Charter Communications: The Biggest Winner of the Comcast-Time Warner Cable Deal?

Charter Communications (CHTR -2.79%) has seen substantial changes in its business amid recent industry consolidation. Following the merger of Comcast (CMCSA -5.84%) and Time Warner Cable (NYSE: TWC), Charter will jump ahead from the fourth-largest cable operator in the U.S. to second place.

The company struck financially savvy deals with Comcast and as a result, its video subscriber base will increase substantially. After the merger clears, Charter's own and managed subscriber base will jump from 4.4 million subs to 8.2 million households. The market is already recognizing that Charter stands to benefit significantly from this deal with Comcast, and as a result, Charter is trading at record highs and should reach newer highs.

Customer acquisitions from Comcast
Charter will own 5.7 million video subscribers and manage systems for another 2.5 million subscribers. After Comcast's merger with Time Warner Cable goes through, Comcast will divest roughly 3.9 million video subscribers. Comcast expects that this divestment will reduce its managed subscriber base to less than 30% of total U.S. MVPD subscribers and in the process aid it in getting regulatory approval. 

Charter will buy 1.4 million existing Time Warner Cable subscribers, and this 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 customers and this will make Charter the second-largest cable company in the U.S. The 1.4 million acquired subscribers are expected to generate $1 billion in EBITDA for 2014, and the transaction in which Charter will acquire them from Comcast is being valued at 7.125 times 2014 EBITDA.  

Charter had $14.1 billion of debt on its balance sheet and that will go up to $21.8 billion. This highly leveraged capital structure will translate into potential for robust earnings and cash flow growth due to bigger operating scale. 

Joint venture and customer swaps
In addition to the acquisition of 1.4 million subscribers from Time Warner Cable, Charter and TWC will exchange 1.6 million existing customers in a tax-efficient exchange which will improve the locational presences of both companies substantially and generate many operational efficiency gains. This realignment of Charter's existing cable markets will enable Charter to realize cost efficiencies and drive up profitability. 

Also, Comcast will spin off 2.5 million subscribers under a new publicly traded company (SpinCo), and Comcast's shareholders will receive 67% of the shares of this new SpinCo entity. And Charter will pay for the remaining 33% stake by issuing new shares worth $2.1 billion to SpinCo shareholders. As a result of this issuance, SpinCo shareholders will own 13% of the new Charter holding company that will be in place, and current Charter shareholders will own 87%. SpinCo will have an enterprise value of roughly $14.3 billion comprised of $8.3 billion in newly raised debt and $5.8 billion in equity. Comcast will not have ownership of SpinCo and this entity will be managed by Charter. 

Charter will provide management services to SpinCo for which it will receive 4.25% of SpinCo's total revenue and reimbursement for costs it incurs in regard to SpinCo. And Charter will get three board seats on SpinCo's board, comprised of nine board members, of which the remaining six will be independent directors. SpinCo will operate with financial leverage similar to that of Charter, and a debt to pro forma EBITDA ratio of 5 times. 

The bottom line
After the deal closes and the newly created Multiple System Operator, or MSO, is publicly listed, both Charter and SpinCo will enjoy scale advantages. And many operational efficiencies will be extracted by all parties involved -- Comcast, Charter, and SpinCo. 

Charter and SpinCo will be the market leaders in 10 states in the U.S. And the subscriber swap with Time Warner Cable will translate into significant benefits which will arise from servicing numerous adjacent states. SpinCo will apply Charter's playbook and strategies and this will ramp up the growth profile of SpinCo, and in the process drive sizable benefits for Charter in the long run. In addition, Charter has many NOLs that it can use to shield future income and as a larger company it will see faster utilization of these tax assets. Charter is clearly gaining a lot from the merger between Comcast and Time Warner Cable.