Charter Stock: Don't Worry About Q2 Internet Net Add Miss – Seeking Alpha

Young man in uniform and with laptop works with internet equipment and wires in server room

standret/iStock via Getty Images

standret/iStock via Getty Images
Charter Communications Inc. (NASDAQ:CHTR) shares lost 11.0% last week (July 25-29), losing 8.4% on Thursday after fellow U.S. Cable leader Comcast (CMCSA) released Q2 2022 results, the day before Charter released its own.
CHTR stock is now down 48% from its peak, wiping out all of its gains since October 2019. Compared to the price at which we initiated our Buy rating in January 2020, Charter shares have lost 15%:
Charter Share Price (Since IPO)
Source: Google Finance (31-Jul-22).
To put the decline in Charter’s valuation in context, since October 2019, Charter’s EBITDA has grown 35%, its Free Cash Flow (as defined by management) has grown 31%, and its share count has been reduced by 26%.
We have unquestionably made mistakes in our Charter investment case. However, we also believe that Charter shares have fallen far more than justified and that many investors are mistakenly focused on a subset of its results.
We set out to review Charter numbers with a fresh perspective, and conclude its stock is still a Buy.
We start by looking at Charter’s Q2 2022 P&L, and show how revenues and earnings are still growing.
Charter Revenues & EBITDA (Q2 2022 vs. Prior Periods)
Source: Charter results release (Q2 2022).
Sequentially, Q2 EBITDA grew 5.7% ($296m) from Q1. EBITDA margin expanded again by 100 bps, helped by revenues growing 3.0% but Programming Costs and Other Operating Costs both growing less. While revenue growth was helped by a boost from political ads that helped Advertising Sales grow 20.1% ($77m), the main driver of EBITDA growth was high-margin Internet revenues growing 2.0% ($110m) from Q1. Video and Voice revenues also grew sequentially, unusual among U.S. Cable operators.
Mobile revenues grew 5.9% sequentially, while Mobile costs growth was slightly less at 4.9%, which meant Mobile EBITDA loss was stable at approximately $70m. (Mobile has been EBITDA-positive excluding customer acquisition costs since Q3 2020, but management’s strategy is to drive growth while running a limited loss.)
Year-on-year, Q2 EBITDA grew 9.7% ($489m), driven by similar dynamics as described above, including Internet revenues growing 6.5% ($341m) and Mobile revenues growing 39.9% (while Mobile EBITDA loss was only $4m higher). Year-on-year growth rates do not necessarily reflect trends in the most recent quarter. However, it is notable that EBITDA margin expanded 130 bps despite escalating inflation in the past year (including Charter’s decision to raise starting wages to $20 per hour and to onshore in-bound sales and retention call centers).
An investor looking at Charter’s Q2 P&L alone would see solid Internet revenues growth and an expanding EBITDA margin driving a high-single-digit EBITDA growth – exactly what we believe in our investment case.
We continue by looking at Charter’s Q2 2022 cashflows, and they are still growing except the start of cash taxes.
Free Cash Flow (“FCF”), as defined by management, fell 7.8% ($141m) sequentially in Q2. However, the decline was entirely the result of new cash taxes ($413m) after Charter exhausted past tax losses. Charter also spent $357m of CapEx on its rural construction initiative, a multi-year project which “has not yet resulted in significant passings growth”, compared to $232m in Q1. On the other hand, Q1 had a $220m one-off litigation payment. Adding all these items back, FCF (management definition) grew 7.8% ($177m) sequentially. On our definition, which deducts share-based compensation, FCF grew 10.3% ($220m) sequentially in Q2.
Charter Quarterly Cash flows (Q2 2022 vs. Prior Periods)
Source: Charter company filings.
Similarly, while reported Q2 2022 FCF figures were approximately 20% lower year-on-year, applying the same adjustments as above show that FCF grew 16.3% on management definition and 16.9% on ours.
