Selling Charter
A quick update as I sold most of my Charter stock after the most recent earnings. Overall loss of ~25%.
I sold most of my CHTR 0.00%↑ position after earnings (still hold a very small amount but I’m basically out). I’ll get into all reasons why I’ve changed my mind so quickly, but it’s never fun to admit defeat and then sell for a loss (~25% overall). It’s also painful because I think this can still work, but the high leverage means I’m unwilling to hold/wait, given the current operational performance and industry trends. The risk is not worth the reward anymore imho.
The key reasons I’m selling:
Comcast’s negative broadband connects during a seasonal tailwind point to larger structural headwinds.
FWA is increasingly showing it’s an acceptable option for a significant portion of the population.
Margins aren’t expanding as video rolls off (key part of my original thesis).
Management.
Comcast
Comcast’s broadband connects are a good proxy for overall cable performance as they are less promotional than Charter, and they don’t have the rural build tailwind. Q3 has historically been a good period for broadband activity as students head back to college, but Charter’s CEO made the following comment in the Q3 2023 cc:
“The core markets, I think similar to what you've heard probably from others, both in the second quarter as well as third quarter, the back-to-school dynamics, both at disconnect in Q2 and at reconnect in Q3, has not gotten back to where it was several years ago. Some of that could tie into the low end of the market where you have some incremental fixed wireless access.”
What I take from this comment is that the seasonal tailwind has disappeared due to a significant amount of college kids choosing FWA? The tailwind is still there (kids are back in person), it’s just not helping cable anymore. Charter also disclosed higher MDU churn in Q4 2022:
“But when some pricing actions were taken in December, we saw for the first time a very limited impact on our voluntary churn, but not where you would have expected it. It's actually in our non-gig overlap and in our MDU footprint where you have higher churn to customers, higher tendency to move around, higher tendency to non-pay.”
These comments, coupled with T-Mobile and Verizon’s FWA connections, make it difficult to come to any conclusion other than FWA is getting traction on college campuses and apartment complexes (price sensitive customers where word of mouth spreads quickly). This is in addition to solid momentum in rural areas, where DSL or satellite might be the only option.
FWA
I think the overall success of FWA has surprised everyone (outside of maybe T-Mobile). My position has been that an internet connection is one of the most important pieces of a home, and most people/families would be unwilling to risk a less consistent connection (no wire to the home) to save ~$10-15 a month.
I think there’s a few things I underappreciated. The first is people don’t just see it as $150 saved. They see it as escaping a cable company that’s been selling them an overpriced video product for years, and even though the standalone internet offer is good value ($2-3 a day for the rails a home runs on), they just don’t want the legacy cableco. This might not be fair, cable doesn’t make much from video anymore, but this appears to be the reality for more people than I thought.
Next, even though there’s a limit to how many homes FWA can service due to capacity limitations and prioritizing mobile data (wireless carriers core product), the number appears to be at least 15mm homes (over the medium-term), which more than replaces the current number of DSL connections; there were ~15mm DSL/VDSL homes in Q1 2022 (less now).
This means cable likely contributes share over the next few years:
Slowdown of internet adoption tailwind (industry growth moving closer to household growth).
FWA will take an outsized share of both price sensitive and rural customers.
Fiber is going to grind towards 30-40% share on their overbuilds.
DSL’s continued declines won’t be enough to offset the above.
We can argue if Comcast’s or Charter’s strategy is better (grow ARPU or fight to keep growing customers with promos), but the point remains that cablecos will be pressured as fiber builds penetration and FWA picks off customers that fit their profile (I also think FWA’s ability to offer home broadband with less buildout requirements makes cables’ classic defensive response less effective as well).
Margins
One of the big parts of my original Charter thesis (~Q2 2022) was video disconnects were going to be good for Ebitda margins. A reasonable estimate for Ebitda margins for video is ~10-15%. Revenue was going to be pressured as video rolled off, but broadband would grow enough to keep total revenue growing slowly and Ebitda would grow faster than revenue (as video mix decreased). This hasn’t happened.
First, inflation forced them to reset compensation for employees, increasing their costs to serve. Management expects to start lapping these in 2024, so this should switch to a tailwind going forward.
Second, they’ve pushed promotions to help keep connect growth positive. The main promotion is SpectrumOne, an offer of internet and a mobile line for ~$50 for the first year (basically a free line). This has pressured ARPU, which is essentially flat since Q2 2022. Also, heighted mobile additions has meant increased device sales (also hurts margins).
Lastly, rural builds and D4.0, while mostly tied to capex, have increased admin costs as they build 1000s of miles of new network and start to upgrade their legacy equipment.
I don’t think these are bad investments for the most part, and I think margins probably start to grow over the next year or so, but it needs to be acknowledged given it was a key part of my thesis. The fact margins haven’t expanded points to more intense competition (they would have passed through costs increases if they could). I think fiber competition is following historical patterns, so again, I think the margin pressures come from more intense FWA competition.
