Cable Operators

Northern Exposure

How GCI tamed the Alaskan telecom wilderness, with a little help from its (cable cowboy) friends 7/10/2017 8:00 AM Eastern
GCI co-founder and CEO started the MSO in 1979, selling long-distance telephone service from his Volkswagen van.

Launched from a small apartment in a section of downtown Anchorage known as Bootlegger’s Cove in 1979, General Communication Inc. has grown from a three-person operation that advertised its services on the side of a beat-up Volkswagen van to become Alaska’s premier telecom, broadband, cable and wireless provider, with 2,300 employees and a dominant position in one of the harshest markets in the country.

Now, with a $1.1 billion buyout pending from Liberty Interactive — headed by one of GCI’s early backers, cable cowboy John Malone — the company has come full circle. (Malone’s Tele-Communications Inc. was the initial backer of GCI in 1979, before it was spun out about a decade later.) Armed with a more deep-pocketed patron and a stronger deal currency, GCI is focusing on streamlining its operations as it looks toward a future that could see it finally extending its reach to the lower 48 states. For these reasons and more, GCI is the Multichannel News 2017 Independent Operator of the Year.

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The typically complicated Liberty deal — GCI will first be acquired by Liberty Interactive and then spun out into Liberty Ventures, which will be renamed GCI Liberty — could return GCI to acquisition mode after that transaction is completed, likely by the first quarter of 2018. In a conference call announcing the deal in April, Liberty CEO Greg Maffei, who will become CEO of GCI Liberty after the deal closes, said anything is possible.

The Liberty transaction comes as GCI battles a declining Alaskan economy: The once-rich oil and gas business has lost thousands of jobs as oil prices have plummeted. In May, the latest figure available, the unemployment rate in the state was the highest in the country at 6.7%, according to the U.S. Bureau of Labor Statistics.

Analysts point to the economy as the greatest concern for GCI investors. With a $4 billion state deficit there is potential for a drop in government spending, which could affect GCI telecom sales. And while there is the danger of outmigration as oil-field workers follow jobs to other states, the Liberty deal, coupled with GCI’s strong management, should help it weather the storm.

“We still view GCI as well-managed and well-positioned to weather the Alaska recession, and view the Liberty transaction positively,” Drexel Hamilton media analyst Barry Sine wrote in a research note.

SunTrust Robinson Humphrey fixed income group senior cable and media analyst Michael Kerrane agreed, adding that GCI’s experience in the wireless business also could be a factor.

“Clearly, both [Liberty Broadband-controlled] Charter [Communications] and Liberty have wireless ambitions, and GCI’s knowledge base in offering the quad play could be helpful to Liberty,” Kerrane said in an email message, adding that, operationally, GCI could see some efficiencies in purchasing.

“We’ve seen other examples of this like Midcontinent Communications, which is 50%-owned by Comcast,” Kerrane wrote. “We estimate that Midcontinent saves about $15 million per year in content acquisition costs because of its association with Comcast. On the flip side, Liberty intends to use a portion of GCI’s free cash flow to fund stock buybacks.”

Liberty’s Vote of Confidence
Liberty is paying a hefty premium for GCI — its offer price of $32.50 was 58.1% above GCI’s close of $20.56 on April 3, the day before the announcement. The stock has since traded above the deal price, at $36.81 on June 28.

But in an April research note, Pivotal Research Group CEO and senior media and communications analyst Jeff Wlodarczak noted that the deal price represented about a 8.6 times multiple to GCI’s expected 2107 cash flow, in line with other recent deals. And he added that it is likely that Liberty will eventually pair GCI with its other cable holding — Charter.

In a note to clients after the deal was announced, Wlodarczak said the transaction “sets the stage long-term for a logical deal with Liberty Broadband and, inevitably, Charter.” Wlodarczak liked GCI’s cash-flow growth potential as a near monopoly in Alaska, a position that could allow Liberty to be more aggressive on both the share repurchase and M&A front.

There is no impediment to eventually merging GCI with its Liberty Broadband unit — which holds Liberty’s interest in Charter Communications — or even with Charter down the road, Maffei said. But for now, the focus will be on internal growth and tuck-in acquisitions.

“On the side of acquisitions, we are very much focused on return of capital; that’s not to say we would not be looking at acquisitions in the lower 48,” Maffei said. “But I would note that GCI has a long history of tuck-in acquisitions in Alaska, and there are further opportunities ahead. I think that would probably be the first place that we’re focused, without foreclosing any other opportunities.”

