WideOpenWest (NYSE: WOW) is not the first name you think of when you hear the words "cable company," but the nearly $1 billion player could be an attractive addition to your portfolio. The company provides high-speed data, cable television, and voice over IP-based telephony services to residents and businesses in 300 communities in Alabama, Florida, Georgia, Illinois, Indiana, Maryland, Michigan, Ohio, South Carolina, and Tennessee. The stock could have serious upside from here.
WideOpenWest looks cheap
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Let's start with the valuation and then move to the challenges faced by the company. Compared to major rivals, WideOpenWest does look cheap, Comcast (NASDAQ: CMCSA) notwithstanding. Enterprise value to EBITDA (EV/EBITDA) is measure of valuation that takes into account a company's debt, so it is especially useful in looking at companies in debt-heavy industries like cable. The lower the number, the cheaper the company.
WideOpenWest trades right at the low end of peers, and surprisingly Comcast also sits near that lower end, despite having one of the best cable franchises. (Investors seem to be skeptical over its foray into content, with its pursuit of Sky, a European satellite broadcaster.) But WOW doesn't have Comcast's scale or power. The best comparable is Cable One, which has about the same level of sales -- an estimated $1.08 billion in 2018 to WOW's $1.17 billion -- but is valued much higher by the market.
For the sake of argument, let's assume that WOW should be valued at 10 times EBITDA, one turn less than Cable One. That would translate into a stock price of $24.40 -- more than a double from today's price. It's not outlandish to expect, but WOW's business has to keep moving in the right direction.
Three for the money
While WideOpenWest is well off its lows for the year, it still has a way to go to reach even last year's IPO price of $17 per share. It needs to tackle three main things if it wants to be valued like Cable One, which generates much more cash flow for the same level of sales.
Where Cable One has leading EBITDA margins, WOW's margins pull up the bottom, (Comcast technically has still lower margins but is diversified into more content businesses). WOW must work on cost control, much the way that Cable One has done, turning more fixed costs into variable costs. Cable One worked tirelessly on reducing headcount, in part by de-emphasizing its video product, which required more customer service calls and so more employees. Despite a similar level of sales, WOW has a headcount of about 3,000, compared to Cable One's 2,300 or so -- a huge disparity for a 10% sales difference. To boost margins, WideOpenWest needs to get this figure under control.
2. Focus more on high-speed data and business services
WideOpenWest could de-emphasize its video product, much like Cable One did when it found video produced little to no cash flow. Because Cable One couldn't get the attractive pricing that made video a viable business to generate free cash flow, it focused heavily on high-speed data and business services, which produced absolutely fantastic margins, about four and five times higher, respectively, than its video product. With an estimated video margin in the low teens, margins in these other units can easily top 50%-60%. As data became a bigger part of its business, overall margins soared skyward.
WideOpenWest should be able to go this route, too. High-speed data is a very "sticky" business, meaning customers stay around a long time. They often upgrade to higher-speed tiers and rarely move down to lower speeds, offering another relatively easy source of incremental margin. Customers also generally stick around even as the company bumps prices a few percent every year. Internet service is simply a "must have." High-speed data is a perpetuity-like business, allowing incremental margin increases.
3. Incremental return on invested capital
WOW is also trying to incrementally expand its "homes passed" number, the number of potential residential connections. In 2018 WOW is targeting an additional 70,000 homes passed, adding to the 3.1 million it had at year's end." To this end, it's pursuing what it calls "edge-outs" and "edge-ins." Edge-ins connect homes that are already in the service area, but for whatever reason aren't directly connected to the network. They're relatively low cost, since the infrastructure is largely in place. Edge-outs are more capital intensive, and are built adjacent to an existing footprint, requiring new construction.
On the latest conference call, CFO Richard Fish stated: "Our return profile on edge-outs is phenomenal. And as you can imagine, it's even better as it relates to edge-ins..." How well is this translating into actual customers? Pretty good. The 2016 edge-outs reached 32.5% penetration, the percent of homes passed that actually are customers. The class of 2017, with less time, reached 25.3% by the latest quarter.
That's helped lead the company to two straight quarters of net customer additions, and in the second quarter the company put up its best net additions results in the second quarter for four years, and the stock rallied hard. Still, it can be a tough road for WideOpenWest, since it has at least one major telecom competitor, often Comcast or Charter, in most of its markets.
What to watch for
Continue to watch net subscriber adds at WideOpenWest, because that's going to be what really helps drive revenue. But the company needs to focus on cost controls, too, so that revenue growth translates into more meaningful margin growth.
Also watch out for the company's debt. It has a fair bit – about 5.3 times EBITDA, and I'd like to see that come down. The company has already made a good effort to bring this down in the last 18 months, by selling off some assets. But a figure well below five times EBITDA would be better. Incremental margin could help improve this ratio, too.
WideOpenWest has a way to go to prove that it's worth twice what it is now, but it's a positive sign that management stepped up to buy stock in May, when the stock was in the $8s. CEO Teresa Elder purchased $100,000 of stock, increasing her stake to nearly 612,000 shares, valued at nearly $7 million now. Three other insiders made comparable purchases in the same time frame. It's rare to see such a concerted move from insiders, and I think that bodes well for the stock.
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