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Morningstar | Initiating Coverage of Charter With a $350 FVE and Narrow Moat; Shares Modestly Overvalued

We are initiating coverage on Charter with a $350 fair value estimate, leaving the shares modestly overvalued at current prices. We expect the firm’s network architecture will enable it to steadily add network capacity at modest incremental cost, allowing it to meet customers’ Internet access needs. However, the firm’s returns on capital are subpar today. Thus, while we believe Charter will enjoy a strong competitive position, we have only awarded it a narrow moat rating. We also believe the efficient scale attributes of the telecom business and the limits of wireless technology will prevent the competitive environment from changing materially, producing a stable moat trend.

Charter’s cable networks have provided a significant competitive advantage versus its primary competitors, phone companies like AT&T and Verizon. The firm has been able to upgrade its network to meet consumer demand for faster speeds at modest incremental cost while the phone companies have largely ignored their networks across chunks of the country. While technological developments have made it possible to build more efficient and reliable networks, deploying these technologies still requires heavy construction outlays. Several firms have attempted to enter the fixed-line market over the years, but few have succeeded. Most notably, Alphabet sharply curtailed its Google Fiber plans in 2016 after six years of effort.

We expect market share will continue to shift to Charter, further entrenching its competitive position and producing steady cash flow. The biggest knock against Charter, in our view, is that the firm generates woeful returns on invested capital today. In part, this poor performance stems from the high prices it paid to put the firm together. The TWC and Bright House deals placed more than $100 billion of intangible assets on Charter’s balance sheet. If we include intangibles in the capital base, we calculate a return on invested capital of around 5% currently.