GCI had looked beyond Alaska’s borders for cable targets in the past — in 2002, it was one of the bidders for AT&T Broadband properties in Montana, Wyoming and Colorado with 340,000 subscribers, which were ultimately won by Bresnan Communications. GCI has toyed with the idea of crossing back into the lower 48 since, but was turned off by high system valuations.

“We had spent the past several years looking at diversification opportunities and ways to expand our footprint beyond Alaska,” GCI co-founder and CEO Ron Duncan said on the call. “We were intimidated by relatively high values in the lower 48 cable segment.”

Duncan, who will remain GCI CEO after the Liberty deal closes, added that GCI has purchased cable systems in Alaska in the past and there are probably one or two more opportunities left within the state.

“Right now, the bulk of our growth can come within the state of Alaska, and we will look to Greg’s [Maffei] guidance as to what other opportunities might appear,” Duncan said on the call.

But for the next two to three years, most of GCI’s energies will be focused on streamlining its operations. The company is in the middle of switching to a common billing platform and simplifying its wireless network.

“We built the company very rapidly, deploying a tremendous amount of assets over the last 10 years,” Duncan said on the call.

GCI got into the wireless business initially through acquisition, he noted, expanding that business through partnerships with other providers and by building on its own. But that strategy has led to a network that is patched together with multiple technologies.

GCI first offered a wireless product in 2004, reselling Dobson Communications service in the state. The company subsequently made several acquisitions to boost its wireless presence — including the communications operations of United Utilities Inc (UUI) in 2007, which opened up mobile service in rural Alaska. In 2012, GCI partnered with Alaska Communications System (ACS) to build out a wireless network, dubbed the Alaska Wireless Network (AWN), to meet anticipated competition from Verizon Communications. Three years after forming the partnership, GCI bought out ACS’s portion of AWN for $300 million. Today, GCI has about 222,000 wireless customers across the state.

Providing that connectivity throughout the state has been a guiding principle for GCI since its inception, senior vice president of consumer services Paul Landes said in an interview.

“In lots and lots of remote locations, we are the only provider in that community. If you go to Bethel, we’re it,” Landes said, speaking of a small city in western Alaska accessible only by river and air. “People in smaller communities have the same wants and needs that people in larger communities do.”

But bringing that connectivity required the company to stitch together different technologies and networks to provide service.

“We may be the only wireless company in the country that operates every single wireless technology in existence,” Duncan said. “We’re now phasing down to a single network, rationalizing all of that on LTE technology and simplifying the network going forward.”

On the billing side, GCI is phasing out a 20-year legacy billing platform and is reorganizing its business structure from a series of separate silos to a system that is organized around a common set of technologies including wireless, software-defined networks and smart technology throughout its network.

“We see lots of opportunity to streamline the way we do business,” Duncan said. “Our success in the marketplace led us to grow very fast. Now we are taking the opportunity to clean up. There will be continued revenue growth; it won’t be as strong as the revenue growth in the past, but I think the EBITDA growth will pick up over the next several years as we implement our streamlined measures, simplify the company and reform our processes.”

An Alaska Gold Rush
The current strategy is a natural evolution from GCI’s humble beginnings, when former NASA engineer Bob Walp met an ambitious Harvard Business School graduate in 1979. Duncan had come up north in 1977 at the behest of friends he met in grad school, living in North Pole, Alaska, while he tried to start a cable company in nearby Fairbanks. The two joined up in 1979, forming GCI initially as a competitor to long-distance provider Alascom. Walp, who died in January at 89, had long been a proponent of introducing competition into the Alaskan phone market using satellite technology. He came to Alaska shortly after completing a satellite communications project for NASA in Brazil, traveling to that country’s climatic opposite to head up a satellite educational project in Anchorage.

Walp later served as director of Alaska’s Office of Telecommunications, and started GCI after funding for that division dried up in 1978. Walp set his sights on creating a competitor to Alascom, but he wasn’t just focused on long distance. His ultimate vision was a satellite-based network that would provide data communications, telephone, facsimile and computer connectivity to all Alaskans. In the end, GCI prevailed, but it wasn’t easy.

A second mortgage on Walp’s family home in Pasadena, Calif., provided some needed capital, as did an investment from cable legend John Malone’s TCI. GCI was actually a subsidiary of TCI, then the largest cable operator in the U.S., until it was spun off on its own in 1986.

“This would be a very different place if he hadn’t come to Alaska,” Duncan said in a video tribute to Walp.