An investor looking at Charter’s Q2 cashflows would conclude that the low-teens FCF growth we foresee in our investment case is continuing on an underlying basis.
We continue by reviewing Charter’s subscriber numbers. Q2 was disappointing, but possibly not meaningful to the overall business and could be due to one-off industry factors. Fiber was not a threat, but Fixed Wireless may be.
The total number of Charter Internet customers stood at just over 30m at Q2. Growth appeared to have tapered since Q3 2021, but not unexpected given pull-forward demand during COVID lockdowns, and Q2 2022 does not look noticeably different from prior quarters:
Charter Internet Customers (Since 2019)
Source: Charter company filings.
Excluding 2020, quarterly Internet net adds are mostly in the range of 200-400k. Next to Charter’s now 30m+ Internet subscribers, each quarter’s net adds represent just an 1% change and may not be meaningful. Charter CFO Jessica Fischer stated on the call that, “on a quarterly basis, net adds is an aggregate of more than 1m connects offset by disconnects”, so small changes in either can easily lead to an outsized percentage change in net adds.
Zooming into subscriber net adds/losses, Q2 had an Internet net loss of 21k, after 59k of subsidized subscribers were lost in a transition from the Emergency Broadband Benefit (“EBB”) to the Affordable Connectivity Program (“ACP”):
Charter Customer Net Adds by Category (Since 2019)
Source: Charter company filings.
NB. 2020 figures include customers on COVID-19 support programs, at 119k for Q1 and 270k for Q2.
Interestingly, management indicated that the many of the lost EBB customers were in fact not using the product, presumably only getting it because it was paid for by government subsidies:
As part of the EBB to ACP transition, a small portion of subsidized Internet customers either did not opt to continue their service after the EBB program ended or did not meet the ACP requirements, particularly the requirement that customers use their service in each 30-day period, which covers the vast majority of the impacted subscribers. This resulted in 59,000 customer disconnects during the quarter.”
This was clearly a COVID one-off. Nonetheless, even excluding this, Internet net add would be just 38k, still lower than prior quarters.
What caused this sharp decline in Q2? Looking at the chart above, an investor would likely conclude that something unusual happened in Q2 that did not happen in prior quarters; competitive products that have long been present in the market could not on their own explain the sudden fall-off. Charter also had larger losses in Video and Voice in Q2, but among the two main competitive products, Fixed Wireless does not offer Video and Fiber (as we will show later) did not make much headway in Q2. Macroeconomic pressures seemed a more likely explanation. (We note that adjusted Altria (MO) U.S. cigarette volume fell 10% year-on-year in Q2.)
Notice also the 170k dip in Internet net adds in Q2 2019; there was a similar 100k dip in Q2 2018. Charter Internet net adds had traditionally dipped in Q2, due to summer seasonality in college towns. This pattern disappeared during the COVID years, but management observed it has returned this year.
The chart above also showed Internet net adds has decelerated since Q2 2021, and have been at levels much lower than in 2019, which could be consistent with an impact from new competitive products in the market. However, U.S. Cable executives have attributed this to other factors (discussed in further detail in the following section).
Next, we focus on Charter’s Internet net adds, and add in figures from its U.S. Cable peers as well as from competitive broadband offerings at AT&T (T) and Verizon (VZ); AT&T and Verizon figures here include non-fiber net adds:
Wireline Broadband Net Adds – Key Players (Since 2019)
Source: Company filings.
NB. Comcast Q1 2022 figures includes one-third benefit from end of COVID free programs.
Comcast has similar broadband net adds trends as Charter (as does Altice USA (ATUS), but these are too small to be visible). However, AT&T and Verizon also have similar trends, with their growing fiber net adds just barely offsetting their non-fiber broadband net losses. So Telco fiber overbuild does not explain Charter’s poor Q2 Internet net add.
Finally, we also insert Fixed Wireless net add figures at T-Mobile (TMUS) and Verizon. These have grown rapidly and together substantially represented all of the broadband net adds among the main players during Q2:
Wireline & Fixed Wireless Broadband Net Adds – Key Players (Since 2019)
Source: Company filings.
