Altice's Business Model Is Not Sustainable

| About: ALTICE S (ATCEY)

Summary

Altice is a telecommunications operator, which has a growth strategy based on acquisitions financed by debt.

Its most recent operating performance was quite weak, raising doubts about the sustainability of its business model.

Its valuation is cheap, but investors should avoid this risky investment.

Altice (OTCPK:ATCEY) is a risky investment due to its high financial leverage that is not sustainable in the long term. Its recent weak operating performance has clearly shown that its strategy of growing through acquisitions and focus on cost cutting is not delivering the expected results, raising serious questions about the company’s investment case.

Company Overview

Altice provides mobile and cable telecommunications to residential and corporate customers in several countries. Altice provides telecom services including broadband internet service, cable TV, mobile phone and fixed line services. It was founded in 2001 and has been listed since 2014. It has a market capitalization of about $22 billion and trades in the U.S. on the over-the-counter market.

Altice has grown rapidly through several acquisitions in the recent past, starting in France and expanding to other countries, such as Israel, Portugal, the U.S. or the Dominican Republic. Altice entered the U.S. market with the acquisition of Suddenlink in 2015, and bought Cablevision a few months later. Its largest operations are in France, where the company is the second-largest mobile operator by number of subscribers, through its subsidiary SFR.

Altice’s revenues are mainly generated in Europe (about 57% of revenue) and the U.S. (35%), while the rest comes from Israel and the Dominican Republic. Wire-line accounts for 60% of revenue, while mobile accounts for 30%. Altice has mobile operations in all markets except the U.S., where it's the fourth largest cable operator with around 3.5 million video subscribers, behind Comcast (CMCSA), Charter (CHTR) and Cox.

Strategy & Financials

Altice’s strategy for growth is to make price-disciplined acquisitions. Its acquisition march across the international telecom industry was very intense in the past three years, expanding considerably the company’s operations. Its strategy is to acquire, absorbing and cut costs aggressively at the acquired companies. However, given that most of its acquisitions are relatively recent, its track record is not yet enough and the success of the company’s strategy is still uncertain in the long term.

Altice is well-known for its aggressive cost-cutting culture at acquired companies, but this also suggests risks to revenues from deepening cost cuts. The company still has a limited period of integration of acquisitions, but its achievements are not particularly impressive so far. Slashing operating costs brings risk to service quality and intense competition is also putting pressure on its operating trends. This is especially true in Europe, where highly competitive markets lead to a very fragile industry environment for all the telecom operators.

Moreover, Altice’s efforts to turn around its European assets with network and content investments aren’t delivering a consistent improvement in Altice’s performance. This was the main reason why Altice reported deteriorating operational performance in the last quarter, which led to a huge drop in its stock price of more than 20%.

Altice aims to retain premium pricing, but customer perception is increasingly of lagging quality on its services. This helps to explain why Altice had muted postpaid net additions across Europe in the past few months and deepening customer losses in France, resulting in lower than expected group revenues.

In the U.S., similar to most pay-TV peers, Altice is facing intense pressure in the video market, losing customers consistently over the past few quarters. On the other hand, broadband has been adding new customers, offsetting to a certain extent losses at Pay-TV.

Regarding its financial performance, Altice has reported strong growth figures due to its aggressive acquisition strategy, but it has failed to report profits since it has been listed. More recently, its operating performance was relatively weak and a rapid turnaround is doubtful.

In the last quarter, Altice has reported mixed figures with the U.S. increasing revenues by 3.2%, while revenues in France declined by 1.3% and in Portugal dropped by 3.1%. At the group level, revenues declined 1.8% year-on-year and EBITDA increased by only 1.8%. This means that its EBITDA margin has progressed positively despite lower revenues, reaching 41% in the last quarter. This shows that its cost-cutting strategy is delivering some results, but intense competition is putting pressure on top line growth and further margin gains may take longer than expected.

Altice’s higher EBITDA margin in the past quarter was mainly driven by good performance in the U.S., which has reached an EBITDA margin of 44%. However, due to weak performance in Europe, Altice revised its EBITDA growth guidance to the lower end of the high single-digit growth rate for the full year. Its goal is to have EBITDA margin above 45% in the medium term, which seems to be achievable in the next few years given its focus on cost efficiency and recent progress in the U.S. and Portugal.

Going forward, Altice’s strategy is to expand fiber and have more in-house content, continue to improve efficiency and offer better customer service. This should lead to higher operating margins, but revenue growth may be harder to resume until more industry consolidation occurs, especially in France where the competitive environment remains fierce.

Financial Leverage

Due to its aggressive growth strategy performed in the past few years, Altice has a very leveraged balance sheet. Altice’s net debt amounts to close to $50 billion, representing a net debt to EBITDA ratio of about 5.3x, at the end of the third quarter of this year. This is a very high ratio even within the telecommunications sector, which usually has high leverage due to the long-term nature of their assets and high profitability rates.

This is one of Altice’s main weak points because during economic recessions, the credit markets usually freeze for leveraged companies and may lead Altice to a tough period. This doesn’t mean the company will face bankruptcy rapidly, but most likely will have to sell assets, cut costs even more aggressively and stop investments to save cash, putting its growth strategy and business model in jeopardy.

Altice acknowledges that it has a leveraged balance sheet and intends to reduce its leverage ratio towards 4.5x. However, this continues to be a high ratio compared to most of its peers, which have ratios between 2-3x. Altice aims to reduce leverage by achieving synergies within the group, which should lead to a higher cash flow in the next few years. This seems to be a rational strategy, given that the company is increasing its scale and can share content between countries, but a lower leverage target is desirable.

Furthermore, if the company was reporting high growth rates and would not perform further acquisitions, in that case, its debt could be sustainable. However, this is not the case taking into account its most recent financial performance with lower revenues and muted EBITDA growth and further acquisitions can’t be ruled out, as the company may be tempted to mask operating weakness in the future through further consolidation.

Given that Altice is not growing much and has high leverage, its debt sustainability is increasingly being questioned. The company has reported operating profits in the past few quarters, but this is not enough to cover interest costs. Altice’s interest expense is about €900 million ($1.05 billion) per quarter, leading to losses of about €500 million ($580 million) per quarter, before restructuring charges. This is not sustainable in the long term and Altice clearly needs to improve its financial performance to have a sustainable capital structure in the long term.

Conclusion

Altice’s business model is based on growing through acquisitions and then focus on cost cutting to achieve higher profitability. The company has historically used debt to finance acquisitions, leading to very high financial leverage. However, this strategy is not delivering the desired results because the telecom industry is facing intense competition in Europe, leading to serious doubts about the sustainability of its business model.

Altice is currently trading at an EV/EBITDA multiple of 7.5x, a discount to its closest peers, but this seems more than warranted by its weak fundamentals. Even though its share price has declined a lot in the past few days, Altice seems to be a falling knife and investors should avoid this high risk investment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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