Tuesday, May 3, 2016

Cable ONE, Inc. ("CABO") - 60 page Slide Deck [5/3/2016]

I welcome any feedback/criticism.

Link to Slide Deck: Cable ONE, Inc. ("CABO") Slide Deck [5/3/2016]

Brief Summary:

  • Cable ONE is the 10th largest cable company in the U.S. and is most known for their radical strategy change in 2012 whereby they de-emphasized video and telephone (the triple play bundle with broadband) and focused heavily on residential broadband and business services
  • They are often well thought of in the value investing community due to their jargon around "free cash flow" and "margins" and "we are where the puck is heading", as well as attracting a solid Board of Directors with notable investing names such as Tom Gayner (Markel Corp.) and Wally Weitz (Weitz Investments)
  • I would only buy the company if it got cheap enough (low $400s/high $300s) primarily due the likelihood of being an acquisition candidate in the next 1-2 years as the cable industry consolidates; otherwise, there are better investment opportunities in the industry.

7 comments:

  1. Interesting presentation. One point about the bull case that I'm not sure you mention is that low historic penetration may have been caused by a poor product that was not much (if at all) faster than competing DSL. Over time, the much faster speeds available through CableOne will differentiate the product and significantly increase penetration rates. Only time will tell whether that thesis is correct, or whether, as you argue, the lack of a compelling video product will keep potential customers from switching.

    Also, on your valuation overview slide you use TTM EBITDA. Given the significance of the October 2015 price increase, would it be better to use Q4 2015 annualized, which would give you a run-rate EBITDA of around $340-$350 million? Assuming about $450 million in net debt, a market cap of about $2.7 billion and $350 million in EBITDA, you get EV/EBITDA of 9, rather than 10. Incremental high-speed internet revenue should be very high margin relative to the video revenue it's replacing, so EBITDA/FCF should grow faster than revenue growth. Whether that happens depends on whether the high-margin incremental internet revenue actually arrives.

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    Replies
    1. You are correct; the run-rate EBITDA for TTM is understated based on the October 2015 10% HSD pricing increase. To each his own, I am more skeptical on their strategy, and believe their markets are a tad more price-sensitive than others. I found it discouraging that they raised HSD rates 10%, which was the first price increase in 4-5 years. They justified it by stating they have reinvested a lot and doubled the speeds to 100 mbps. All true, but the product should be a necessity (less a commodity) and pricing shouldn't have to be justified by doing such large measures. At 100 mbps, are they going to increase base speeds even more to try to increase prices? This shouldn't be necessary; instead, just increase prices!

      Cable ONE's speeds are ALREADY a huge differentiator in all of their markets; in most it's not even close, on a cost-per-mbps and on absolute speeds. Given this, why are they barely growing subscriber count? If you have a better answer, please share.

      I'm neither short nor long CABO, and likely won't be either. I prefer purchasing solid companies that can operate on their own at a decent level, and hopefully increase value over time. I'm less convinced CABO can do this; or they will, but it may take a lot more "cord cutting" to get to this point. I won't short CABO as I truly believe they are a high takeover candidate.

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    2. My first comment wasn't clear. I understand part of the bull case to be that, historically, CableOne's speeds haven't been much faster than competing DSL, which may explain the low historic internet penetration rate. The recent CapEx has significantly increased the speed CABO offers, so it has now become much different. But it will take time for people to switch to the higher speed, both because of inertia and because having the higher speeds will become more important over time as data demands increase. That is the portion of the bull case as I understand it. I don't have enough knowledge about CABO's historical speed relative to its peers to evaluate whether the thesis is valid.

      I believe they've grown residential HSD PSUs at around 2% per year over the last few years. I agree that doesn't sound too compelling. But what is the annual free cash flow growth if PSUs go up by 2% per year, ARPU goes up by 2-3% per year (though it may be lumpy, with some years seeing 5% and some years seeing none), and the incremental revenue being very high margin?

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    3. In some of their main markets (see slide deck for top 5 markets) CABO has had very little broadband speed competition for a few years. In some markets, the speeds are a little more comparable, although not close to the 100 mbps. For example, in CABO's top market (Treasure Valley, ID/ Boise) they have been offering 50 mbps for $35+/- since mid-2013. This is not dissimilar from CABO's other markets as well. Thus, there has been ample time (almost 3 years) from them to increase HSD subscriber growth numbers, as they have been superior not just as of recent.

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    4. Thanks for the information. I think that weighs against the bull thesis (at least as I understand that thesis). I appreciate your work on this.

      Regarding your view that CABO's lack of scale in video makes its video offering much worse that the industry-wide presentation slides suggest, have you looked into some of the smaller telecom providers that are aggressively expanding their video offerings through fiber expansions, such as Hawaiian Telecom and Cincinnati Bell? It's odd that these companies, which have fewer video subscribers than CABO, seem to think that they can make money on video while CABO thinks its unprofitable. Perhaps the reason is that their customers are willing to pay more for video than CABO's.

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