Charter: Better Days Are Ahead

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Bankruptcy behind it - along with about half of its former debt load - Charter Communications is striding toward what has been unfamiliar territory for the fourth-largest U.S. cable operator: Growth.

When it was the most highly leveraged company in cable - with a debt-to-cash flow ratio of about 10 times - Charter had to tread cautiously.

Now, with a stronger balance sheet - a 5 times leverage ratio and positive free cash flow of $135 million in the third quarter alone - Charter can focus (and spend) on new products and services.

St. Louis-based Charter emerged from a bankruptcy reorganization on Nov. 30, 2009, having shaved about $8 billion of debt and pumping in $3 billion in new equity.

"If you think about the narrow margin for error with that type of leverage, it doesn't give you a lot of wiggle room," CEO Mike Lovett said. "We feel like we've done all the right things to get through that phase successfully. And the things that we've done were with the thought in mind that we would get through that phase successfully: to come out on the other end, as we have this year, in a position to be much more competitive and much more aggressive."

Charter has accelerated its rollout of DOCSIS 3.0 technology, stepped up switched digital video deployment and is closing the gap in digital and telephone-service penetration. About 35% of Charter's footprint is DOCSIS 3.0-enabled (growing to 50% by yearend); 44% of the footprint is switched digital (expected to grow to 60% by the end of the year); and digital and phone penetration has reached 75% and 16%, respectively.

Miler Tabak media analyst David Joyce, who has a "buy" rating on Charter, said with its newly solid balance sheet, Charter is finally able to join its peers and target businesses with data and communications products.

"They've really stuck to their knitting," Joyce said.

Commercial revenue should reach about $500 million this year (up 12% from $446 million last year) and free cash flow should top about $665 million in 2010, compared to a $552 million free-cash-flow deficit in 2009, Joyce figured.

Charter estimates the addressable spend for small and medium-sized businesses in its footprint at about $5.5 billion a year.

Add on an estimated $3 billion in carrier and cellular-backhaul opportunities, and the market for commercial services balloons to about $8.5 billion.

Lovett believes Charter is uniquely positioned on the commercial side because it faces less competition from the major phone companies in this segment.

"Being in Tier 2 and rural markets serves us well from two aspects: [regional Bell operating company] video overbuild is lower than a lot of our industry peers and there is less of a competitive aspect between the existing [local- exchange carrier] and the commercial space," he said.

Charter's footprint is decidedly more rural than some of the other publicly traded MSOs. Financially, Charter has managed to keep up with its peers. In the third quarter, revenue was up 4.6%, to $1.8 billion and operating cash flow rose 4.5%, to $632 million, in line with expectations.

Charter lost about 64,000 basic customers in the period, in keeping with trends throughout the industry.

Lovett and company are gaining ground with non-video customers - those who take phone and/or high-speed data, but not video service. Charter was an early adopter in targeting non-video customers (primarily those who already have satellite TV) and in the third quarter about 564,000 customers were nonvideo.

"We've got [more than] 500,000 nonvideo relationships," Lovett said. "We see the 12 million homes we pass as an opportunity."

Charter executive vice president and chief marketing officer Ted Schremp pointed to Charter's home-networking product, which has about 19% penetration of data customers. Penetration is even higher with new customers - about one-third of new connects take the service, for which Charter charges about $10 per month.

The rise of devices in the home - such as iPads, iPhones and high-defi nition DVRs - have put home networks almost on equal footing with faster download speeds, in terms of consumer demand.

Charter has been subject to intense speculation regarding the possibility of its selling or swapping large swaths of its footprint. While Charter has made some smaller deals - such as selling about 65,000 customers to Cobridge Communications in October - Lovett said has no interest in shrinking.

"Scale counts," Lovett said. "We are happy with the size we are today." Charter would consider growing through acquisitions, further investing in commercial services and even making some nontraditional acquisitions, as Comcast did earlier this year by buying a competitive local-exchange carrier, he said.

"It's a luxury we have today that we certainly didn't have in the last phase," Lovett said.

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