Events: “New Charter” Analysis
May 31, 2015
(“New Charter” pro forma for $100 cash election)
- NASDAQ: CHTR
- Recent PPS: $179.02 (5/29/15 close)
- Shares Out: 346 million
- Market Cap: $61,941
- Net Debt: $61,500
- Enterprise: $123,441
- 2015 EV/EBITDA: 8.9X
- P/FV: 66% ($272 FVPS)
John Malone finally has his target, not two years after his initial indication of interest in TWC. On May 26th, “New Charter” was officially created (pending regulatory clearance, of course) with CHTR announcing a combination with Time Warner Cable (NYSE: TWC) and Bright House Networks (BHN).
The brilliance of this transaction is awe-inspiring. Not only did Malone/CHTR create almost $100 of per share business value over night (Standalone CHTR is worth ~$184; New Charter ~$272), but in less than two years Malone managed to turn a 27.3% economic stake in a $9.59B standalone CHTR into a de facto controlling stake (25% voting; 19% economic) in New Charter, the industry’s second largest cable company worth approximately $61.94B at current prices.
Like VRX in 2014, CHTR now is the epitome of why I love event-driven investing. Transactional confusion is the ultimate “event”: A) it creates an entry point [arguably the most important part of an investment (I say arguably because I could make the case that letting a winner “run” is potentially more important)], and B) there is no waiting for a deal to close, a corporate decision to be made, or a regulatory hurdle to clear – the catalyst comes built-in…
As Carl Icahn likes to say, I look for investments that are “no brainers”. CHTR is a no brainer, and it is as simple as this: the greatest cable operator of all time is nearly doubling his position in CHTR at current prices. No amount of “proprietary” industry due diligence or valuation work beats the margin of safety Malone’s involvement/endorsement provides (though of course, Malone’s investment is not purely valuation driven, as there is intangible value associated with “control”; thus valuation work remains critical). Yet, the market does not get it, as evidenced by the pervasive commentary regarding Malone/CHTR “overpaying” for TWC (see the Economist article: “Malone Wolf”), and the relative weakness in CHTR’s stock price in the face of significant value creation. While I anticipated a sharp move up in CHTR’s stock price on the deal announcement, I am thrilled to have been wrong, as I would love to build a bigger position over time. Fingers crossed for CHTR to trade below $160 on broad market weakness prior to regulatory approval…
In my CHTR FV Update a couple of weeks ago, I concluded New Charter was worth approximately $338. I incorrectly assumed CHTR would be more aggressive with the pro forma balance sheet capacity, letting leverage climb to over 6 times 2014 EBITDA. Given how rapidly New Charter can delever – 2.97 times 2020E EBITDA on growth alone (i.e. assuming no cash accumulation) – frankly I am surprised CHTR is being so conservative keeping leverage below 5X. Large-scale acquisitions are unlikely given the pro forma size of the Company, so perhaps they want to preserve buyback capacity? Maybe a push into the WiFi/mobile space?
Regardless, the lower-than-estimated leverage in combination with a higher-than-anticipated TWC purchase price reduced my New Charter FVPS estimate to $272. The only key input difference is the terminal EBITDAM, which I now assume to be 42% versus 40% previously, as I believe the margin expansion opportunity is significantly higher than the initially-stated $800MM synergy target (per mgmt commentary). Still, I believe 42% is likely too low in the long run, given the shift toward high-margin broadband, the step-down to TWC’s programming rates, and the wide gap between New Charter’s penetration rate and CVC’s (mgmt’s long-term target).
A scenario analysis yields a FVPS range of $196 to $331, with CHTR currently trading for 66% of the base-case, 91% of the worst-case, and 54% of the best-case.
As with my DISH/Charlie Ergen thesis, I believe the market dramatically undervalues the brilliance of Malone due to the “lack” of near- to medium-term certainty. The article above does a good job outlining Malone’s modus operandi:
“When he talks, I listen. And he is a significant talker,” Charter’s chief executive, Thomas M. Rutledge, said in an interview on Tuesday. “I know what he thinks, and he knows what I think.”
“He’s got tremendous confidence of his vision of where this industry should go,” said Jim Nail, an analyst with Forrester Research. “And he is incredibly determined and creative in pursuing that vision.”
“He has a core set of beliefs about where the world is going,” Mr. Bazinet said. “And he’s very patient. He waits for the stars to align.”
“Malone is like an alligator,” Mr. Robichaux said. “He is perfectly content to wait for the right opportunity for a long time, then will pounce with a ferocity that knows no bounds.”