The last 12 months have not been kind to shareholders of Charter Communications (NASDAQ: CHTR). The Connecticut company behind Spectrum Cable has dropped from around $400 per share to today's $300 and change, yet the company keeps on performing. In the latest quarter, sales were up nearly 5%, while EBITDA climbed a bit higher than that, and the company keeps making moves that will enhance long-term value. Here are three reasons that you should love Charter.
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1. John Malone is backing Charter
John Malone is arguably the best investor of all time, taking businesses that he's led to enormous success. For extended periods, Malone has earned investors more than 30% annually. From 1973 to 1998, as the CEO of cable company TCI, Malone generated a 30.3% annual return. Then from 2006 to 2014, during the renaissance of his Liberty empire, Malone again generated 30% annual returns, according to the company. So it's good news when John Malone likes your company.
It's been more than five years since Malone's Liberty empire took a 27.3% stake in the once-beleaguered cable company for $2.6 billion. Following the deal's announcement, the stock hit $100 a share, which seems like a steal at today's prices. Currently Malone's Liberty Broadband (NASDAQ: LBRDA)(NASDAQ: LBRDK) tracking stock owns a 23.3% stake worth about $16.6 billion.
Since then he's run the usual Malone game plan: grow cash flow and aggressively buy back stock using borrowed money. It's the same ongoing leveraged recapitalization that he used at his former cable company, TCI, for years. It's part of the financial engineering that's made him and many of his investors very wealthy. While the increased borrowing does raise risk, Malone and his team have a lot of experience with this model and communicating their plans to investors.
2. The economics of cable are fantastic
While many investors are crying over "cord-cutters" leaving the industry and "cord-nevers" who have never signed on for video services, many are missing the stunning economics of high-speed data, the "other cable." For example, rival Cable One (NYSE: CABO) notes in its annual report that its data and business services units generate EBITDA margins that are four and five times greater, respectively, than its video unit. In other words, the much smaller Cable One can generate margins better than 50% of sales, and it has industry-leading margins.
And Charter has focused exclusively on its cable franchise, rather than diversify into content, as rival Comcast (NASDAQ: CMCSA) has done with its ownership of NBCUniversal. While Comcast's overall EBITDA margins suffer due to the lower-margin content business, Charter's margins have climbed over the past five years as it's reinvested in its cable operation. I expect margins to continue to trend higher over time.
3. CEO Tom Rutledge is incentivized with options
Many investors consider CEO Tom Rutledge the top operator in the cable industry. After more than seven years as COO at Cablevision, now part of Altice USA, Rutledge made the leap to CEO at Charter in 2012. He owns more than $85 million in stock at current prices and stands to hold even more if the stock can reach certain milestones in the coming years.
In early 2016 Rutledge signed a contract that pays him one-fifth of his total options package at various stock prices: approximately $290, $365, $456, $497, and $564. The options entitle him to purchase stock at each level and really become valuable once the stock exceeds those thresholds. Charter has only just recently resurpassed the lowest threshold after dipping below $290. To obtain the maximum value of these options, Rutledge needs the stock to run as high as possible, but certainly above $564 per share, where the last set of options goes "in the money."
Knowing this gives us insight into what the CEO might have been thinking last year when it was revealed that Softbank had reportedly bid $540 a share for Charter. Some have speculated that Rutledge would like to see a company bid over $564 a share, in order to realize the full value of his compensation package. A still-higher price would be even better as his lower-priced options become worth even more. Earlier in 2017, Verizon had bid a reported $350 to $400, a figure that Charter summarily snubbed. With the stock around $320 per share, a buyout at a substantial premium would be a positive.
Value creation continues apace
After aggressive stock repurchases in 2017, many thought Charter was pumping the brakes on buybacks. The company retired 11.5% of its stock last year, but with the decline in shares this year, it ramped up buybacks in the second quarter, after a slowdown in the first quarter. Still, the high levels of 2017 repurchases will likely not continue unless the stock dips significantly from here. In the meantime, Charter will continue to add value by growing its operations. With the stock well off its highs and the subject of much interest from would-be suitors, it's a good time to buy the stock.
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