NB. Comcast Q1 2022 figures includes one-third benefit from end of COVID free programs.
The total net adds among the key players, even if we include Fixed Wireless figures, were decelerating each quarter in 2021, supporting the theory that the decline in Charter net adds last year was mostly due to industry factors.
However, both T-Mobile and Verizon Fixed Wireless net adds have clearly accelerated in 2022. The key questions for us are how much of this has come at the expense of U.S. Cable operators, and how much was Q2 exceptional. We address these in the following section.
To sum up, an investor looking at Charter’s Internet add figures would likely conclude that H2 2021 net add weakness was mostly industry-driven, there was something unusual with Q2 net adds, and that telco fiber is not a competitive threat but Fixed Wireless may be.
We believe many Fixed Wireless customers would not have subscribed to Charter anyway, but are instead either naturally-churned former U.S. Cable customers or entirely new broadband customers.
The first piece of evidence for this is the continuing low churn at both Charter and Comcast. As in prior quarters, executives from both companies observed churn was at historic lows in Q2, in fact lower year-on-year at Charter:

The trends that we saw through the second quarter have largely continued into the early parts of the third quarter, with connects remaining soft while churn is still near all-time lows”.
Michael Cavanagh, Comcast CEO (Q2 2022 earnings call)
“Voluntary churn, when excluding the EBB-ACP impact I mentioned, was even lower than last year”
Jessica Fischer, Charter CFO (Q2 2022 earnings call)
Executives from both companies described Fixed Wireless as a factor, but not a major one, potentially affecting new gross adds but having little impact on churn among existing customers:

Activity levels in the marketplace are … our biggest impact on our growth rates relative to historic growth rates … And there is a new fixed wireless competitor. It’s actually relatively small. It’s not the major component of our quarterly performance, but it is a factor.”
Tom Rutledge, Charter CEO (Q2 2022 earnings call)
“We are not seeing fixed wireless have any discernible impact on our churn, but its early growth appears to be another contributor to our lower connect activity.”
Brian Roberts, Comcast CEO (Q2 2022 earnings call)
T-Mobile has continued to make claims about taking Home Internet subscribers from U.S. Cable, most recently stating that “a little over half were switching from cable” in Q2. However, with T-Mobile Home Internet net add of just 560k in Q2 (and another 256k at Verizon), compared to 1m+ of typical gross churn per quarter at Charter (and likely a similar number at Comcast), Fixed Wireless gains could have come entirely from U.S. Cable’s natural gross churn, i.e. customers each operator would be losing anyway (but would have made it harder for U.S. Cable to regain them).
Fixed Wireless net adds also looked different from U.S. Cable customers, being one third business in the latest quarter, whereas SMBs were typically less than 10% of both customers and net adds at Charter:
Verizon Fixed Wireless Net Adds By Quarter (Since Q2 2021)
Source: Verizon results presentation (Q2 2022).
The sudden jump in Fixed Wireless customers in Q2 also could not be explained by the availability of the product alone. T-Mobile commercially launched its 5G Home Internet to more than 30m households in April 2021, whereas Verizon’s Fixed Wireless Access (“FWA”) had coverage of 20m households by 2021 year-end (with a mixture of 4G and 5G). Both companies have continued to expand their coverage since, but on what we believe to be a relatively consistent trajectory (except the switch-on of C-band spectrum for Verizon in January 2022).
We continue to believe Fixed Wireless to be an inherently inferior product to wireline broadband.
Wireless broadband is structurally slower than wireline broadband. T-Mobile’s Home Internet website currently state that customers “see typical download speeds between 33-182 Mbps” (there is no tiered pricing based on speed), though some online reviews have reported speeds of up to 500 Mbps in certain locations at certain times of the day:
T-Mobile Home Internet FAQs (Selected)
Source: T-Mobile website (01-Aug-22).
