Altice USA Presents Huge Uncertainty as Its Turnaround Progresses

Director

Michael Hodel

Altice USA has struggled to maintain revenue growth recently—more than cable peers Comcast and Charter—as it battles stiff competition from Verizon in the New York market. It has broken from its peers with plans to aggressively upgrade its networks with fiber rather than rely on traditional cable network technology. This strategy will sharply curtail free cash flow over the next few years. Still, we expect the firm’s networks will remain vital pieces of infrastructure that will generate strong, albeit slow-growing, cash flow over the long term. 

Around 60% of Altice’s business is in the New York metro area, where favorable demographics have historically enabled the firm to claim high customer penetration rates and revenue per customer. The market is also far more competitive than average, though, as Altice faces competition from Verizon’s Fios network across more than half the territory. After a period of neglect, Verizon has shifted its attention back to Fios recently as part of a broader corporate restructuring, causing Altice to lose customers. But Altice is upgrading its network in Fios areas to fiber, eliminating any network advantage Verizon enjoys. 

The rest of Altice’s territory covers mostly smaller markets and rural areas where demographics aren’t as favorable but competition is also more limited. Customer penetration and revenue per customer were both below average before Altice acquired the operation and we believe these areas still provide some growth potential. Altice recently announced plans to extend fiber to some of these markets as well, a potentially unnecessary move, in our view. 

Like its cable peers, Altice has used its network advantage to steadily increase data speeds in recent years and claim more than half the internet access market in the territories it serves, providing a solid foundation for the business. If anything, the pressure Altice has already faced in New York and the smaller markets it serves elsewhere should limit incremental competition relative to that which other cable firms will face as AT&T and other phone companies ramp up their own fiber network construction.

Business Strategy & Outlook

We believe Altice USA possesses a narrow moat based on efficient scale and a cost advantage versus most of its rivals, offset in part by the competitive challenges it faces in the densely populated New York City market. 

The vast majority of U.S. homes today can receive fixed-line internet access service from only two providers: the traditional cable or phone company. The cost to enter this market is enormous. While technological developments have made it possible to build more efficient and reliable networks than legacy providers possess, deploying these technologies still requires heavy construction outlays, while also overcoming the regulatory hurdles that municipalities often impose. Assuming successful network construction, entrants then face steep customer acquisition costs and startup losses as they attempt to gain share with a modestly differentiated product in a rapidly maturing market. Several firms have attempted to enter the fixed-line market over the years, but failures far outnumber successes. Most notably, Alphabet sharply curtailed its Google Fiber plans in 2016 after six years of effort ended with likely less than 1% of the U.S. connected, despite the firm’s deep pockets. 

Cable networks across the U.S. were built in a highly fragmented manner largely during the 1980s. Once built, these networks have generally provided a cost-effective platform for owners to steadily invest in upgrades to enable new service offerings. The costliest upgrade in the industry’s history, primarily undertaken in the late 1990s and early 2000s, involved the shift to a hybrid fiber-coax network architecture, a move that has paid handsome dividends since. This architecture, coupled with steady advances in technology, has enabled cable companies to repeatedly add network capacity at modest incremental cost. Most recently, firms have deployed DOCSIS 3.1 technology, enabling gigabit speeds without significantly increasing capital spending budgets. 

By contrast, the fixed-line phone companies are typically incapable of increasing network speeds broadly across their networks without heavy investment to bring fiber closer to customers. As a result, large swaths of the phone network remain incapable of delivering the speeds beyond around 20 megabits/second or so, increasingly falling short of customer demand. In those areas where phone companies have made the investment to build fiber-to-the-home networks, these firms offer services that are as good or better than the cable companies. 

While less than half of the phone networks across the U.S. have been upgraded with FTTH, Altice USA faces extensive fiber competition in its Cablevision unit, which serves the New York market and accounts for about 60% of the business. Verizon’s Fios fiber network competes across about 55% of this footprint. In our view, the high cost to deploy Fios and the difficulty of rapidly gaining market share has prevented Verizon from pricing the service aggressively. Fios customer growth has stagnated in recent years as Verizon’s focus has shifted primarily to wireless, allowing Cablevision to hold customer penetration relatively stable at around 55%-60% of homes passed, in line with or modestly better than most cable peers. 

