Charter Communications: A Buy at All-Time Highs?

Charter Communications (NASDAQ: CHTR  )  made a great deal with Comcast (NASDAQ: CMCSA  ) (NASDAQ: CMCSK  )  which will push the company from 4th place to becoming the 2nd largest cable operator in the U.S. Based on the deal, Charter's video households will almost double and the company will be operating at a much greater scale, which should boost shareholder returns. 

Solid company
Charter had 6.1 residential and commercial relationships at the end of Q1 2014. The company continues to grow its average revenue per residential customer, which is a key metric for all cable firms. In the last quarter, revenue per residential customer grew 2.8% year-over-year to $110.29. Just like other major companies, the number of Internet customers is growing and now makes up the biggest segment with 4.5 million ISP customers.

In the last quarter, Charter's revenues grew 7.5% year-over-year to $2.2 billion driven by growth in Internet and commercial customer revenues. Similarly, the company's residential consumer revenues grew 6.5% year-over-year. The company recorded a small net loss, but is positive on a cash flow basis. In Q1 2014, operating cash flow stood at $577 million and free cash flow stood at $74 million. The company is investing heavily to grow its business in the form of new customer acquisitions and its all-digital initiative. 

Charter's management stated they forecast capital expenditures of $2.2 billion in 2014. Owing to the significant tax assets, the company is not expected to be a significant tax payer until 2018. On a tax basis the company has 10.3 billion of tax assets that can potentially shield net income. 

Fantastic deal with Comcast
After Comcast's merger with Time Warner Cable (NYSE: TWC  )  goes through, Comcast will divest roughly 3.9 million video subscribers. And this divestment, according to Comcast's expectations, will reduce Comcast's managed customer base to below 30% of the total MVPD subscribers in the U.S. and aid a lot in getting regulatory approval. 

Charter will buy 1.4 million existing Time Warner Cable subscribers, which will ramp up Charter's combined residential and commercial video customer count from 4.4 million to 5.7 million. Charter will pay $7.3 billion for the 1.4 million Time Warner Cable subscribers and this will make Charter the 2nd largest cable company in the U.S. The 1.4 million customers being acquired by Charter will generate $1 billion in terms of EBITDA for the current year. 

Also, Time Warner Cable and Charter will transfer 1.6 million video customers in a tax-efficient exchange that will lead to operational efficiencies arising due to geographical placement of subscribers. And after the Time Warner Cable-Comcast merger gets green-lighted by regulators, the owned and managed sub-base of Charter will get a huge boost from 4.4 million video subscribers to 8.2 million. 

Potential for attractive returns
To fund these transactions, Charter will be leveraging up its balance sheet even more. Charter's net debt is expected to grow to $21.8 billion from $14.1 billion. Charter's highly leveraged business model should be able to deliver robust growth in free cash flow in the future because of the larger scale advantages, operating efficiencies, and lower cost of capital for the company. As a result, the company's fundamentals can improve substantially as the company undergoes these material changes. 

In addition, Charter will have a 33% stake in a new publicly traded entity (SpinCo) which will be spun-off by Comcast. Charter will issue new Charter shares to SpinCo shareholders for the 33% stake, and Comcast's shareholders will get 67% of the new SpinCo company. Due to new share issuance by Charter to SpinCo's stock holders, the SpinCo shareholders will end up owning 13% of Charter. In addition, Charter will be providing management services to SpinCo and in the process will be receiving 4.25% of SpinCo's total revenues and also Charter will get 3 board seats with SpinCo. 

Going Forward
Charter was already doing very well on its own, and this great deal with Comcast will provide the company with significantly greater scale and provide numerous growth opportunities as well as realize cost efficiencies from geographical rationalization of Charter's cable systems. 

Charter should perform very well as it is focused on optimizing cash flow and not earnings per share. Considering the fact that the company almost doubled its subscriber base and stands to benefit a lot when its SpinCo holding company goes public, Charter and its share price should see new record highs. ISI Group upgraded the stock price of Charter to a buy rating with $180 price target, and based on the recent developments in the company, the target price set out by ISI Group seems very reasonable. 

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