Finance

Charter Flight

Op Soars to No. 4 With $10B Bright House Buy. Who’s Next? 4/06/2015 8:00 AM Eastern

When Tom Rutledge became CEO of Charter Communications in late 2011, he annunciated a clear vision of his goals, which centered around his vow for broadband: Be the fastest.

 

With the proposed purchase of Bright House Networks for $10.4 billion last week, he’s now not only one of the fastest — he’s one of the biggest.

 

Rutledge and Charter have spent that past three years upgrading plant, boosting HD channel capacity, raising highspeed data service speeds and repackaging video offerings in an attempt to hold on to and grow the operator’s 4.2 million-strong subscriber base.

 

“We have invested in our plant, our products, our service and our employees,” Rutledge said after announcing the Bright House deal. “Today, we are all-digital; we offer minimum Internet speeds that are some of the fastest in the country; we offer more high-definition channels than do our satellite competitors, all at highly attractive prices, and the results are showing.”

 

RETURN ON INVESTMENT

 

Charter has spent about $560 million on upgrades and rebuilds since 2012, and the results have been strong, according to its financial statements. It added 3,000 residential video customers in the fourth quarter and finished the year with 4.3 million video subscribers, down slightly from the 4.34 million in the prior year.

 

Rutledge has applied to Charter the same principles he applied at his past two jobs: Better customer service, aggressive pricing and even more aggressive packaging. As chief operating officer of Cablevision Systems, he helped introduce the first $90 triple-play package of video, voice and data; before that, as Time Warner Cable’s president, he helped run some of the Bright House systems Charter is now buying. At TWC, he also helped usher in such innovations as the Full Service Network, the precursor for video-on-demand and interactive TV.

 

At Charter, Rutledge has focused on high-speed data. As soon as Charter markets went all-digital, the Stamford, Conn.-based MSO immediately ratcheted up minimum broadband speeds to 60 Megabits per second. In some Charter markets, the minimum data speed is 100 Mbps, compared with 15 Mbps for the rest of the industry. And Rutledge said he believes speeds can be even faster.

 

“By going all-digital and investing in all-digital and clearing out our networks and taking full advantage of the capacity of our networks, we can actually add that capacity into the broadband network and take speeds up dramatically at relatively low cost on a per box or per customer basis,” Rutledge said. “We will take our networks and use the networks as well as they can be used by making them all-digital.

 

“There are digital technologies coming down the line in DOCSIS — DOCSIS 3.1 — which actually take the capacity that we already have and make it even greater,” he added. “That’s a bigger investment in the long run, but still relatively small because you are not rebuilding plant.”

 

The $10.4 billion purchase of Bright House Networks will add 2.5 million quality cable subscribers to Charter’s rolls. When coupled with the customers Charter will gain in a series of swaps, sales and spinoffs related to Comcast’s pending acquisition of Time Warner Cable, the mid-market Charter will vault into a solid second place among U.S. cable operators and No. 4 among all domestic pay TV distributors, with about 10.1 million owned or serviced customers.

 

SCALING UP

 

That could go a long way toward easing Charter’s programming cost burden. With the Bright House deal, Charter crosses the 10 million-subscriber threshold, approaching Time Warner Cable’s current customer tally of 10.8 million subscribers. It was an irony not lost on Rutledge.

 

“And while it’s not assumed by us, as we now go over 10 million video customers and by programming for 10 million plus video customers, we are kind of in the shoes of where Time Warner was proportionally in the rest of the industry and we had not really assumed that kind of product pricing in our modeling, but it should be available to us over time if we are good negotiators and take advantage of our scale,” Rutledge said.

 

The deal also gives a vote of confidence to the much-maligned Comcast-Time Warner Cable merger — both Charter deals are contingent on that larger transaction closing. And Rutledge added last week that by removing 2 million video customers (and 1.9 million highspeed data subscribers) from TWC, his deal could make it easier for the Federal Communications Commission to approve the larger deal. Opponents of the $67 billion Comcast-TWC marriage have objected to the combined company’s dominance over the broadband market.

