Cable One Vs. Uniti Group: An Early Mover Vs. A Laggard
Summary
- Cable One more than doubled its income per share over the last 5 years.
- CABO shows the future: high-speed internet is where the money is, not TV.
- Uniti/Windstream still have some work to do to achieve the new 1 gigabit/s benchmark.
- Uniti’s $1.75 billion two million home fiber programme will make the company far more valuable.
This article gives you a brief summary of the success of Cable One (CABO) over the last five years after the company, already in 2012, acknowledged that the future was in high-speed internet and not in TV. After having learned the details of that success we look at Uniti/Windstream (OTCPK:WINMQ), a laggard in high-speed internet services, and ask ourselves whether Uniti (UNIT) can copy this success. Since Uniti has started a $1.75 billion ten-year fiber investment programme we ask ourselves how valuable this investment may become.
Both Cable One and Uniti Group were listed on the stock exchange in 2015. Cable One was split-off from Graham Holding Company and Uniti was formed in a sale-and-lease-back transaction with Windstream. Both companies operate in non-metro tier 2 and tier 3 markets in the west and midwest (Cable One) and east/southeast (Uniti).
Footprint Cable One, after recent acquisitions:
Figure 1 Cable One footprint including acquisitions MBI and Hargray Source: Company presentation q4 2020/ SNL Kagan
Footprint Uniti:
Figure 2 Uniti footprint Source: Company presentation
Cable One
Cable One is credited to be one of the earlier US companies that recognized that the future of cable companies was in high-speed data delivery for internet usage, away from cable TV subscriptions. It argued that content providers required a too big slice of the subscription income and that so-called ‘cord cutters’ were the profitable customers to go after. As a result, Cable One somewhat ignored its TV clients and invested in high-speed 1 gigabit/s internet. Initially, this led to revenue decline, but almost immediately the bottom line benefitted due to lower transmission fees.
Cable One | Growth | ||
Revenue | $807 | $1,347* | 67% |
EBITDA | $318 | $716* | 125% |
EBITDA margin % | 39% | 53% | |
EBITDA/ share | $55 | $119 | 116% |
# homes passed | 1.644 | 2.300 | 40% |
EBITDA/ # homes passed | $193 | $311 | 61% |
As the table shows, CABO did the right thing from a commercial perspective. EBITDA per home passed went up from $193 a year to $311, an increase of 61% over just five years. The most important drivers behind this success were a better mix of more profitable clients, higher prices and a higher penetration rate. In 2015, only 51% of clients had an internet subscription, going up to 69% in 2020, a 37% increase. Internet and TV subscriptions went up in price from $54 and $72 to $75 and $101, respectively, in both cases an increase of about 40%. The penetration rate in CABO’s footprint went up from 30.5% to 37.3%, an increase of 22%. Over half of this increase was achieved in 2020 alone, likely as a result of the Covid scare.
EBITDA itself increased even more, by 125% over the period. Apart from the above-mentioned drivers, this was the result of a 40% increase in the number of homes passed, partly financed by retained earnings and partly by increased debt levels – so not by shareholder dilution.
These are impressive numbers over a five-year period. The only weak point may be the very high price rises, even for TV. An investor should ask the question of how long CABO can continue increasing prices at a rate of 7% per annum.
Cable One as an investment
Shareholders can be happy as EBITDA per share doubled, although some of that was due to a higher debt ratio. The below chart shows CABO stock performance over the last five years.
Figure 1 Cable One stock price Source: Seeking Alpha
Shareholders made over 300% as the stock price increased from $395 to $1,803 over the period April 2016 – April 2021. CABO’s current $13.1 billion enterprise value, including 2.2 billion debt, is 18 times EBITDA. In terms of EBITDA minus CapEx, the company is valued at 32 times. In terms of homes/businesses passed, CABO is priced at $5,700 per each of the 2.3 million homes passed (excluding Hargray).
Hargray acquisition
In February this year, Cable One announced the acquisition of Hargray, a cable provider in the southeast. We will look more closely into this acquisition as it gives us an indication of a 2021 valuation of fiber in the southeast, the area where Windstream’s footprint is primarily located.
Figure 3 Source: Cable One Q4 2020 presentation
CABO paid $2.2 billion for a network of 299 thousand homes and businesses passed, or $7,357 per connection. Based on Q4 2020 numbers the purchase price is 17.2 times EBITDA. 99% of Hargray’s customers have access to 1 gigabit internet speeds, although only 40% of customers have a fiber connection. Hargray hardly generates any free cash flow, $19 million, as CapEx is still substantial. It is unclear whether this CapEx is spent on enlarging the footprint or further upgrading the current network.
The strength of this purchase is in the high penetration rate of 41% (124k clients over 299k homes passed) and the low level of competition with only 35% of homes passed having access to another connection with 100 megabit/s or faster speeds. Whether this was a good acquisition at the right price I leave to the comments section. At least we learned how the market is valuing an up to speed internet service in a rural southeastern market, the footprint of Uniti Lease and Windstream.
Uniti/Windstream
Similar to CABO, Uniti/Windstream’s footprint is largely rural, as explained in Windstream’s ESG report:
At the end of 2020, Windstream had 4.9 million locations in its ILEC footprint: 4.6 million are residential with the remaining 0.3 million classified as business. Windstream’s footprint is largely rural with 97% of our service territory falling outside of municipal boundaries. More than 52% of Windstream’s residential locations and 29% of business locations fall outside of municipal boundaries. Those locations are spread across 151,000 square miles in 18 states for a population density of 16 locations per square mile.
