Cable Operators

Phone, Financial Gains Bolster Charter

7/20/2007 8:00 PM Eastern

Telephone sales, overall financial improvement and a little bit of takeover speculation are being credited with helping Charter Communications outperform just about every other cable operator stock this year, adding $1.54 to its share price so far this year, a 50.5% gain.

Perhaps even more telling: As of July 18, when it hit $4.64, Charter’s stock price is more than three times above its 52-week low of $1.10.

Why the big gains this year?

Charter had a big run-up in 2006 — rising more than 152%, to $3.02 — but not too long ago analysts were fearful the 5.4 million-subscriber cable operator was teetering on the edge of bankruptcy.

With the highest debt ratio in cable — $19 billion in long-term debt is equal to about 9.4 times annual cash flow — Charter is still burning cash at an alarming rate, about $900 million in 2006 and an estimated $750 million in 2007, Miller Tabak media analyst David Joyce said.

SOURCE: NASDAQ
7/18 $4.64
7/17 $4.67
6/18 $4.13
5/17 $3.56
4/17 $3.30
3/19 $2.93
2/20 $3.19
1/17 $3.48

CITIGROUP UPGRADE

But on June 14, Citigroup media analyst Jason Bazinet upgraded the stock, repeating a “buy” rating but ticking up his 12-month price target to $5.30. Bazinet pointed to Charter’s two consecutive quarters of double-digit cash-flow growth — the first time it has reached that benchmark in four years — and strong performance in telephony sales.

At the end of the first quarter, Charter had about 572,000 phone customers, up about 127,000 since the end of the fourth quarter.

Revenue in the quarter rose 10.7%, to $1.425 billion, and cash flow rose 13.2%, to $496 million.

“Voice net adds now [are] at Cablevision levels (the industry leader) and well ahead of other blue-chip cable firms (like Comcast and Time Warner Cable),” Bazinet wrote in his upgrade report.

Joyce isn’t as surprised about the increase in Charter’s stock price — he has had a “buy” rating and a $5-per-share price target on the shares since May — as he is about the positive turn in investor sentiment.

Joyce had hinted in an earlier report in April the stock could move toward the $5 range, but didn’t pull the trigger on that forecast until May.

In the May report, he showed two different discounted cash flow models for the stock, one that valued Charter at $1.30 and the other at $5.

The difference: the $1.30 model is based on levered free cash flow (which includes debt service) and the $5 model is based on unlevered free cash flow (which does not include the debt).

“As investor sentiment shifted more positively, in terms of putting greater confidence in the long-term viability of the company, that started shifting sentiment toward the $5 version of my models,” Joyce said. “I have been surprised at how quickly investor sentiment has improved.”

Joyce cited two possible factors — improving financial metrics and takeover speculation.

Charter systems in Los Angeles, the Great Lakes region and New England could be the target of acquisitions or swaps with Time Warner Cable and Comcast, each of whom have major systems in those markets.

At last week’s Allen & Co. media summit in Sun Valley, Idaho, Charter chairman Paul Allen opined that further consolidation is inevitable in the cable industry.

His comments were followed by Time Warner Inc. chairman and CEO Richard Parsons, who said the media giant still wants to be a cable consolidator.

Joyce doesn’t see Charter as an attractive candidate to sell out in total: its debt is still too high to make that attractive. But Charter could sell strategic systems, like Los Angeles, in the future.

For the record, Charter has said on several occasions it has no desire to sell its Southern California systems.

Oppenheimer & Co. media analyst Tom Eagan agreed that the strong first-quarter numbers and deal speculation have been the main drivers for the stock price.

“Q1 was one of their best quarters in a long time,” Eagan said. “That certainly helped investors feel good about expectations for the balance of 2007.”

NO FREE CASH YET

While Charter’s financial picture is improving, most analysts don’t expect the company to report positive free cash flow — an important benchmark in the industry — for another three years.

Joyce estimates that Charter won’t be free-cash-flow positive until the fourth quarter of 2010. And to get there, he estimates that Charter would have to pile on nearly $2 billion more in debt to fund growth.

That would put Charter’s total debt level at about $21 billion by 2010, compared to its current $19.4 billion.

But if cash flow continues to grow at a double-digit clip, Charter could actually reduce its leverage ratio from the current level of 9.4 times cash flow to 7.25 times by the end of 2010.

“That’s still not terribly unreasonable,” Joyce said. “But you still need that long-term faith by the credit markets to continue to finance it.”

September