It has been about five months since I outlined the valuation disconnect between the two leading consumer telecommunications providers in the United States in a post entitled Is the Enthusiasm for Charter Communications Getting Overdone? Charter (CHTR) and Comcast (CMCSA) together provide nearly half of the country's households with cable, broadband, and phone service. A lot has happened since then, so I thought it would be interesting to revisit the situation.
It turns out that my post last August roughly marked the short-term peak, and shares have fallen about 30% since:
Whereas the shares near $400 seemed very overpriced compared with the likes of Comcast (11.5x EV/EBITDA vs 8.6x), they now appear closer to fair value at around 8.8x my 2018 EBITDA estimate. Comcast has also hit a rough patch in terms of stock performance, on the heels of its bid for UK's Sky Plc, which would further entrench them into the pay television world. While CHTR has fallen 30%, CMCSA has dropped 20%, and now fetches $32 per share, or just 7x my estimate of 2018 EBITDA.
In my mind, Comcast looks very cheap and Charter appears to be reasonably priced, without factoring in any upside they could see from increasing prices on broadband services (they are priced well below Comcast currently), or from their upcoming cellular phone service offering, which promises to look very similar to Comcast's recently launched and fast-growing Xfinity Mobile service.
My wife recently switched from Sprint to Xfinity Mobile and is paying $12 for every 1 GB of data usage, with no additional charges other than the phone payment itself. Having switched to Google Fi from Sprint earlier this year, I had planned on adding her to my plan upon the termination of her contract, but Xfinity Mobile is actually an even better deal because Google Fi pairs a $15 plan charge along with a $10 per GB data rate. You can add family members for just $10 more )rather than another $15), but it would have cost $20 to add my wife to my plan, whereas Xfinity charges just $12.
With such a compelling price (using Verizon's network), it is no wonder that Comcast last quarter added more post-paid mobile subscribers than AT&T and Verizon combined. Charter is set to launch a similar service later this year, also using Verizon's network (pricing not yet available), and I would suspect they will see quite a bit of traction at that point. In fact, with Comcast and Charter in attack mode, it is easier to see why Spring and T-Mobile might think they can get regulators to bless their merger. The big cable companies, along with Google, are truly strong competitors in the marketplace.
And there is the constant merger talk involving Charter, whether they be the buyer or the target. Talks with Verizon and Sprint supposedly did not progress too far last year, but as a large triple play operator without a dedicated mobile or content business, it is not hard to understand why Charter could continue to be a player in the M&A market (thus far they have simply rolled up a bunch of regional cable companies).
Simply put, Comcast would fetch $40 per share if it just traded at 15 times annual free cash flow, and they have a fairly diverse business as it stands, even without buying Sky. Investors are worried about them overpaying in the M&A world, but the current price seems to account for those fears already. And with Charter stock now trading at a fair price, the risk-reward appears very favorable given that they have optionality in terms of their mobile offering, broadband pricing, and continued M&A activity. For the intermediate to longer term, I do not see material downside for either stock, and 20% gains would not surprise me.
Investors should also take a look at T-Mobile, now that they are going to try to get a Sprint deal done officially. The stock initially bounced well above $60 on the news, but has faded back into the mid 50's. They are performing best in the mobile world right now and the stock is not expensive. It looks like it could be a case of "heads, we win" (continued strong operating performance going at it alone, and "tails we win big" (the deal with Sprint has massive synergies) situation.
Full Disclosure: Certain clients of PCM were long CHTR, GOOG, TMUS, VZ, and Sprint debt at the time of writing, but positions may change at any time without notice