Overall, I think that cable companies are extremely well positioned going forward. The value of the information carried over their pipes will naturally get better due to better content on the Internet, Internet TV getting better, and illegal downloading getting better. Going forward, I think that video content will be increasingly higher quality and cost less. This will give cable companies more pricing power. The cable companies that may do the best are the ones that can raise prices without fear of competition.
Right now, Charter is in the early innings of a turnaround. If Charter can ultimately achieve $450 in EBITDA per video passing, then it can eventually be a double or a triple (see “What is Charter worth? How undervalued is it?” in my post on the Liberty Broadband spinoff).
Rutledge has intentionally positioned Charter into areas with little competition from fiber (e.g. Verizon Fios) and high-speed DSL (AT&T U-Verse). If the TWC-Comcast merger succeeds, then Charter will swap subscribers with the new company. While the investor presentations regarding the merger talk about subscribers, I think that Rutledge cares more about home passings. A cable system with low penetration has more upside than another cable system with high penetration and the same number of subscribers.
Charter will likely end up with most of what Rutledge considers to be the most desirable home passings. Then, Comcast will spin out cable systems into Greatland (a new spinco entity). Greatland will hold subscribers that aren’t as desirable to Rutledge. Charter will issue shares to take a stake in Greatland. It will also receive a contract to manage Greatland’s operations. This allows Charter to enjoy the benefits of scale when purchasing programming and capital expenditures. In the somewhat distant future, Greatland may not be able to raise prices as much as Charter due to higher competition in its footprint.
Malone seems very happy with the proposed deal between Charter, TWC, and Comcast. From a transcript of the 2014 investor day:
<Q>: [Inaudible] (02:04:27). If the Comcast deal works great for any reason, would you resume your pursuit of Time Warner Cable Inc (NYSE:TWC)?
A – John Malone: But that said, we’re totally happy with the deal has been negotiated and in many ways, and I’m speaking now from a Liberty Broadband perspective. We’re perfectly happy with the deal has been negotiated and in many ways from our point of view, it’s a better deal than going after a 100% of the deal.
In terms of pricing power, Charter should be able to raise prices until too many consumers complain and regulators step in (regulators have done so in the past). Because of its footprint, Charter will not see that much competition from fiber and high-speed DSL. Rutledge stated at a conference (transcript):
FiOS is about 4% of our network, and AT&T [U-Verse] is less than 30%
Cable companies have small growth opportunities in offering Internet to businesses and in providing Wifi infrastructure (so that smartphone users can access Wifi away from home).
All in all, Charter is in my opinion the most attractive cable company right now.
- Malone’s cable strategy
- Liberty Broadband spin-off
- Transcript of Charter’s presentation at a Deutsche Bank conference
Liberty Broadband consists mostly of Charter stock. It also owns TruePosition and debt, which will throw off tax losses. I think that Malone may eventually sell shares of Time Warner Cable. The capital gains tax on such sales would be offset with the tax losses from TruePosition and interest on the debt.
Why Malone doesn’t like Time Warner’s management
Time Warner’s merger with AOL during the Dot-Bomb era turned out to be a bad idea. During that time period, Malone sold call options against his stake in Time Warner. Some of those call options were embedded in convertible debt that ended up in Liberty Interactive and subsequently Liberty Ventures.
Since then, Time Warner decided to spin-off its cable assets into Time Warner Cable (TWC). Malone states in a Nov 2014 CNBC interview:
[…] having a history in the business I never would have done that.
Combined, Time Warner could have used its cable assets to support its cable channels and content businesses (e.g. HBO/HBOGo). The content business is all about scale. Having a captive cable company helps upstart content businesses (e.g. various channels that HBO is trying to start) achieve scale.
Unlike America, some foreign countries have “open access” Internet. The cable companies and telcos are forced to open up their networks to competing ISPs. This limits the long-term potential of the cable companies. I think that all cable companies will lose some video services revenues as customers replace those services with Internet TV services. Unfortunately, open access Internet will limit the price increases on the Internet side. Because of the limited upside, I don’t think that open access markets will see much competition from fiber (except in newly-built residences).
Germany for example is an open access market. Liberty Global’s UPC in Germany has low market share and happens to be one of Liberty’s faster growing markets. The Q3 2013 investor presentation states 5% revenue growth year-over-year.
Management-wise, I think that Charter has better management than Liberty Global. Global customers complain about the disaster that is the Horizon box (see this bitchfest on Reddit). I have a feeling that Global will continue with its strategy of sticking with the Horizon box. Charter does not receive nearly as much negativity about its set-top box. Global is trying to start an over-the-top service called My Prime. Users generally give the service bad reviews.
