Cable One: A Case Study Of Rationality Applied To Business Decisions
Seeking Alpha Analyst Since 2020
Abhay's interest lies in Business and Investing. His investment philosophy is rooted on the principles of value investing. He is the author of www.skymemos.com.
Summary
- CABO provides a great example of how businesses can use rational decisions to generate enormous shareholder value.
- Clues could be derived from looking into return on incremental capital.
- Looking for management that is taking rational but unconventional steps to improve their businesses can help investors uncover new opportunities.
- This article was originally published at skymemos.com.
I have been an avid student of great businesses. But, cable companies are not the first that comes to mind. Why? They take capital to grow, and they usually take on a lot of debt. However, as is often the case with investing, there are rare gems. Through this post, I will emphasize looking for companies that are taking rational but unconventional steps to improve their businesses and therefore have a true shot at generating huge shareholder value.
Cable One (CABO) is one such case. It is an easy business to understand. The company primarily sells broadband service that allows you to browse, watch movies, listen to songs, and do anything over the internet. Its footprint is in rural parts of the U.S.
The traditional business model of a cable company is to benefit from scale through selling bundles of video, internet, and phone services. By selling more services per customer, the cable company can spread its large fixed cost. That business model worked for a long time but came under assault due to the rise of streaming services, high programming costs, and the use of mobile phones over landline. Cable companies had to decide between hurting their margin or passing the cost increases to customers, which impacts product demand given cheaper streaming options. Most large cable companies still make some money from the video business because of the benefit of their size, but smaller ones don’t.
Seeing these fundamental changes, CABO began adapting to the situation in 2012. The company pivoted towards broadband-only business (very high-margin) while intentionally churning video customers that were not making money. In addition, CABO focused on gaining high-value customers that are less attracted by discounting, require less support, and churn less. In the words of the company:
“We count cash flows not subscribers”
From 2012 to 2016, Cable One lost more than 45% of residential video subscribers but the company’s profits grew by more than 30%. Moreover, the profit margin improved by 9%. (Notice I used until 2016 to avoid discrepancies from acquisition CABO did in 2017).
This increase in profitability should be compared with the incremental capital required to produce it. On this metric, CABO has been outstanding with its new approach: In 2012, the company generated pretax profits before the interest payments of close to $130 million. During the next 4-years, the company reinvested roughly $60 million (only!) to produce cumulative profits north of $640 million. This is a great result, earning huge returns on incremental tangible capital.
Cable One’s rational behavior is not new. In the 1990s, when rural markets were not considered cool, the company shifted to those markets. Why? The competition and operating costs in rural markets are lower than in metros.
Cable One’s recent focus on internet-only customers also suits its customer base. People in rural areas are more value-focused than in urban markets, meaning they not as attracted to expensive cable channels versus their urban peers. That further helped CABO save on video costs.
I think rationality begets rationality. As CABO has perfected its non-conventional business model of “broadband-first” and “rural focus”, they are spreading it more. They are acquiring companies in similar markets as theirs and "converting" them to their differentiated operating philosophy. The cleanest example is the 2017 acquisition of New Wave.
CABO provides a great example of how businesses can use rational decisions to generate enormous shareholder value. CABO’s market value has grown close to five times in roughly 5-years. That is a better return than owning either Apple, Facebook, Google, or Microsoft (see here). Meanwhile, the company has beaten S&P 500 index (represented by SPY) returns by a wide margin. Think of Cable One as the kind of company to study that could help to find businesses making rational decisions.
Analyst's 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. I have no business relationship with any company whose stock is mentioned in this article.
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