.7% by my calcs) DFFCF/EV, that any debt rate above 4% becomes dilutive & thus leverage is of little use here and you are dependent upon the growth to grow value?  The company may not go bust but at a 3.7% FCF yield there is a good amount of growth in the number already. 

 

No for two reasons.  1) The 4% is after a 39% tax rate.  Pre-tax the yield is 6.5%, they can borrow cheaper than that.  2) If you buy a 20 year zero coupon bond with a YTM of 10%, and finance it with 20 year debt at 7%, won't the IRR on your equity go up even though it is "dilutive" for 19.9 years? 

 

If we look at Cogeco as another mid sized cable co, they currently have a FCF yield of 5.3% Comcast is 5.7%.  At the current price, CABO has grow 2% more implied growth forever than Comcast.  That is baked in so any appreciation is making a bet that CABO can grow unlevered CF by more than 2% greater than Comcast.  I agree there is some Alaska risk with GNCMA but with CABO you have pricing risk.

 

I think it's very reasonable to anticipate 2%+ higher growth for CABO vs Comcast.  Comcast has 42% HSD penetration vs 31% for CABO.  Comcast HSD prices are ~20% higher than CABO's per Mbps.  Price is 100% incremental margin.  Comcast EBITDA is more at risk long term if cord cutting accelerates.  Comcast HSD pricing power is also likely much lower given higher fiber overlap and denser markets which will make it easier to deploy next generation technologies to compete with cable.  I'm much more confident projecting out 20 years into the future for a rural cable operator with no video business than I am for a non-rural cable operator with a large video business.  I think you need to project out that far to want to own either CABO or Comcast.  So even if I thought CABO would grow only 1% faster than Comcast in perpetuity, I'd rather own it because I have a lower hurdle rate when I think the future is clearer. 

 

Can't comment on Cogeco, haven't looked at it.

 

[Packer16]

You are correct on the debt as they do have a good amount taxes that they could shield.  My main point is 3.7% FCF is not cheap unless there is a good amount of growth compared to some other alternatives.  If you look at the comps they all trade at higher FCF yields & maybe they should based upon the factors you have brought up, however, there is already a 2% lower yield or almost 50% premium in the pricing for those factors, so, the bet in buying CABO is that the premium should be higher.  I wish you the best but I am not a growth investor so this is out of my circle.

 

Packer

[rishig]

You are correct on the debt as they do have a good amount taxes that they could shield.  My main point is 3.7% FCF is not cheap unless there is a good amount of growth compared to some other alternatives.  If you look at the comps they all trade at higher FCF yields & maybe they should based upon the factors you have brought up, however, there is already a 2% lower yield or almost 50% premium in the pricing for those factors, so, the bet in buying CABO is that the premium should be higher.  I wish you the best but I am not a growth investor so this is out of my circle.

 

Packer

 

The headline number of 3.7% FCF is not representative of their earning power for two main reasons:

* CABO is under earning. It's product is currently priced much lower than comps. Data ARPU as of last quarter is $61. GNCMA, an alaska based comp, has DSL based model ARPU at $85. $85 for dsl and $61 for fiber!

* CABO rolled out the 100 Meg product in Q4 '15 and is rolling out Gig in 2016. Their capex has been much higher than normalized capex.

 

[Packer16]

This is true but how much is this going to add to DFFCF?  It has to be 50% to approach the multiples of Comcast.  The big difference between GNCMA and CABO is competition. I am assuming that is what is driving CABO's pricing otherwise why charge such low rates.  Competition IMO is what destroys the most profit for most firms.  GNCMA has one small weaker competitor.  It looks like CABO has stronger competitors.

 

Packer

[Munger_Disciple]

GNCMA, an alaska based comp, has DSL based model ARPU at $85. $85 for dsl and $61 for fiber!

 

GNCMA's service is not based on DSL. In fact General Comm offers 1G speeds in urban areas:

 

https://www.gci.com/internet/1gig-red

 

Also you cannot compare Alaska where the population densities are an order of magnitude smaller to the regions in which CABO operates. As Packer mentioned, GNCMA is basically a monopoly and due to the quad-play offering (including wireless), customers are way stickier. Providing HSD and wireless in very remote areas is a different proposition (higher capex requirements which translate to higher cost of service for customers).