 

With Bright House, Charter gains markets outside its customary footprint, with Tampa and Orlando, Fla., systems, as well as markets adjacent to its existing properties, with smaller systems in Detroit; Birmingham, Ala.; Bakersfield, Calif.; and Indianapolis.

 

When Rutledge first joined Charter, the strategy was to build scale organically, not through acquisition. Armed with a stronger balance sheet — a 2009 bankruptcy erased about $8 billion in debt and pumped $3 billion in new equity into the company — Charter finally had the financial wherewithal to invest in its plant and equipment to grow the business.

 

In a 2012 interview with Multichannel News, Rutledge said the new capital structure removed the obstacles to growth.

 

“I do think the capital structure makes a huge difference, because it doesn’t handicap management,” Rutledge said at the time. “Management can do what it needs to do to be successful; it can spend money where it needs to spend money and it can spend money to make money. That wasn’t always the case in the past.”

 

When Liberty Media and cable legend John Malone invested $2.6 billion for a 27% interest in Charter in 2012, the MSO’s growth path shifted toward acquisitions. After a run at Time Warner Cable that ended with Comcast winning the prize, Charter managed to wrangle a consolation prize that could effectively add 3 million owned and serviced customers to its rolls — purchasing about 1.4 million subscribers, swapping systems with about 1.6 million customers and by taking a 33% interest in a spinoff entity called GreatLand Connections with 2.5 million customers, which Charter will manage.

 

Now, with the Bright House deal, Charter will get a new largest individual shareholder in Advance/Newhouse; its 26.3% stake will outstrip Liberty’s 19.4% equity interest (it will have equal voting footing with A/N at about 25%). And it gains breathing room to pursue further acquisitions.

 

“The macro trends in the cable business point towards an increasingly greater need for scale — from acquiring programming, to product development, to an increasingly centralized operational approach — which is driving smaller operators to look to get larger and/or exit,” Morgan Stanley cable analyst Ben Swinburne said in a recent research note. “Charter is benefiting from this trend as the natural acquirer for operators serving much of the mid- and smaller-sized footprint in the U.S.”

 

Pivotal Research Group principal and senior media & communications analyst Jeff Wlodarczak, who recently raised his 12-month price target on Charter to $230 per share from $215 per share, believes the time is right for the operator to start its consolidation binge.

 

DOMINO EFFECT

 

“I think this starts the dominos falling, and Charter consolidates most of the rest of the U.S. cable industry,” Wlodarczak said. “But they may want to wait a bit to consolidate these two fairly big deals, likely until sometime in 2016.”

 

Charter certainly has the currency in a robust stock — its shares were up 8%, or about $10 per share, after the Bright House announcement to $193.11 each — and ample debt capacity, as it will have about $6 billion in available credit lines after the Bright House deal.

 

There is a line of candidates for possible consolidation. In a note to clients Wlodarczak named four: Suddenlink Communications (private), Mediacom Communications (private), Cable One (planned to be spun off from Graham Holdings as a separate public company this year) and Cablevision Systems (public), with the latter possibly involved in a later system swap with Comcast.

 

Charter also is expected to eventually acquire the remaining two-thirds of Great- Land Connections, the publicly traded entity that will be spun off as part of the Comcast- Time Warner Cable deal. Greatland will have about 2.5 million customers and will be 33% owned by Charter once it is spun off.

 

A potentially harsher regulatory environment also could spur consolidation, especially among smaller operators. FCC chairman Tom Wheeler’s moves to regulate cable companies as common carriers could be the final straw for some smaller MSOs. Some pointed toward the last big sea change in the regulatory environment that caused some operators to seek larger suitors— the 1992 Cable Act, which set pricing parameters for cable service.

 

“It’s forcing people to ask themselves, ‘Is there a place for me going forward?’” said one executive in the cable financial community that asked not to be named.

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