Charter Communications: Turnaround Seen Underway

Citigroup’s Jason Bazinet Friday repeated his Buy recommendation on Charter Communications (CHTR), and increased his price target on the cable systems operator to $5.30 from $4.35.

Controlled by Microsoft (MSFT) co-founder Paul Allen, Charter is a highly leveraged company that for a long time was largely ignored by many investors as too indebted to be considered a viable equity investment. But that view has changed.

Bazinet writes Friday that “Charter has just about everything working for it.” He notes that the company is finding great success signing up its customers for telephone service. Meanwhile, he says the company is showing improving incremental EBITDA margins. Bazinet says there is lack of M&A risk, by which he means it is unlikely that the company will attempt to acquire companies outside its core business.

And he argues that the stock is attractive on an absolute basis (though skeptics see it as more expensive than other cable stocks). He also says the stock has relatively low risk to competition from telco fiber optic cable projects, since it has primarily a rural customer base.

Bazinet concedes that the company continues to have negative cash flow. But he thinks the level of cash flow burn will moderate in the next few years.

“The crucial part of the Charter bull case, in our view, is that once the firm generates free cash flow, the enterprise value doesn’t have to change for the equity value to increase,” he writes.

That is, with free cash flow, the debt within Charter’s capital structure simply morphs into equity. So, as long as Charter can show progress toward shrinking the free cash flow burn, we believe equity holders will be willing to pay a premium for Charter’s equity on a relative basis if…Charter’s equity isn’t expensive on an absolute basis.

CHTR 1-yr chart: