The cable industry is certainly an interesting one today. In recent years, concerns over cord-cutting have brought a cloud over the industry. And yet the future of communications will most certainly occur over the coaxial and fiber-optic cables these companies own. Even 5G communication, which is thought to be the wireless way of the future and a potential threat to cable, will need to offload its traffic to fiber-optic cable in order to work.
Charter Communications (NASDAQ:CHTR) understands these dynamics better than anyone. Unlike its larger competitors, Charter hasn't gone on an expensive media buying spree, as AT&T (NYSE:T) did in buying Time Warner or Comcast (NASDAQ:CMCSA) did in acquiring Sky TV.
That's not to say Charter hasn't been spending money. In fact, even earlier than these aforementioned media content acquisitions, Charter bought both fellow broadband and cable networks Time Warner Cable and Bright House Networks in 2016, and it has spent the last three years integrating these disparate networks into one unified, best-in-class platform.
Charter's recent earnings release shows that it is just now starting to reap those rewards.
In the quarter, Charter reported revenue growth of 4.6% and EBITDA growth of 3.3% -- figures that were slightly lower than analyst expectations but not by a large amount. When adjusting for the expenses involved in Charter's new start-up mobile phone venture, adjusted EBITDA grew a better-looking 5.4%.
However, the real relevant story for investors is a huge 38% surge in free cash flow, and even better 53% free cash flow growth when excluding start-up capital expenditures for Charter's new mobile offering.
How is Charter achieving such cash flow growth? After acquiring Time Warner Cable and Bright House, Charter invested even further, integrating these huge networks into a uniform, all-digital infrastructure based on DOCSIS 3.1, which is an enhanced coaxial cable standard that enables super-fast download speeds and two-way communication.
Besides technology upgrades, Charter has also upgraded its cable boxes to require fewer truck rolls, which also enables customers to self-install. Additionally, Charter has spent a lot of money insourcing its customer service operations and centralizing these offices, which has also required up-front capex and closing costs. This shift was recently completed.
The completion of all these initiatives has enabled Charter's capex to fall from $2.4 billion in the year-ago quarter to just $1.6 billion last quarter and the trailing 12-month capex to plunge from $9.5 billion to $7.5 billion. Even better, management has guided to just $7 billion in capex for its nonmobile operations for full-year 2019, and on the recent conference call with analysts, management said that it might not even quite get that high.
Now that Charter's integration work is largely behind it, the capex going forward will probably be around these levels and focused more on the line extension side, expanding Charter's network to more buildings. Thus, new capex will likely be more growth oriented, as opposed to the cost-savings side. That could help reaccelerate the company's somewhat tepid growth rate -- although Charter's growth is pretty good for the utility-like broadband industry.
Additionally, the company accelerated its mobile relationships this quarter, adding 208,000 mobile customers, a sequential acceleration over the 176,000 added in the first quarter. That indicates that the incremental spending on the new mobile offering is working.
Charter's pullback looks to be just a pause
Because Charter slightly missed analyst estimates on the revenue side -- mainly due to declines in video and legacy landlines -- its stock sold off after the release. And yet Charter has still had quite a good year, up 35% versus just 19% for the broader market.
Thus, I think the pullback is more of a pause after a pretty big run than anything else. Free cash flow more than $1.1 billion and greater than $1.4 billion (ex-mobile) would annualize to $4.4 billion and $5.6 billion, respectively. With a market capitalization of $85 billion, that translates to just 19 and/or 15 times cash flow.
That's not expensive at all for a relatively stable, utility-like service such as Charter's. Though Charter does incorporate a significant amount of debt at 4.4 times EBITDA, that's a fairly standard ratio in the cable industry. And if interest rates continue to go down, that will not only help the company's interest expense but would also make its "safe haven" business all the more attractive versus bonds.
Furthermore, the mobile phone opportunity is intriguing. Not only will mobile help retain broadband and video customers through attractive bundling, but management expects it to be a meaningful profit driver on its own once it reaches scale. It should also help offset video losses should cord-cutting continue to accelerate.
All in all, Charter is entering an intriguing position as it ends its integration activities and ramps up mobile. With accelerating free cash flow and lower stock price, the post-earnings pullback seems to have produced an attractive entry point.