Rather than rely on the efficiency of the hybrid fiber-coax network used across the industry, Altice has chosen to rebuild its network in New York with FTTH. The firm’s view is that this move is necessary to compete over the long term in this market. Also, Altice Europe has experience deploying FTTH in densely populated markets, and management believes it can construct its U.S. network extremely efficiently, with minimal change in its historical capital spending budget. We agree that New York likely can be built relatively cheaply and technology costs have come down, but the potential return on this investment is still questionable in our view. On the positive side, the firm’s FTTH effort has started slowly, allowing the firm time to adjust its plans if needed. As of the end of 2020, the firm had passed only about 1 million homes with fiber, less than 20% of the Cablevision footprint. In addition, Altice is using its legacy cable network to support wireless small cells in the Northeast for T-Mobile. 

In the Suddenlink portion of Altice’s business, AT&T is the most significant competitor, as Verizon did not build Fios in any of these markets. In addition, all the areas where Verizon competed with Suddenlink have been sold off to Frontier, a much smaller, cash-strapped firm that ended up in bankruptcy. AT&T’s more advanced fixed-line network, dubbed U-verse, remains inferior to cable in most places. Because the Suddenlink territory covers smaller cities and towns, AT&T hasn’t invested heavily in its networks in these markets, with U-verse likely available in around 10% of the Suddenlink territory. 

Despite the relatively benign competitive position, the economics of the Suddenlink business aren’t dramatically different than the typical cable operator. Demographically, customers in Suddenlink markets tend to spend less on telecom services, as seen in customer penetration rates that are similar to other cable companies. Also, the costs to build and operate networks in less densely populated areas are generally higher than in urban areas. 

Looking at Altice as a whole, the firm stacks up very well versus its phone competitors. About 56% of the homes and businesses in its footprint subscribe to at least one service. As Altice increases its share of total customer telecom spending in a given neighborhood, we expect it will be able to further outspend rivals on network maintenance and upgrades while gaining operating cost efficiencies. In other words, we believe the phone companies will logically respond to the efficient scale attributes of the fixed-line telecom business, and milk uncompetitive networks for cash rather than reinvest aggressively, especially in less densely populated areas where they can’t leverage this investment to serve wireless or enterprise customers. 

We also expect AT&T and Verizon will increasingly turn to fixed-wireless internet access as 5G wireless technologies emerge to close the gap with the cable companies, but we’re skeptical that fixed wireless will challenge traditional internet access offerings on a broad scale anytime soon. We are especially skeptical of fixed 5G in a market like New York, where population and building density will likely hurt the quality and reliability of the technology relative to fixed-line alternatives. We expect 5G will provide incremental capacity to meet growing mobile wireless demands, but serving in-home needs is a challenge, an order of magnitude larger. The typical wireless customer uses around 5-10 GB of data per month while Altice reports that its average internet access subscriber uses more than 450 GB, a figure that continues to grow rapidly. However, we do believe that traditional 5G networks could prove effective at serving less densely populated markets, such as those common in parts of Suddenlink’s territory. 

We expect Altice and its cable peers will have a role to play in the wireless business over the longer term. Altice has access to the nationwide T-Mobile network under a wholesale agreement and began offering wireless service to its customers during 2019. While Altice’s relatively small size likely precludes it from making a huge splash in the wireless business, its deep fiber networks make the partnership model an attractive option. 

The biggest knock against Altice, in our view, is that it generates subpar returns on invested capital today. In part, this poor performance stems from the prices it paid to put the firm together. The Optimum and Suddenlink deals have left nearly $25 billion of intangible assets on Altice USA’s balance sheet, mostly composed of goodwill and franchise rights, which are functionally the same as goodwill. These assets compare to only about $6 billion of actual net network and other equipment assets. If we include intangibles in the capital base, we calculate a return on invested capital of around 8% currently. Without intangibles, Altice’s return on capital, per our calculation, comes in at about 28%. By contrast, wide-moat-rated Comcast’s cable business produces a 10% return with all intangibles included in the capital base and about 40% without.

Narrow

Economic Moat

Altice USA

Altice USA, Inc. engages in the provision of broadband, pay television, telephony services, proprietary content, and advertising services. Its brands include Optimum, Suddenlink, Optimum Mobile, Altice Business, News 12 Networks, Cheddar News, a4 Advertising, and i24 News. The company was founded by Patrick Drahi in 2001 and is headquartered in Long Island City, NY.

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