Value investing can be defined in many ways. This can mean buying stocks at cheap earnings multiples or buying companies with very fast revenue growth that are not liked by other investors. Generally speaking, 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 buy value stocks at a price lower than where they were trading in 2021.
Let’s take a look at Charter Communications (CHTR 0.27%)a leading broadband internet provider in the United States, as a potential buy-now stock for value investors.
What is the Communications Charter?
Charter is a leading internet service provider thanks to its broadband infrastructure. It serves more than 32 million customers in various geographies in the United States, ranging from individuals to large enterprises. In addition to this basic Internet service, it offers its customers cable video subscriptions and mobile phone plans. Almost all of its business runs through its Spectrum Internet brand, which you’ve probably 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. In the past 12 months, it generated $52.4 billion in revenue. Given the high margins in the broadband Internet business, this translated to approximately $20.9 billion in adjusted EBITDA, or an EBITDA margin of 40%. However, with high capital expenditure requirements (laying cables in the ground) and high interest charges due to its high level of debt, Charter’s free cash flow over the last 12 months is significantly lower than its Adjusted EBITDA, at $8.63 billion. Free cash flow is the money available to pay out to shareholders and is the best measure by which investors value Charter’s stock.
Decline in video, growth in mobile segments
Charter’s broadband internet business is stable, but it has two other segments (video and mobile) that are moving in opposite directions.
As is now well established, cable video subscribers are declining due to the growth of streaming video, Internet-connected TVs, and platforms like YouTube. That’s what’s happening to Charter, which lost about 123,000 video subscribers last quarter.
While this is concerning at first glance, investors are well aware of the decline in video business and its effect on the wiring harness. Management operates the business in run-off mode until it disappears over the next decade. Additionally, with much lower margins due to the programming costs of channels like ESPN, the video cable business is less profitable than broadband internet. This should show up in Charter’s financial statements with expanding margins over the next few years.
More exciting is Charter’s foray into mobile wireless internet. With an agreement to operate Verizonof its wireless infrastructure, Charter now offers Spectrum Mobile in all of its broadband geographies. The segment added 357,000 mobile lines last quarter and increased revenue by 40% year-over-year. Margins are negative right now and won’t reach very high levels due to payments to Verizon, but the segment may be accretive to Charter’s business this decade. Additionally, the more people who bundle internet and mobile subscriptions under Spectrum, the lower the churn rate is likely to be.
Is this the perfect value stock?
All is not sunshine and rainbows for Charter. There are more and more threats from two different Internet services that will seek to take market share from Spectrum during this decade. Fiber-to-the-home (FTTH) companies such as AT&T, Verizon Fios, and many smaller players are building on legacy DSL lines and adding new infrastructure, often in direct competition for existing Charter customers. The 3 major wireless players (AT&T, T-MobileVerizon) also compete with so-called “fixed wireless” offerings that don’t require a wired connection at home, although they only work well in certain situations.
These threats, along with the bear market, are likely the reason Charter’s share price is down 30% year-to-date. However, I think these competitive threats are overstated (fixed wireless isn’t as good a product as broadband, and fiber is just an equivalent service), and shouldn’t hurt the base too much. Charter Internet subscribers, if at all. Additionally, with the rapidly growing mobile segment, Charter can offer an excellent package for customers that many of its competitors cannot match.
With an enterprise value of $181 billion, Charter shares trade at an enterprise value to free cash flow (EV/FCF) ratio of 21. That’s not an expensive earnings multiple, from less compared to many other stocks currently. With stable Internet subscribers, pricing power, growing mobile business and a significant share buyback program reducing outstanding shares, I believe Charter’s free cash flow per share can grow at a rate of two figures for many years. In my eyes, this makes the stock a great value pick at these prices.