Charter Gets a Little Respect

The stock of Paul Allen's cable company has doubled in the past six months. Has the "wired world" he envisioned finally arrived?

What's the clearest sign yet that the cable television industry is firing on all cylinders? One of its hottest stocks is Paul Allen's Charter Communications (CHTR). The cable company that the Microsoft (MSFT) co-founder bought in 1998 has been buffeted for years by management turmoil, accounting scandals, and a slide in subscribers. But in the past six months, the stock has been a rocket, nearly doubling in price—albeit, to a still-sickly $2.30 a share on Oct. 31.

What's behind the run-up? Maybe the "wired world" that billionaire Allen envisioned when he bought Charter—and spent another $8 billion merging it with other cable operators—has finally arrived. Led by industry giant Comcast (CMSCA), which on Oct. 26 announced that it had added more digital and broadband customers than analysts expected, the cable industry has been on a "triple-play" tear of late as it signs up phone and data customers. That's got Wall Street thinking that the cable guys are winning their battle with rivals in the satellite and telephone business to sign those folks—and to boost their all-important average revenue-per-subscriber numbers.

It may be a little late to the party, but Charter finally seems to be joining in (see, 5/29/06, "Charter: Cable's Sucker Stock"). On Oct. 31, Allen's majority-controlled company reported stronger-than-anticipated results. Revenue grew by 10%, to $1.39 billion, as Charter beat Wall Street estimates by signing 88,100 new high-speed data customers and 82,000 new Voice-over-Internet-Protocol (VoIP) phone customers.

Upside Potential

Charter still lost $133 million, compared with earnings of $498 million a year earlier, but the company's prospect of snaring higher revenues from its new digital customers has some on Wall Street salivating. "Charter is at the first or second inning of this trend," UBS Investment Research analyst Aryeh Bourkoff said in a recent conference call for his clients."Where Time Warner (TWX) and Cablevision Systems (CVC) have had success in rolling out VoIP, and the bundle and the resulting cash flow growth that's come with it, Charter…is now under way with some very strong growth patterns."

Bourkoff, who has a buy rating and $2.50 target for the stock, figures that Charter's operating margins are "artificially depressed" because they have so many startup costs associated with launching voice services over the past year. Those costs, he says, will "subside now and certainly into 2007-08."

Indeed, Bourkoff thinks there's even a case to be made that Charter shareholders could see price appreciation to the $7.70 to $10 a share range—a level not seen in four years. In Bourkoff's analysis, the upswing in new, higher-paying digital customers would push Charter's average revenue from its subscribers from its current $83.76 closer to Comcast's $92 per subscriber, and would lift its expected 2007 margins of 35% closer to Comcast's 41%. That could boost Charter's earnings before interest, depreciation, taxation, and amortization (EBITDA) by $2.42 billion, he estimates. Bourkoff also figures that Charter could also refinance parts of its still-mountainous $18.8 billion in debt. That could save interest payments of about $255 million, he projects.

Allen could use a little good news on the cable front. His Seattle Seahawks pro-football team has been hit lately by a nasty wave of injuries. His pro-basketball team, the Portland Trailblazers, traditionally loses both games and buckets of money. Maybe, just maybe, he's finally getting a little jolt from the fortune he bet on the wired world.

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