By comparison, the entire Charter network is capable of delivering 1Gbps+ download speeds with DOCSIS 3.1.
How important is speed? Comcast Cable CEO Dave Watson stated at an investor conference in May that two thirds of their customers are on speeds of more than 300 Mbps. We know the percentage has been increasing as video streaming continues to grow and improve in quality, and as new use cases continue to be found for broadband connectivity (work-from-home, video conferencing, augmented reality, etc.)
In addition, Fixed Wireless products share the same wireless capacity as mobile customers, and their connection quality can suffer during periods of high mobile traffic. Operators have to carefully manage the number of Fixed Wireless products they sell in each local area based on expected data usage. At the moment, the new 5G roll-out seems to mean there is excess capacity in some areas (especially in rural locales), but this will likely prove temporary as overall data usage continues to grow.
Fixed Wireless also does not come with the Video offerings that are still important to a large number of households. (Out of Charter’s 32.1m total customers, 15.5m subscribe to one of its Video offerings).
As Fixed Wireless is an inherently inferior offering and promotes itself largely on price, we suspect it is over-indexed to lower-income groups. This would also explain its acceleration in Q2, when macroeconomic pressures mounted.
Our view on what is happening in U.S. broadband, largely in line with those held by Charter and Comcast, is that:
This version of events is most consistent with the data and management comments we have described above.
If this view is correct, there is a reasonable chance of a seasonal reacceleration in broadband net adds in Q3. Longer-term, U.S. Cable earnings should continue to show solid growth, driven by broadband, though potentially at a lower pace if the low-end of the market becomes permanently attached to Fixed Wireless offerings.
Comcast disclosed at results last week that they had broadband net losses of 30k month-to-date, which they attributed to summer seasonality. Charter declined to provide the same disclosure, highlighted the same seasonality, but stated they “expect to see those gross additions come back in August and September”.
At $432.10, CHTR shares are trading at a 10.4% FCF Yield relative to 2021 financials; adjusted for cash taxes (on a 24% rate) that has started in Q2 2022, the FCF Yield is 8.0%:
Charter Earnings, Cash flows & Valuation (2018-21)
Source: Charter company filings.
Charter is trading at a 17.0x P/E, but EPS is not a meaningful metric due to large non-cash costs like depreciation.
Cash taxes started in 2022 after tax losses have been exhausted. Management has indicated these will be a mid-to-high teens percentage of (EBITDA – Interest – CapEx) in 2022, and 23-25% of the same thereafter.
Q2 2022 FCF was $1.56bn (see above). This does include higher cash taxes as well as new CapEx on the rural construction initiative, and annualizes to FCF/Share of $33.93 per share, implying a FCF Yield of 7.8%.
Charter FCF / Share (Q2 2022 vs. Prior Periods)
Source: Charter company filings.
Charter does not pay a dividend, but continues to buy back shares with its FCF and new debt raised in line with new EBITDA. Another $4.3bn of shares was repurchased at an average $511 per share in Q2; a total of $7.8bn, or 7.2% of outstanding shares, were repurchased in H1.
Net Debt / EBITDA was 4.45x at Q2 quarter-end, and management continue to target the high end of a 4.0-4.5x range.
We cut our forecasts substantially to reflect the current uncertainty in Charter’s business. We now assume:
Keeping other assumptions unchanged, our new 2025 FCF is 15% lower (was $9.21bn):
Charter Cashflow Forecasts (2022-25)
Source: Librarian Capital estimates.
We also changed our FCF Yield assumption at 2025 year-end to 7.0% (was 5.5%), reflecting a de-rating.
Our 2025 FCF/Share forecast is $62.52, 15% lower than before ($73.84):
Illustrative Charter Return Forecasts
Source: Librarian Capital estimates.
With shares at $423.10, we expect an exit price of $834 and a total return of 93% (21.2% annualized) by 2025 year-end.
We reiterate our Buy rating on Charter Communications Inc. stock.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of CHTR,CMCSA either through stock ownership, options, or other derivatives. 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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