When Microsoft co-founder Paul Allen jumped headfirst into the cable industry over a decade ago, he believed in the power of connectivity in the "wired world." But the company he wrought is a distant cry from the smooth-running empire he had envisioned.
After rising from the ashes of bankruptcy, relegating its former chairman to the sidelines and losing its CEO to the largest cable operator in the nation - all in the past three months - Charter Communications is at a crucial point in its 17-year history.
No longer saddled with debt, the St. Louis-based MSO known for its strong operating history is considering three options, according to analysts and members of the cable investment community: get smaller, get bigger or sell out.
Whatever happens to the nation's fourth-largest cable operator - it has about 5 million subscribers in 27 states - will be felt by other big cable operators. Many people who follow the company say it will most likely resort to a combination of options, selling off some nonstrategic systems and swapping larger systems to beef up existing clusters. Up to this point, though, Charter's story also offers lessons about what happens when a company pays too much for assets and gets too bogged down by debt.
TIME TO DEAL
Charter has been pretty quiet on the deal front, but with Paul Allen on the sidelines (he stepped down as chairman earlier this year, but remains the largest single shareholder); former CEO Neil Smit becoming president of Comcast Cable Communications on March 1; and new owners that appear to be open to deal-making, that stance could change. And for some observers, it is about time.
While the bankruptcy did not technically create a change in control - Allen still holds the largest individual stake - the influence of Charter's bondholders, led by Apollo Management, has increased. That is evident from the makeup of the MSO's nine-member board of directors, four of whom are representatives of former bondholders, including chairman Eric Zinterhofer, a principal at Apollo Management. Other bondholders represented on the board include Oaktree Capital Management and Columbia Capital.
"These are deal guys," said one debt analyst that requested anonymity. "They are all former bankers and investors who are going to say, â€˜All of those adjacent properties to Time Warner that you've talked about for years, how do I cluster them up?'â€Š"
Some say the driving force behind the company is not Smit, but private-equity fund Apollo Management.
For its part, Charter is keeping its cards close to the vest. In a statement, interim CEO Mike Lovett said the company is well positioned for the future.
"Neil Smit leaves Charter in a good place on many fronts," Lovett said in the statement. "We have enhanced our video, Internet and phone services and improved the customer experience. We achieved strong operating results throughout a challenging year, and completed a financial restructuring that better positions us for the future."
Charter emerged from bankruptcy on Nov. 30, with a streamlined balance sheet after a group of bondholders agreed to swap a chunk of the debt owned them for equity in the new company. As part of the deal, bondholders like Apollo, Oaktree and others exchanged about $8 billion of their debt for stock and pledged to pump another $3 billion in equity in a new Charter.
Much less leverage
The bankruptcy reorganization reduced Charter's leverage ratio dramatically from more than 10 times cash flow. The MSO is carrying about $13 billion in long-term debt, or about 5.2 times cash flow. That compares to about 6.3 times for Mediacom Communications, around 3.25 times for Time Warner Cable and about 2.5 times for Comcast.
Charter is currently split into two geographic divisions - the East and West regions - each with about 2.5 million subscribers. Its largest clusters include: Alabama and Georgia (609,100 customers); Michigan (592,100 subscribers); Wisconsin (507,500 customers); Louisiana/Tennessee (533,400 subscribers) and Central States (543,200 customers).
Rounding out the group are Southern California (mostly the Los Angeles area, with about 376,800 customers); Texas (with 159,300 customers) and Northwest (including parts of southern Washington state and Northern Oregon (248,500 customers), which are all also likely fodder for deals.
"We have thought it made sense that various Charter systems be sold, not necessarily the whole company," said Collins Stewart media analyst Tom Eagan. "There are definitely markets or systems that make sense for either Comcast or for Time Warner Cable to buy."
Southern California has been speculated as a Time Warner Cable target ever since that MSO gained 1.1 million Los Angeles customers through its joint purchase of Adelphia Communications with Comcast in 2006. In Texas, where Charter has about 159,000 customers in Fort Worth and outlying areas around the state, Time Warner Cable (Dallas) and Comcast (Houston) could be potential suitors.
Charter's Alabama/Georgia cluster is also near Comcast's Atlanta systems, which have about 600,000 customers, and its Louisiana/Tennessee cluster borders Cox- and Comcast-owned systems. Charter's North Carolina/South Carolina/Virginia cluster, with 516,400 customers, is also near properties owned by Time Warner Cable and Comcast.
Aside from those larger deals, Charter is rife with smaller systems that could fit in with other operators either as outright sales or as swap fodder. Included in that list are several properties within spitting distance of Comcast clusters, including Reno and Carson City, Nev.; Vancouver and Pasco, Wash.; Medford and Lincoln City, Ore.; and Benton, Minn. Charter's New England cluster, which includes Massachusetts, New York, Vermont, Connecticut and Rhode Island, is close to Time Warner, Cox and Comcast properties,
Another possibility: Concentrating on the Minnesota, Michigan and Wisconsin, Alabama/Georgia and St. Louis (Central States) markets - which have about 2.6 million customers combined - and selling or swapping the rest.
That could mean that Charter could trade systems in markets considered more strategic to Comcast and Time Warner for properties both hold in those areas (such as Minneapolis, Detroit and Milwaukee).
Moody's Investors Service senior vice president Russell Solomon and others stressed that deals would hinge on several factors, including price, availability of financing, how the systems fit into the buyer's operations and the number of willing buyers.
"The board composition does suggest that they are going to try to maximize the value that they received in the bankruptcy process," Solomon said. "To the extent that driving toward a smaller company that is more tightly clustered in markets they can focus on does that, I'm sure that the direction they would head. But they might just as easily look to get bigger."
Growing larger through acquisitions becomes more of a possibility as Charter comes nearer to issuing new stock - it has been trading on a when-issued basis since Dec. 2, at between $29.10 and $39.50 per share - which could be used as a deal currency.
But that will hinge on the price at which the stock ultimately trades. When-issued prices are a benchmark, but can vary widely from the regular trading price. And cable stocks already trade at a wide variety, with Mediacom, the smallest publicly traded operator, at between $4 and $5. In contrast, Time Warner Cable trades in the $40-per-share range.
"If it trades like it's Mediacom on the basis of the per-sub valuation, then I think you really have to do something to unlock some value," said Wunderlich Securities media analyst Matt Harrigan. Harrigan does not currently cover Charter, but has in the past.
Smaller operators like Mediacom Communications, which has about 1.3 million subscribers in the Midwest, and Suddenlink Communications, with 1.2 million customers, could be potential acquisition targets, although neither company has expressed any interest in selling.
Charter also could focus on growing organically, without going on a buying spree. Although it had been saddled by debt in the past, Charter has always been a strong operator. With its debt considerably lower - it is about 5.2 times leveraged, compared to around 10 times before the reorganization - it should be able to begin generating free cash flow on a similar pace to its peers.
Interim CEO Lovett has been running day-to-day operations since 2005 and has a strong track record. Since 2005, Charter has grown revenue from $5.3 billion to $6.8 billion in 2009 and adjusted cash flow from $1.8 billion in 2005 to $2.5 billion in 2009.
"Today, Charter is a stronger company and we stand on a foundation that is solid," Lovett said last week. "Every one of us at Charter is determined and dedicated to providing our customers with excellent service and great new products."