Cable Operators

Hopes Rise as Charter Approaches $2

10/27/2006 8:00 PM Eastern

Charter Communications stock, up about $1 since March, has been flirting with the $2 mark in recent weeks, buoyed by investor expectations the cable operator could be on the verge of a big growth spurt.

Charter is expected to release third-quarter earnings results on Oct. 31. According to a recent report by UBS Securities analyst Aryeh Bourkoff, Charter, which mostly serves secondary markets, is expected to report 9.2% revenue growth ($1.357 billion) and 6% higher cash flow ($459 million) compared with the same period in 2005.

Those numbers are below industry averages of 10% quarterly growth for revenue and cash flow, but Bourkoff believes Charter is getting ready to close the gap.

VOIP RAISES HOPES

Bolstering Bourkoff's enthusiasm: Charter's entrance into the voice-over-Internet Protocol telephony business.

While lagging behind some peers — Charter began its push into telephony last year — the service is now available in 20 markets, including Worcester, Mass.; Madison, Wis.; Los Angeles; St. Louis; and Greenville, S.C. It's expected to be available to 6 million to 8 million of its 12.6-million-home footprint by the end of the year.

Charter stock, once one of the worst performers in the cable sector, has been on a healthy run. It hit $1.99, a 52-week high, on Oct. 23. While it has slipped a bit — it closed at $1.89 on Oct. 25 — the stock is still up about 56.2% (68 cents) since Jan. 3.

That's a far cry from the $20 price it enjoyed in 2001, but the first time it has seriously flirted with $2 in more than a year.

Charter reported about 257,600 VoIP customers at the end of the second quarter, and Bourkoff expects those ranks to grow by another 77,300 in the third quarter to a total of about 335,000 phone customers.

Bourkoff also sees Charter's telephony penetration rising from 3.4% of homes passed in 2006 to 11.8% of homes passed in 2008. That's comparable to high-flying Comcast, which Bourkoff estimates will increase telephone penetration from 5.6% of homes passed in 2006 to 13% of homes passed in 2008.

Other operators, like Cablevision Systems, Time Warner Cable and Comcast, experienced big gains in revenue and cash flow shortly after emerging from the start-up phase in their telephony rollouts.

According to Bourkoff, total cash-flow growth at Cablevision bottomed out at 15.1% in 2005, the second year of its telephony rollout, rising to 17.6% in the third year. At Time Warner, total cash-flow growth increased from 12% in the second year of the rollout to 14.3% in the third year.

CASH FLOW RISING

Bourkoff estimates Charter's total cash-flow growth will rise from an estimated 4.4% in 2006 to 10.3% by 2007, the second year of the telephone rollout, and to 10.7% by 2008.

Bourkoff increased his 12-month price target on Charter stock to $2.50 from $2, based mainly on the promise of telephony rollout.

Bourkoff, who also has a “buy” rating on the stock, apparently feels so strongly about Charter's prospects that he sent a second e-mail message, titled “Charter — Time to Buy the Stock,” to clients about a week after his initial report on Oct. 16.

“We highlighted our buy thesis for the Charter stock last week, but wanted to come back to reinforce it again as we have a strong level of conviction here,” Bourkoff wrote in the Oct. 23 e-mail message.

Bourkoff noted he's the only analyst with a “buy” rating on Charter and added there are risks to buying the shares — mainly Charter's industry-leading debt levels and the chance it might not execute on its VoIP rollout strategy as well as other operators have.

But he also believes the pluses outweigh the minuses.

The theory is that as capital expenditures for the phone rollout begin to decline — beginning in the second year — more revenue from telephone sales will fall to the cash-flow line. Bourkoff estimates Charter's total capex per subscriber will peak at $213 by the fourth quarter of this year, falling to $184 per customer by year-end 2008.

At the same time, average revenue per unit will increase as customers upgrade to higher video and high-speed data packages through the triple-play bundle.

While telephony ARPU is expected to stay flat at around $40 by 2008, total ARPU will rise from an estimates $82.44 per month in the third quarter to $98.21 per month by the end of 2008.

At the same time, annual cash flow per subscriber will grow from an estimated $333 in 2006 to $415 in 2008, according to Bourkoff.

Bourkoff also noted in the Oct. 23 missive that Charter convertible notes, once his top pick in the company's complicated structure, are now trading above par, or face value.

With a conversion price of $2.42 per share for the converts, Bourkoff believes it makes more sense now to own the stock.

He also noted the rise in the price of the convertible notes could be an indication the company is buying in the converts in the belief the stock could rise above the $2.42 conversion price.