Uniti, the cable owner, and Windstream, the telecom operator, last year started a ten-year $1.75 billion investment programme in order to upgrade the network to 1 gigabit/s internet speeds. About $100 million has been spent in 2020 and the result can already be seen in this investor update:
Figure 4 Source: Full year 2020 Windstream presentation
The chart must be read cumulative so the total Q4 2020 number is 589 thousand 1 gigabit/s connections, an increase of 371 thousand since Q4 2019.
Windstream in the recent past already upgraded a large part of its network to 100 gigabit/s, as seen in the left chart below.
Figure 5 Source: Windstream 2020 presentation
The blue 44% bar indicates that Windstream currently operates 2.0 million homes at 100 megabit+/s speeds. It is likely that the vast majority of this is located in Windstream’s 2.2 million footprint within municipal boundaries. Another 1.3 million connections are at 25 megabit/s, still good enough to watch HD quality films.
Given the high costs of fiber in rural areas, it is questionable whether Windstream will substantially increase the number of homes passed outside municipal boundaries. The low-hanging fruit may have been taken. However, Windstream won $523 million of rural subsidies to expand fiber to the home towards an incremental 192 thousand locations. That is a subsidy of over $2,700 per home. It indicates the high costs to bring fiber to these scarcely populated areas.
Growth Capital Improvements
Looking closer at the $1.75 billion ten-year fiber programme, from the cleansing material we learn that Uniti and Windstream agreed upon a target to upgrade 1.9 million homes to 1 gigabit/s. It is unclear whether these are the current 100 megabits+ connections, which is likely, or that this is another part of the footprint. Total costs are estimated to be $1.7 billion ($800 million investment CapEx plus $900 million success-based CapEx, what is the difference?) which implies a total cost per premise of $900.
Valuation of Uniti/Windstream
To get an impression of the market value of Uniti's Ilec network after the upgrade, we can compare the total 2 million homes plus 100k businesses at 1 gigabit/s speed with the enterprise value of CABO and the Hargray transaction. CABO’s valuation of $5,689 per home passed translates into Uniti’s future network value at $11.9 billion, and Hargray’s valuation translates into $15.5 billion.
That is far higher than the implied valuation of Uniti's/Windstream's Ilec high-speed internet network. Uniti's current enterprise value is $7.5 billion of which a maximum of $3 billion* can be attributed to the 100 megabits+ network. About a similar value should then be attributed to Windstream's*. Uniti's 100 megabit+/s network is, therefore, currently valued at about $6 billion. Including the incremental $1.75 billion investment the implied valuation of Uniti's future 2 million homes 1 gigabit network is, therefore, a little under $8 billion. Compare that to the $12-15 billion CABO/Hargray valuation.
* The calculations behind these $3 billion numbers are as follows.
Uniti's current enterprise value is $7.5 billion. About $1.5 billion of that is related to Uniti Fiber which is outside Uniti's Ilec footprint. Of the Windstream lease contract, only two-third is related to the Ilec footprint, one-third is the Clec business. So a rough estimate of Uniti's enterprise value related to the Ilec footprint is about $4 billion (7.5-1.5)*2/3. The last adjustment we have to make is to account for the 56% of the network that may not be upgraded to 1 gigabit/s, see figure 5.
Figure 6 Source: Windstream 2020 presentation
The above chart shows that currently, 40% of Windstream's broadband customers are outside the 25 megabits or higher footprint (green line). Only 25% of its 1.1 million customers are currently enjoying speeds of 100 megabits+. Let's be very, very pro speed and attribute 75% of Uniti's network value to the 100 megabit+/s footprint. This part of the network is then valued at around $3 billion (75% of 4 billion).
Windstream is more difficult to value as it has become a private company. However, we can derive from the bankruptcy documents that Windstream should be valued in the range of $4-5 billion (enterprise value). Since the consumer segment is the most profitable part of Windstream, its Ilec business may be worth 80% of the company, or $4 billion applying the same 75% to the very high-speed footprint results in a similar $3 billion valuation.
Conclusion
Cable One made a smart management decision by steering away from TV towards high-speed internet. This gave CABO very strong pricing power over the past five years, resulting in 40% higher prices and increased penetration rates. The company’s income has more than doubled and the stock price went fourfold. CABO is currently priced in the range where tower REITs are trading, which implies that CABO is regarded as a low-risk infrastructure growth company. That is a strong achievement.
Uniti/Windstream are the laggards in high-speed internet and have only recently begun upgrading their network. If CABO is indicative of the value of rural area, very high-speed internet connections then Uniti’s $1.75 billion capital improvements will be enhancing value tremendously in the coming years.
This article was written by
Analyst’s Disclosure: I am/we are long UNIT. 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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Comments (8)
In what footprint is Windstream investing the 1.75bn? Is that to upgrade the 100 megabit/s to 1 gigabit? To what extent? Is there so much added value in a 1 gig vs 100 megabit network? Isn’t 100 meg more than good enough? Is $900 per connection worth the spending if it is only to upgrade from an already high level?