Historically, Liberty Global has seen most of its growth from turning around poorly-managed cable assets and opportunistically buying assets cheap. There may be mild strategic synergy between Discovery and Global since Malone can encourage Global to carry Discovery’s channels (helping Discovery achieve scale). I see a brighter future ahead for Charter than Discovery due to better management at Charter. Because Malone has a higher percentage of his net worth in Liberty Broadband than in Liberty Global, it is possible that his best cable company ideas will go into Broadband rather than Global. If Charter/Broadband and Global were to ever merge, it is possible that Broadband shareholders will get the better deal.
They make money in wireless. Then they allocate capital poorly everywhere else. They overpaid for DLR / Digital Realty (unfortunately I was short DLR). Malone rags on Verizon because they invest in fiber to the home at very low rates of return.
Discovery Communications (DISCA/B/K)
In the past, Discovery was about documentaries and learning interesting things about the world. Over the past several years, Discovery has been
selling itself out re-inventing itself in the quest for ratings. It noticed that its competitors (e.g. History) were getting strong viewership for scripted/fake documentaries. So Discovery also started doing “docudramas”. It noticed that SyFy was getting good ratings for programs designed to appeal to the crowd that wants to believe in the supernatural, Sasquatch, etc. etc. So, Discovery started airing fake documentaries about mermaids and how 50-ton sharks exist today. Most of Discovery’s primetime slots are devoted to reality television. Sometimes American reality television does not work well internationally due to cultural differences. David Zaslav’s investor presentations state that most of Discovery’s content works well internationally (which is probably true for daytime but less true for primetime); his claims are slightly misleading.
John Hendrick’s book about the company he founded (A Curious Discovery) talks about the importance of branding. The book largely whitewashes what Discovery has turned into. That being said, Discovery has demonstrated excellent growth in revenues and free cash flow. It has a number of new cable channels that are losing money and to some degree obscuring Discovery’s true earnings. The Oprah Winfrey Network and Discovery Family are carried on Discovery’s books as unconsolidated joint ventures. They are near breakeven and on the cusp of turning into profitable channels. If you think that they will turn into highly profitable channels, then there is some hidden value that isn’t obvious on Discovery’s balance sheets.
Like Global, Discovery also buys poorly-managed assets at low prices. Discovery paid $264M for a stake in Eurosport, a second-tier sports network. Discovery and Liberty Global teamed up to buy All3Media, a production company. The main value in a production company is in the back library of content. Discovery can use that content on its various channels. Global can use that content to jumpstart its over-the-top service (though I think that My Prime will fail). The people who work at a production company are extremely important. Unfortunately they can leave and start their own production companies. I think of the acquisition mainly as an acquisition of a small content library (with a mediocre production company attached to it).
In the long term, I’m not sure how badly Internet TV will disrupt traditional content companies. Sports and live programming may not be affected that much. Discovery has made efforts to move into both of those areas (e.g. it is trying to do more live programming such as Nik Wallenda’s tightrope walk stunts). Other areas may see declines in viewership. What piracy did to the music industry could happen to the video industry. Musicians moved away from selling content to consumers and towards alternative business models (concerts). In general, I’m not a fan of messing around with ‘melting ice cube’ type businesses. If earnings shrink (even if they shrink slowly), there is not much upside in the stock. Discovery could potentially grow its earnings for a long time simply due to great management navigating the changes in the industry. It’s just that I’m not smart enough to figure out what will happen.
Discovery has little leverage especially compared to other John Malone companies. It has issued a lot of low-risk 30-year debt at very low interest rates. The proceeds have gone to buy back shares.
World Wrestling Entertainment (WWE)
Management is bad. If management changes, this could become an attractive turnaround opportunity. I think that WWE will do quite well in an Internet TV world. By going direct to its consumers with its over-the-top WWE Network, WWE can avoid giving a cut of its profits to intermediaries. However, WWE Network has had terrible execution.
Management is excellent. They are great at running the business and very transparent with shareholders. They also understand the concept of buying low and selling high. In the past, Netflix started buying back some shares when the valuation was a little low. Now that the current valuation is a little rich, insiders have been selling down some of their personal stakes. Perhaps they have some fear that they will not be able to buy old content so cheap now that competition is flooding into the over-the-top game. Higher content prices will hurt their competitiveness and potentially their margins. I think that Netflix recognizes that (A) there will only be a handful of mainstream over-the-top services that survive and (B) they need to reach a global scale to survive. The companies with a global scale (broadcast networks, major movie studios, HBO) will have a massive advantage in content costs.
Netflix will be really interesting if the company were to buy back shares again.
*Disclsoure: Long LBRDA.
EDIT: I am not chasing these stocks on the way up.