[dwy000]

You also can't extrapolate the growth at CABO going forward.  They took a massive price increase on HSI last year (in excess of 15% if I recall) that is not replicable.  It may still be cheaper than others but you cannot take that kind of price increase every year without having customers revolt.  The increase starts to grandfather out over the next few quarters so you will see growth slow substantially - or even decline unless they can slow down the video and telephony sub declines.

[Nassau]

Actually, Cable One has quite a few strong tailwinds working for it.

 

1 - Despite a small ($5/month) HSD price increase in 2015, CABO's HSD service remains deeply under-priced relative to other larger cable companies, who charge significantly higher absolute prices for significantly slower data speeds.

 

2 - In Q2, for the first time total revenue inflected to growth as HSD and Business Services overtook video.  This is important.

 

3 - Business services penetration is very low (single digits according to the company).  This is growing quickly and the highest margin business under the CABO umbrella. 

 

4 - The only real "competition" CABO has is DSL.  They have virtually no fiber overlap, and they are unlikely to see new competitors enter as they are already offering 1Gbps speeds.  As such, transition to CABO from DSL should continue for a long time.

 

5 - Unlike other large cable companies, CABO continues to have data caps, which act as a toll on the heaviest users.  Charter, for instance, just had to give these up to get the FCC to approve their TWC deal.

 

6 - Demand for streaming video, video games, 4K TV and multiple devices at same time will drive users to upgrade to faster data speeds.

 

Also, if anyone thinks CABO is the only cable company raising prices, you need to do more research.  EVERY cable company is raising prices.  Further, it is important to remember that a little over a year ago (at the time of the spinoff), CABO's maximum internet speed was 50Mbps.  It is now 1,000Mbps.  Average Revenue per User (ARPU) growth is a function of existing customer plan upgrades, new users at better plans, tolls on heavy users via data caps, and base price increases as speeds increased rapidly.

 

If you look out to 2018, with continued growth in HSD, Business Services, plan upgrades, and improved pricing, the current valuation is likely only about 6.9x 2018 EBITDA, and meanwhile free cash flow is growing as earnings grow and capex falls.

 

It's not hard to get to $1,000 per share in a strategic sale here, particularly as we are now seeing that large cable co's are wringing out more synergies on a faster timeline than "expected."

[bookie71]

GNCMA is basically a monopoly

They are very much a monopoly and have a very large number of very unhappy customers who would leave in a second if there was a choice (myself included).  They beat up their competition early on by being customer friendly, now they are worse than the  competition they either drove out of business or bought out.

[muscleman]

For GNCMA fans, how would you be comfortable with the greedy management? I pointed out a few things in that post before.

I am copying and pasting that here:

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/gncma-general-communications/msg272011/#msg272011

 

 

[maybe4less]

 

Levering up at low rates to buy back stock you'll do a lot better.

 

 

 

cmlber,

 

How clear have management's statements on debt and buybacks been? Are the definitely going to increase leverage?

[cmlber]

 

Levering up at low rates to buy back stock you'll do a lot better.

 

 

 

cmlber,

 

How clear have management's statements on debt and buybacks been? Are the definitely going to increase leverage?

 

They have been very clear about debt, saying they "would feel comfortable with leverage being in the 3 times to 4 times range."  But they can't buyback stock too aggressively given the low daily volume, and since EBITDA is growing it's very hard to increase debt/EBITDA without M&A or a special dividend.  They've said they're spending a good amount of time since the spinoff looking at M&A opportunities. 

[dwy000]

The price increase on HSI last year was in the order of 16%. It may have been $5 but they also changed their buckets and caps which forced people into higher buckets.  They may still be underpriced relative to other cable companies  but they are also focaused on rural Mississippi and Boise Idaho.  And they still have the headwind of double digit declines in video and phone.  I think revenue declines starting in 4q.  they can make up for it down the road but this company isn't worth the same multiples as the Charters andnComcasts.

[Nassau]

dwy, seems you do not appreciate the math of customer growth in HSD and business services, coupled with an underpriced service with no competition.  you notice the quiet confidence of management as they buy back shares at what they call "very attractive prices"?

