Altice’s U.S. Spinoff Looks Like a Winning Bet
By Bill Alpert
May 26, 2018
Patrick Drahi was riding high in 2015, when his European telecom company Altice gobbled up the U.S. cable systems Suddenlink and Cablevision. Altice topped an enterprise value of $70 billion as it vowed to transform the stodgy cable business with a lean, high-tech approach that Drahi called the Altice Way.
But then investors started to lose confidence that debt-laden Altice had a way around the cable industry’s challenges, which include tough competition in countries like France and the loss of pay-television subscribers everywhere to services like Netflix (ticker: NFLX). After the Cablevision deal, the shares of Altice (ATC.Amsterdam) slid from five euros ($5.83) to below one euro this year.
So on June 8, Altice will lighten its load by spinning off its U.S. systems. Some shares of the Altice USA business (ATUS) have traded here since last year, and arbitrage sales ahead of the spinoff have pushed them down to levels that are cheap in comparison with other communications stocks. Tax loss carryforwards will shield Altice USA’s rising cash flow, so as the U.S. business buys back stock with some of that cash, the NYSE-listed shares could rise from a current $18 to the high 20s.
The French-Israeli Drahi became a billionaire in the last decade by assembling cable and wireless properties that stretch from Israel to France to the U.S. By cutting costs and reinvesting the savings in new technology, Altice had early success in the French business that accounts for half its revenue. That spurred Altice shares to a fivefold return in the year after its 2014 initial offering on the Dutch bourse.
But lately, Altice has found it hard to sustain its financial success in the French market. Its U.S. operations have fared better, with Altice USA already able to trim $1 billion in costs. At the Optimum network that it acquired with Cablevision, cash-flow margins rose from 28% in 2014 to 41% in 2017.
“When we came to the U.S.,” says Altice USA Chief Executive Dexter Goei, “people thought we were absolutely crazy…there’s no way we could take out that kind of cost. Well, we’ve not only taken out the costs that we said we would, but we’ve done it in two years, instead of the expected five, while also introducing new services.”
As the fourth-largest cable operator in the U.S., Altice USA has 4.5 million customers among the 8.6 million homes that its wires pass. To better show off its U.S. business, Altice made an initial offering of some 10% of Altice USA’s shares for $30 each in June 2017. The U.S. shares have since sagged. Cable stocks lost favor after industry leader Comcast (CMCSA) warned it had lost a larger-than expected number of pay-TV subscribers in its September quarter. An arbitrage play that shorted the U.S. stock and went long the parent’s shares further undermined Altice USA shares.
After the spinoff, the stock of Altice USA could do well. For one thing, the arbitrage trade will unwind. Both stocks started trading ex-dividend for the split last week, so the float in Altice USA will increase from a paltry 10% to 42%. Then, on June 6, Altice USA will pay a one-time cash dividend totaling $1.5 billion. And while European institutions may unload the 0.4163 of a U.S. share they’ll get for each share of Altice in the spinoff, the U.S. company plans to absorb some of that “flowback” by buying up to $2 billion worth of its stock over three years.
Those trading improvements could be shored up by continued progress in Altice USA’s business. Subscriptions will probably continue to subside for the pay-TV services that contributed 45% of the company’s $9.3 billion in 2017 revenue. To fight that decline, CEO Goei says that the company has pressed its content providers to allow Altice USA to offer skinny bundles of channels with lower price points, to counter competitors like Sling TV and Hulu Live. This year, Optimum and Suddenlink are rolling out new hardware that combines a set-top box and WiFi router in a single unit that they’re calling Altice One. The product comes with a voice-activated remote control and accommodates “over-the-top” apps that will initially include Netflix and YouTube.
Like its cable peers, Altice USA hopes to offset declines in video by growing its revenue from high-speed internet service. Over the next five years it will upgrade its networks by running fiber-optic lines all the way to subscribers’ homes.
The company’s fans think it will be able to pull off these upgrades while keeping capital spending at levels below peers like Comcast and Charter Communications (CHTR), as a percentage of revenue. The resulting free cash flow should rise from $1.3 billion this year to $1.6 billion in 2020, predicts JPMorgan analyst Philip Cusick, who added Altice USA to his focus list this month and has a price target of $32 on the shares.
And unlike other free-cash-flow plays in the communications sector, Altice USA has tax-loss carryforwards that should shelter its earnings from taxes until around 2020. Comparing taxed free cash flow, Goldman Sachs analyst Brett Feldman notes Altice USA shares trade at a sharp discount to other growth stories like T-Mobile US (TMUS), Charter, or Sirius XM Holdings (SIRI)—as seen in the nearby chart.
Goldman has the stock on its Conviction List, with a $28 price target. As free cash flow rises from $2.10 a share this year to $3.09 in 2020, Feldman believes Altice USA will be able to maintain a reasonable debt level of 4.5 to 5 times cash flow, while still repurchasing up to $2.5 billion a year in stock. By 2022, he thinks Altice USA will have retired 75% of its stock market capitalization.
As for CEO Goei, he’s ready to start narrowing his stock’s discount to its peers.