Charter's Wireless Efforts Will Be Tested Over the Coming Quarters

Director

Michael Hodel

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We generally like Charter’s efforts to drive customer penetration by limiting price increases, improving customer service, and expanding its offerings to appeal to a variety of preferences. However, we aren’t enamored with the extremely heavy discount on broadband and wireless services that its Spectrum One offer provides. We believe this type of promotion tends to attract disloyal customers while also diminishing the value of these services in consumers’ minds. Still, we believe the firm is positioned to remain a dominant broadband provider and produce stable cash flow.

Charter’s cable networks have provided a significant competitive advantage versus its primary competitors—phone companies like AT&T—as high-quality internet access has become a staple utility. We estimate the firm now claims about 70% of the internet access market across the territories it serves, up about 7 percentage points over the past five years. Charter has been able to upgrade its network to meet consumer demand for faster speeds at modest incremental cost while the phone companies have ignored their networks across big chunks of the country. Phone companies, notably AT&T, have increased fiber network investment, which we expect will limit Charter’s ability to grow as fast as it has over the past few years. However, we believe Charter will remain a strong competitor even when faced with improved rival networks and that competition will remain rational.

Wireless technology has emerged as a potential new competitor to fixed-line internet access. We’re skeptical of wireless’ ability to meet network capacity on a wide scale for the foreseeable future. Also, we expect dense fixed-line networks like Charter’s could play an increasingly important role in powering wireless networks in the future. Charter also faces declining demand for traditional television services, but here again we don’t believe investors should be concerned. The amount of profit the firm earns from television service has been declining for several years.

Business Strategy & Outlook

We believe Charter possesses a narrow moat based on efficient scale and a cost advantage versus most of its rivals, offset in part by the challenges to returns on capital that have come with the 2016 acquisitions that formed the company. 

The vast majority of U.S. homes today receive fixed-line internet access service from only two providers: the traditional cable and 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 the 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 the failures outnumber the 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 have provided a cost-effective platform 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 steadily add network capacity at modest incremental cost. Most recently, firms have deployed DOCSIS 3.1 technology, enabling gigabit speeds without significantly increasing capital spending as a percentage of sales. Charter claims the cost to deploy DOCSIS 3.1 totaled $9 per home passed, or about $450 million (1% of annual sales) to upgrade its entire footprint. The next iteration of DOCSIS technology will be more expensive to deploy—Charter estimates around $100 per location—but this still remains far below the cost of fiber deployment. 

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. Charter claims that fiber-to-the-premises is available only to around 40% of its network footprint, meaning the phone networks across most of its service territory remain incapable of delivering speeds much beyond around 20 megabits/second, increasingly falling short of customer demand. 

Several phone companies are increasing network investment, most notably AT&T. Under new leadership, AT&T started to invest in fiber expansion again in 2021, but its FTTH network only reaches about 22 million customer locations throughout its territory, only about one third of the total AT&T footprint. The firm recently curtailed its core fiber expansion initiative somewhat, though it formed a venture with BlackRock to build FTTH to 1.5 million new locations. Charter has reported only a modest increase in the number of markets where it faces strong competition from AT&T, claiming that this rival can offer internet access speeds of at least 25 Mbps across 35% of the Charter footprint at the end of 2022, up from 33% two years before.

Charter’s superior network position, coupled with management’s preference to keep pricing relatively low, has enabled it to steadily take market share. Since the Charter/TWC/Bright House merger closed in early 2016, Charter has handily outperformed its cable peers in terms of market share gained. Nearly 58% of the homes and businesses in Charter’s footprint subscribe to at least one service from the firm. Internet access penetration sits at 55%, up from 48% five years prior. Phone companies like AT&T, Verizon, and Lumen have seen internet access penetration levels decline over this period from around 27% in aggregate to less than 23%, with only Verizon holding steady around 30% thanks to its high proportion of FiOS FTTP customers. 

We also expect the major wireless carriers will increasingly push fixed-wireless internet access to generate a new revenue streams and potentially replace older fixed-line phone networks. T-Mobile and Verizon have taken an early lead in this effort. While these efforts bear careful watching, we’re skeptical that fixed wireless will challenge traditional internet access offerings on a broad scale anytime soon. 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 10 GB of data per month while Charter has reported that its average broadband-only subscriber consume around 650 GB. As consumers connect more devices in the home and stream higher-quality video content, we expect demand for superior capacity and reliability will only increase. 

We further expect Charter and its cable peers will have a role to play in the wireless business over the longer term. Comcast and Charter have formed a wireless partnership that leverages each firm’s agreement with Verizon Wireless for wholesale capacity. The firms have collectively built millions of Wi-Fi hotspots across their footprints and are experimenting with other technologies to offload traffic and use Verizon’s network only when needed. At a minimum, we expect the cable firms’ wireless efforts to provide an option to go after this business more aggressively if the wireless carriers move into the fixed-wireless broadband market more aggressively than we expect. 

The biggest knock against Charter, in our view, is that despite its qualitative similarity to Comcast’s cable business, the firm generates woeful returns on invested capital today. In part, this poor performance stems from the high prices it paid to put the firm together. The TWC and Bright House deals placed more than $100 billion of intangible assets on Charter’s balance sheet, mostly composed of goodwill and franchise rights, which are functionally the same as goodwill. If we include intangibles in the capital base, we calculate a return on invested capital for Charter of around 7.5% currently. Even without intangibles, Charter’s return on capital, per our calculation, isn’t stellar at around 20%. By contrast, we estimate Comcast’s cable business produces a 10% return with all intangibles included in the capital base and about 25% without, including capital used to acquire the underperforming Sky business. 

Comcast’s pricing position and operational maturity show up in margins, with cable EBITDA averaging nearly 43% of cable revenue over the past three years versus about 39% at Charter, a gap that is likely explained largely by differentials in pricing. We believe Charter has more runway to increase prices over the next decade than its cable peers. Higher pricing coupled with strong customer penetration should produce strongly improving returns on capital over the next several years. Still, with returns on capital that are subpar today, the challenges that come with raising prices, and the potential for regulatory and technological change, we don’t have adequate confidence in Charter’s ability to maintain excess returns over the long term to award a wide economic moat.

Narrow

Economic Moat

Charter Communications

Time Warner as an American cable television company. Prior to its purchasing by Charter Communications on May 18, 2016, it was ranked the second largest cable company in the United States by revenue behind only Comcast, operating in 29 states

Time Warner

Bright House Netowrks was an American telecom company. It was the tenth-largest multichannel video service provider and the 6th largest cable internet provider (based on coverage) in the United States. The company served more than 2.2 million customers. Bright House Networks' primary service offerings included digital television, high-speed internet, home security and automation and voice services

Bright House

Charter Communications, Inc. engages in the provision of broadband communications services. Its services include Spectrum TV, Spectrum Internet, and Spectrum Voice. The firm offers business-to-business Internet access, data networking, business telephone, video and music entertainment services, and wireless backhaul. Its advertising sales division, Spectrum Reach, offers local, regional, and national businesses the opportunity to advertise in individual and multiple service areas on cable television networks and advanced advertising platforms. The company was founded in 1993 and is headquartered in Stamford, CT.

Earnings data Q1 2024

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STAMFORD, Conn. , Nov. 28, 2023 /PRNewswire/ -- Charter Communications, Inc. (NASDAQ: CHTR) (along with its subsidiaries, "Charter") today announced that Jessica Fischer, Chief Financial Officer, will participate in the UBS Global Media and Communications Conference in New York, New York on Tuesday, December 5, 2023.

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