[dwy000]

I appreciate the math and think this is ultimately where the industry is going long term - I just question the logic of intentionally shedding video and phone customers who continue to be profitable even if it's at lower levels than HSI. And while the competition is not strong, there is a level where the competition is "acceptable" for most people given the price differentiation. 

 

Note that the number of residential HSI customers actually declined quarter over quarter in 2Q.  As prices continue to rise its going to be tough in these regions to grow customer numbers.  That's fine long term but in the intermediate term its in the face of huge reductions in video and phone customers/revenues.  Modelling the overall EBITDA and revenues is tough until those stabilize.

 

If the ultimate value play here is an acquisition, you have to question the logic of going in the opposite direction of the potential acquirers who still value video and phone and triple play customers.

 

Not saying this is not going to be profitable or successful long term - but there will be volatility until the numbers stabilize and the stock is fully priced in the interim.

[hooplaer23]

Isn't a big part of management's argument that video generates essentially no free cash flow, so in theory you could still see free cash flow growth even if overall revenue was declining due to losses of video subs?  Obviously that still requires growing HSD and business services longer term. 

[rishig]

Isn't a big part of management's argument that video generates essentially no free cash flow, so in theory you could still see free cash flow growth even if overall revenue was declining due to losses of video subs?  Obviously that still requires growing HSD and business services longer term.

 

Based on SNL Kagan industry data from Q1 2015, here is the math for video programming for a small/mid-sized cable operator:

 

Video Average Revenue Per Unit $81.03

Less: programming & retrans cost (45.86)

Contribution per video sub $35.17

% contribution margin 43%

Less: indirect cost per PSU (24.55)

OCF per video sub $10.61

% OCF margin 13%

Less: capex per PSU (11.58)

FCF per video sub ($0.96)

% FCF margin (1%)

[cmlber]

I just question the logic of intentionally shedding video and phone customers who continue to be profitable even if it's at lower levels than HSI.

 

Usually when the facts don't add up, they're wrong.  Why would management be stupid enough to intentionally shed video customers "who continue to be profitable?"  One of two things must be true, either this is the dumbest management team ever and despite having decades of experience in the business they can't see what you can see, or you aren't correct that these customers "continue to be profitable."  Which is more likely? 

 

If the ultimate value play here is an acquisition, you have to question the logic of going in the opposite direction of the potential acquirers who still value video and phone and triple play customers.

 

We'll have to agree to disagree, but I think you have this backwards.  If Charter can come in with lower content costs and be profitable offering video to its customers, isn't that a huge opportunity for an acquirer who thinks there is money to be made in video?  They'd have a huge opportunity to increase video penetration. 

[cmlber]

I just question the logic of intentionally shedding video and phone customers who continue to be profitable even if it's at lower levels than HSI.

 

Usually when the facts don't add up, they're wrong.  Why would management be stupid enough to intentionally shed video customers "who continue to be profitable?"  One of two things must be true, either this is the dumbest management team ever and despite having decades of experience in the business they can't see what you can see, or you aren't correct that these customers "continue to be profitable."  Which is more likely? 

 

To add to this, management said in May "So, we've actually – since we've shift the strategy, we lost about 30% of our video sales, but our video cash flow has grown because we found there's a lot of hollow revenue in video – I mean, other – some customers as well who has a lot revenue but there was a lot of revenue, but there was no profitability with video-only customers."

[KJP]

Isn't a big part of management's argument that video generates essentially no free cash flow, so in theory you could still see free cash flow growth even if overall revenue was declining due to losses of video subs?  Obviously that still requires growing HSD and business services longer term.

 

Based on SNL Kagan industry data from Q1 2015, here is the math for video programming for a small/mid-sized cable operator:

 

Video Average Revenue Per Unit $81.03

Less: programming & retrans cost (45.86)

Contribution per video sub $35.17

% contribution margin 43%

Less: indirect cost per PSU (24.55)

OCF per video sub $10.61

% OCF margin 13%

Less: capex per PSU (11.58)

FCF per video sub ($0.96)

% FCF margin (1%)

 

What incremental CapEx is required for video subs above what is required to provide those people with broadband internet?  Is it set-top boxes? 