Management
This isn’t really my reason for selling, management communication hasn’t really changed over the past year, and their levered buyback strategy is explicit (you can take it or leave it). The $100 a passing rollout for D4.0 is lower than the market originally anticipated, and the aggressive rollout of D4.0 makes sense (the risk is moving too slow), even if the announcement and investor day were suspiciously timed. But I’m seeing certain comments that remind me of the fiber overbuilders I’ve been critical of in the past (from Q3 cc):
“For the full year 2023, we now expect capital expenditures to total approximately $11.2 billion. Capital expenditures, excluding line extensions, should total approximately $7.2 billion, higher than our previous expectation. The increase reflects additional Xumo CPE purchases and an acceleration of network spend related to future high split markets, including inventory accumulation and other preparation activities like walk-out and design and proactive equipment swap-outs of both DTAs and MPEG2 boxes.”
This is usually how it starts “we’re spending a little extra capex for supply purposes, building inventory!”, then it moves to “we’re experiencing some inflationary pressure but nothing major”. Next we get “you can’t just look at the number of passings to capex spend (which is nowhere near communicated cost per passing), the costs are front-end weighted!”, and finishes when management stops disclosing as the upgrades slow/end (way over budget), or a new management team steps in to pick up the pieces.
As a rule I’m very skeptical when management claims they “voluntarily” exceeded capex targets they communicated to the market. From previous jobs, I’ve seen management teams go to extreme lengths to hit targets, so building inventory supply for any reason other than an increase in demand is a big red flag for me.
The tracking stock comment I’m going to put down (speculating here) to the CFO having lunch with Dr. Malone the week before and talking cable cowboys type ideas. I’d be excited after talking financial engineering with Dr. Malone(!), but I have no idea why a tracking stock for ~2% of your passings would make any sense. The $9k per passing comment has been picked up by fiber bulls as evidence of management being delusional; as I’ve said in the past, I don’t think comparing a rural RDOF passing to a competitive fiber overbuild is particularly relevant, but the comments make it sound like Charter management thinks their stock is undervalued because their rural builds aren’t getting valued appropriately? I don’t think that’s the case, it’s the least of their problems, the issue is the market has priced in increased competition from both fiber and FWA. The stock will rocket if they can answer that question.
Summary
I sold on Friday and Monday but wanted to get something out reasonably quick (for the few of you that read I felt it was the least I could do). I do plan on writing more about it and I’m not against jumping back in if things change. It’s the leverage that’s made me get out so quickly; if you run ~4.5x, I think you need to move fast if fundamental operating performance starts showing signs of weakness (you can’t give the benefit of the doubt - e.g., Disney issue during the quarter). It is also starting to feel like the management needs to thread the needle to make this work. It’s possible, I just think the risk is becoming too big compared to the potential reward.
Matt,
I came across your writings on Charter and the industry a few months ago and was impressed with the depth of coverage and your rationale for owning Charter. I am an owner of Liberty Broadband (therefore an owner of Charter) since early 2023. We shared (past tense since your opinion has changed) a similar investment thesis, however I still believe an investment in Liberty Broadband is a very attractive investment.
Much of my thesis rests in the outlook that Charter will continue to be a significant free cash flow generator in the years to come and will return the capital back to its owners (required to deliver cash to Liberty Broadband via the stockholders agreement). Normalized free cash flow yields at Liberty Broadband are 15% currently.
Additionally, I think the company has modest growth drivers coming from RDOF, state grants, and eventually BEAD at attractive rates of return given the government subsidy as well as growth in mobile. I don't view mobile as significant value driver for my investment but Charter will finally be getting paid a fee for a service it has been providing for free historically (wifi to smart phones in the home and business). Again, I believe these are modest growth drivers for cash flow somewhere in the mid-single digits.
I am surprised to see you change your mind for the reasons you provided. Sure FWA will be a competitor and limit the growth opportunity for Charter, but I don't think it will have a material impact on Charter's cash generation. Given the low price I am paying, I feel appropriately compensated for this factor. On margins, they are in a very healthy place to start with and I believe will improve with added EBITDA from the growth drivers I noted above. Charter's cost structure provides a lot of operating leverage. Again, I am willing to be patient on this front and let it play out over the next 2-3 years as I am already being compensated with double digit free cash flow yield. The rural build penetration rates are very encouraging on this front. Lastly, I believe Charter has a very sound Board that has set the company up well from a leadership standpoint. John Malone, Tom Rutledge, and Greg Maffei really know what they are doing.
I'd love to have a conversation to understand your rationale on a deeper level. Does a little bit higher capex, or a little more competition from FWA kill my investment thesis on a long-term basis? The market has already decided these are obstacles for the business, but I think its been overdone from a price standpoint which creates the opportunity today.
Thanks,
Connor
Good note. I am somewhat in the same camp as you. That said, I think you might want to wait a few quarters before judging yourself right or wrong on the margin issue. Price increases about to flow through as will the roll off of Spectrum One. What happens then? I'm watching churn (as are others).
I sold as well because if you look at the new passings relative to net adds the numbers get pretty bad in 4q21 and continue. Lack of existing home sales + FWA entry makes the analysis tough for me to pinpoint a reason this is happening. End of the day the core plant is getting less dense (so it seems). That is a real potential issue for a company running a unit driven strategy.
Appreciate you sharing. Good stuff.
-Bill