Value investing can be defined in many ways. It can mean buying stocks at cheap earnings multiples or buying companies with super fast top-line growth that aren't appreciated by other investors. Broadly, value investing is buying something at a discount to the cash it will generate for shareholders in the future. With stocks currently in a bear market, investors now have the opportunity to purchase shares of value stocks at a discount to where they were trading in 2021.
Let's take a look at Charter Communications (CHTR -0.60%), one of the leading broadband internet providers in the United States, as a potential stock for value investors to buy right now.
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What is Charter Communications?
Charter is a leading internet service provider through its broadband infrastructure. It serves over 32 million customers across various geographies in the United States, ranging from individual homes to large businesses. On top of this core internet service, it offers customers cable video subscriptions and mobile phone plans. Almost all of its business goes through its Spectrum internet brand, which you have likely heard of if you live in one of its geographies.
With so many customers, Charter is one of the largest cable companies in the world. Over the last 12 months, it has generated $52.4 billion in revenue. Given the high margins of the broadband internet business, this translated to around $20.9 billion in adjusted EBITDA, or a 40% EBITDA margin. However, with high capital expenditure needs (laying cables in the ground) and high-interest expenses because of its large debt load, Charter's trailing-12-month free cash flow is significantly less than its adjusted EBITDA, at $8.63 billion. Free cash flow is the cash available to pay out to shareholders and is the best metric for investors to value Charter stock.
CHTR Revenue (TTM) data by YCharts
Declining video, growing mobile segments
Charter's broadband internet business is steady, but it has two other segments (video and mobile) that are moving in opposite directions.
As is well established by now, cable video subscribers are declining because of the growth of streaming video, internet-connected TVs, and platforms like YouTube. This is happening to Charter, which lost around 123,000 video subscribers last quarter.
While this is concerning at first glance, investors are well aware of the declining video business and its effect on the cable bundle. Management is operating the business in run-off mode until it goes away over the next decade or so. Plus, with much lower margins because of programming costs to channels like ESPN, the video cable business is less profitable than broadband internet. This should show up in Charter's financials with margins expanding over the coming years.
More exciting is Charter's foray into the mobile wireless internet business. With a deal to operate on Verizon's wireless infrastructure, Charter is now offering Spectrum Mobile across its broadband geographies. The segment added a whopping 357,000 mobile lines last quarter and is growing revenue 40% year over year. Margins are negative right now and will not reach very high levels because of payouts to Verizon, but the segment can be accretive to Charter's business this decade. Plus, the more people who bundle internet and mobile subscriptions under Spectrum, the lower customer churn will likely be.
Is this the perfect value stock?
Not everything is sunshine and rainbows for Charter. There are increasing threats from two different internet services that will look to take market share from Spectrum this decade. Fiber-to-the-home (FTTH) companies like AT&T, Verizon Fios, and plenty of smaller players are building over legacy DSL lines and adding greenfield infrastructure, often directly competing for Charter's existing customers. Big 3 wireless players (AT&T, T-Mobile, Verizon) are also competing with what are called "fixed wireless" offerings that don't require a wired connection to the home, although they only work well in certain situations.
These threats, along with the bear market, are likely why Charter's stock price is down 30% year to date. However, I think these competitive threats are overblown (fixed wireless is not as good a product as broadband, and fiber is only an equivalent service), and shouldn't hurt Charter's internet subscriber base too much, if at all. Plus, with the fast-growing mobile segment, Charter can offer a great bundle for customers that many of its competitors are unable to match.
At an enterprise value of $181 billion, Charter's stock trades at an enterprise value-to-free cash flow (EV/FCF) of 21. This is not an expensive earnings multiple, at least compared to many other stocks right now. With steady internet subscribers, pricing power, a growing mobile business, and a heavy share repurchase program reducing shares outstanding, I think Charter's free cash flow per share can grow at a double-digit rate for many years. In my eyes, that makes the stock a great value pick at these prices.
