Is Cable One Too Expensive?

At around $850 per share, Cable One (CABO -3.97%) looks expensive, but of course the share price doesn't tell you how the stock is being valued. For that, let's look at how the cable company is priced compared to peers, using a metric that factors in the relatively high level of debt being used by industry players, that is, enterprise value to EBITDA. Here's the upshot: Cable One is pricy, but it's also arguably the best-run outfit in the industry, at least on one metric. 

Image source: Getty Images.

Here's how Cable One shakes out relative to major peers.

 Data source: Capital IQ estimates.

Enterprise value to EBITDA (EV/EBITDA) is a ratio that measures valuation, and it's especially useful in debt-heavy industries such as cable, because it accounts for how much debt a company has. The lower the number, the cheaper the company. 

Cable One has the highest valuation in this matchup, and with that high margin profile turning so much revenue into cash flow, it's not surprising. Even Altice, which is not too far behind, doesn't enjoy that multiple, but it's also burdened with a lot more debt than Cable One. While Cable One sports a modest net debt to EBITDA ratio of just 1.9 times, Altice looks weighed down, with net debt of 5.4 times. That's even more aggressive than Charter (4.3 times), where legendary investor John Malone lets the leverage run high to support massive stock repurchases.

Cable One has the highest EBITDA margin of its publicly traded peers, suggesting the company is run efficiently, and it's been trending higher. That's because years ago the company made a deliberate effort to de-emphasize its video customers, which earned the company little or no free cash flow. Instead the company focused on its high-speed data unit and business services, which earn margins that are four to five times higher than video customers. In addition, less focus on video also requires fewer employees, so Cable One saves cash there, too.

At first, this focus on high-margin customers hurt. In some quarters, revenue went down as video customers decreases more than offset gains elsewhere, but as data and business services became a bigger portion of the company's revenue, revenue began to tick higher and EBITDA began to march upward. Now these growing units are big enough that the company is consistently generating gains in revenue and EBITDA.

How much can they grow? Then-CEO Tom Might laid out a good paradigm during the company's conference call in May 2016. He suggested a three-part mix for thinking about annual revenue growth:

• The number of customers grows 2%-3%.
• 2%-3% of customers move up to more expensive speed tiers. 
• Prices rise 2%-3% annually.

In total, he thought the business could generate 6%-9% revenue growth, more or less indefinitely. New CEO Julia Laulis took over at the start of 2017. She was the company's chief operating officer, so the game plan remains the same in this respect.

What about those margins?

Cable One's strong margins translate into robust cash flow, and even revenue growth at the low end of projections can translate into solid EBITDA growth. And it's reasonable to expect that as its business becomes more focused on the higher-margin units, that margins will continue to climb.

Here's how EBITDA margin has performed since the company spun off from Graham Holding Company in mid-2015.

DATA SOURCE: CAPITAL IQ. Chart by author.

And that downturn in mid-2017? That was from the cost of acquiring and integrating NewWave  Communications. While the cost happens once, it allows the company to continue its strategic approach across a broader footprint.

Cable One is a potential takeover target

Investors have been willing to bid up Cable One because of its attractive and growing margin, which sends so much cash to the bottom line. But a strategic acquirer may be able to do even more with the company, especially if it could achieve better content costs than the small Cable One can, and the economics of cable strongly favor consolidation. If a takeover doesn't happen, then Cable One can continue to acquire smaller cable rivals and run its game plan on them. The company's modest leverage gives it a lot of flexibility in making acquisitions. It'd be foolish to bet on a buyout, because it might never happen, but Cable One should continue accruing value.

So there are many ways the stock could work out well for investors, even if it's the priciest stock in the industry. The stock has just had a nice run recently, potentially giving investors pause, but it could be a great one to take an initial stake and then buy on any dips.