Healthy Growth in Wild Country
According to its financial statements, GCI has outpaced its larger peers in revenue and cash-flow growth despite being the most sparsely populated state in the union. In the past 10 years (2007-2016), GCI has grown revenue at a 6% annual clip. That compares to Comcast’s annual revenue growth rate of 5.5% over the past 10 years. “We definitely saw upside in GCI’s operations,” Maffei said on the call.

And GCI has managed to turn in that growth without any major population centers. Alaska is the largest state in the U.S. by area — 570,641 square miles — yet has a population of just 741,841, according to the U.S. Census Bureau, making it the third least populous state behind Vermont and Wyoming. Alaska has the lowest population density of the 50 states (1.2 people per square mile, according to the Census Bureau), well behind New Jersey, the densest state, with nearly 1,200 people per square mile.

Most of Alaska’s population is centered in its cities — half of the state’s residents reside in Anchorage — and despite their low numbers, residents are hungry for video, telephone and broadband services. Broadband, which GCI first introduced in 1998, now accounts for 60% of revenue and GCI has more high-speed data customers (140,000) than video customers (106,100) a milestone it first reached in 2014. The company is winding down an ambitious $300 million broadband hybrid fiber-microwave project dubbed Terrestrial for Every Rural Region in Alaska, or TERRA, which will bring state-of-the art broadband service to more than 80 Alaskan communities.

GCI has grown revenue in every year of its existence save for one, 2016, and that decline was largely due to a wireless roaming agreement that reduced revenue by about $50 million. The company has said it expects to return to its past growth rates — when revenue and cash flow were up by double-digit percentages — in 2017 and beyond.

“We’re very bullish about our ability to grow our EBITDA both back to where it was prior to that and well beyond over the next several years,” Duncan said on the call.

A key to that growth appears to be GCI’s ongoing reorganization.

“Our path to growth for both EBITDA and free cash flow is one of rationalizing our organization and our network,” Duncan said on the call. “We’ve put together a large collection of different technologies in a race to grow the company over the last 20 years, and we are now going to streamline that and extract efficiencies by simplifying the network, simplifying our operations, implementing a new billing system and increasing the margins.

“Today, our margins are on the low end of what the industry does, in the low 30s. We think there is lots of room for margin growth,” he added. “Our capital intensity is declining, so there is an opportunity for free cash flow growth.”

With the TERRA project winding down, capital expenditures are expected to decline dramatically for GCI, after a big bump (10%) from $176 million in 2015 to $194 million in 2016. Current guidance is for 2017 capex of about $165 million, which should help boost free cash flow for share repurchases. Cash flow, down 12.7% to $288 million in 2016, is expected to rise to between $300 million and $325 million in 2017. Cash-flow margins, which dipped to 31% in 2016 from 35% in the prior year, are also expected to return to their past form.

On the conference call, Maffei said the reorganization will go a long way to setting GCI on the path to margin improvement.

Maffei said Liberty was confident GCI could increase those margins “because they have been in a series of businesses which were created relatively on a silo basis and find synergies across those businesses and operate the company more consistently as they move from the growth phase to a phase where they are looking for efficiencies and substantially increase their cash flow and margins over the next three to five years.”

And it continues to have strong margin businesses.

Broadband makes up about 60% of GCI’s total revenue — it has about 140,000 broadband customers compared to 106,100 video subscribers. Data revenue in the first quarter was $114.2 million, up 6.8% from $106.9 million in the prior year. Video revenue in Q1 was $29.1 million, compared to $33.4 million in the prior year.

Like other small cable operators, GCI has found the video business “problematic,” Duncan said on the call. The company has pushed back on high programming costs — it was one of several small operators that dropped AMC Networks in 2016 in the middle of a carriage dispute with the National Cable Television Cooperative, an industry buying group. When the NCTC reached a more favorable agreement later in the year, GCI and others kept the channels off their systems.

Circling Back to Telecom
Kerrane added that most small cable operators are de-emphasizing video in favor of high-margin broadband, something that Duncan hinted toward on the April conference call. And now with Malone’s Liberty back in the picture, GCI has come full circle, focusing yet again on its telecom roots.

“We have a tremendous broadband business, probably one of the best broadband businesses in the country,” Duncan said. “We see continued growth and opportunity there. We’re really bullish. We’ve got an internal plan that shows strong growth, we’ve promised Greg [Maffei] that we’ll deliver it and I have little doubt that we will perform.”

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