 

I'm not suggesting the SNL numbers are wrong.  Just wondering what the $11.58 video-specific CapEx consists of.

[dwy000]

It's not just me questioning the strategy.  Greg Maffei recently commented on it with a bit of a chuckle at a Liberty presentation saying that they didn't understand the strategy there. 

 

Forget me (and I have no dog in this fight) - it's a strategy followed by Cabo that goes in the opposite direction of that being followed by Rutledge, Malone, Roberts, etc.  If it is the economics of being a small player then don't you get more value for shareholders by selling out to the big ones who want your customers and can make them work than shrinking the business.  It suggests that there is no intention of selling anytime in the future.

 

From the SNL figures, I don't know the difference in programming costs for Cabo vs big player but Dish and Directv both have strong margins at a much lower video ARPU. 

[cmlber]

It's not just me questioning the strategy.  Greg Maffei recently commented on it with a bit of a chuckle at a Liberty presentation saying that they didn't understand the strategy there. 

 

Forget me (and I have no dog in this fight) - it's a strategy followed by Cabo that goes in the opposite direction of that being followed by Rutledge, Malone, Roberts, etc.  If it is the economics of being a small player then don't you get more value for shareholders by selling out to the big ones who want your customers and can make them work than shrinking the business.  It suggests that there is no intention of selling anytime in the future.

 

I saw the Maffei comments.  If you were a potential acquirer, what benefit is there to publicly saying anything positive?

 

I don't think it suggests that there is no intention of selling.  I think it suggests they believe they can create more value running the business than they would receive in an acquisition.  I prefer they don't sell for a while.  I'd rather the underlying business compound and then sell rather than get a 10-20% premium now and be out.

 

I guess we'll see with time what happens here, but my guess is much faster growth than you expect and an exit multiple higher than what you would think fair. 

[AccentricInv]

I have some experience covering the cable industry, so thought I'd just chime in a couple thoughts.  I've been following CABO since they spun out last summer, and have met with mgmt a couple times.

 

For a mid-tier player like CABO, the video economics are significantly different that that of one of the big three (CMCSA, CHTR/TWC, CVC).  The programming costs for CABO can be $10-15 higher per sub in some instances.  This is because programming costs aren't linear, they follow an inverted curve.  The more video subs you have, the exponentially cheaper it is on a per sub basis.  Also, I believe CABO is part of the rural cable operators agreement (forgot the name of the association), which tries to collectively bargain with programmers for lower costs.  So they do get some scale benefits from that without having to merge with a larger player.

 

Also on the subject of mergers, CABO is unlikely to get sold at least for another year.  If you read the tea leaves, it's like that CABO will sell at some point.  It spun out of Graham for a reason afterall.  However, CHTR is unlikely to make an attempt until the two year mark.  This is because with spin offs, from what I remember there's special treatment for NOLs and capital gains taxation.  So for CABO to be willing to sell, CHTR would either need to pay a higher price to compensate Graham for the tax hit, or they will wait another year for that to expire.

 

Lastly, we've spoken with Comcast before, and they actually agree with the "video makes no FCF" idea.  However, they won't admit this publicly anytime soon.  This is because they can pass on pricing increases easier in a bundled triple play (a $5 increase is easier for customers to digest on a $110 bill, than a $60 bill in a HSD or double play scenario).  Additionally, triple play reduces churn by ~50bps, which is very valuable by itself across a vast sub base like Comcast has.  However if programming costs keep rising at 8-11% a year, even the large 3 players will start cutting back video and stop promoting the offering.

 

Also on the video costs, the set top box is one incremental capex cost.  Also you need to send a truck / installation guy (aka a "truck roll"), which generally costs ~$100-150 in one time costs.

 

 

[Munger_Disciple]

Also on the video costs, the set top box is one incremental capex cost.  Also you need to send a truck / installation guy (aka a "truck roll"), which generally costs ~$100-150 in one time costs.

 

Long term, video set-top box installation will be similar to a cable modem installation today. Customers typically buy their own modems and can authorize their device on-line on cable company's web site. Moving to this model will drastically reduce if not eliminate capex and truck roll costs related to video service.