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Charter: Cable's Sucker Stock


When I went to work on Wall Street after college, I immersed myself in the equity culture. I ate breakfast watching Maria Bartiromo and scarfed down lunch in front of a Bloomberg terminal. I took home stacks of research reports, valuation models, and prospectuses. Blinking Excel spreadsheets appeared in my dreams. I'd say I was a fairly avid student. And yet it was during that period of my life when I managed to buy perhaps the worst stock in America: Charter Communications Inc. (CHTR), the country's No. 4 cable-TV provider.

In early 2000, Charter seemed a no-brainer of an investment -- that rare intersection of vast potential and minimal risk. I was buying alongside majority owner and Chairman Paul G. Allen, a co-founder of Microsoft Corp. (MSFT) and one of the world's richest men. Allen had put up $8 billion of his own money to make Charter the keystone of his "wired world" strategy that also included big stakes in Priceline.com, RCN Corp., and Oxygen Media. Much ink has been spilled about Allen's troubles as an investor in such companies. But at Charter he also ran -- and continues to run -- the show. Wall street loved how he rolled up small cable outlets across the map, culminating in a $3.2 billion initial public offering in 1999.

And so, in my prelapsarian naivete, I bought some shares a few months after the IPO. I figured I'd be getting in on the deal of a lifetime: Cable companies were the toll collectors to the broadband gold rush. Plus, if anything were to go wrong, Allen's billions represented the ultimate safety cushion.

What I ended up getting was an absentee father of an owner; book-cooking; Royal Tenenbaums-like dysfunction in the executive suite; and the kind of corporate governance that would get a company booted from Zimbabwe's stock exchange.

From a financial perspective, Charter has turned into one of the ugliest U.S. companies still in solvency. Its $19.5 billion in debt dwarfs its market cap of $510 million. Its interest expense alone devours a third of its revenue; rival Comcast Corp. (CMCSA), which has four times Charter's revenues and subscribers, pays about the same. Charter also has a knack for posting nasty quarterly losses, including, earlier this month, red ink of $459 million, or $1.45 a share, for the first quarter, vs. $353 million a year ago. Charter's quarterly losses per share now exceed its share price, which, at $1.20, has collapsed from a 2001 high of $25. It's perverse, the realization that each of my $1.20 shares generates a $1.45 loss. It's a wonder I don't owe Charter money.

A company spokesman says Charter has ample liquidity and financial resources. But because so much of its cash flow is eaten up by servicing the debt, say analysts, it's unable to invest in the things necessary to keep customers from flocking to satellite TV and the regional Bell rivals. It's no coincidence that Verizon Communications (VZ) chose a Charter cluster in Texas to pilot its foray into video last year. So easy were the pickings that Verizon says it quickly took 25% of the local market. (Charter does not agree with Verizon's calculations.) And spending-constrained Charter, say analysts, is the cable provider most susceptible to AT&T's (T) competitive onslaught now that it's in the process of acquiring Bell South Corp. (BLS). The company says that its overlap with AT&T-BellSouth in major markets is minimal. Nevertheless, news of that deal sent my Charter shares down to 94 cents apiece -- barely enough to get me in the door at a Taco Bell.

CRUSHING DEBT

Sporting the fiscal soundness of a banana republic, Charter has every reason to erase its debt by declaring bankruptcy, finally wiping out long-suffering holders like yours truly. But it won't, because Allen, who has billions of his own money plowed into the equity side of the ledger, refuses to cede control to creditors, who would pick through the choicest assets the way they did in the Adelphia Communications Corp. bankruptcy. While Allen declined to comment for this story, a source close to his holding company notes that "the incentives are a hundred percent aligned. And if the company goes bust, he suffers the most."

There's nothing inherently wrong with taking on debt to assemble a cable empire. Cable is a long-haul, capital intensive business. But with Charter's debt load now at crushing levels, I'd like to see some spending from Allen's personal coffers -- he's worth an estimated $20 billion -- to pay off some of it. It's not an unreasonable request; Allen could get some of that money back immediately as shares rallied on the improving fiscal outlook.

At the very least, Allen could issue a press release saying that he stands behind the company. That might give analysts and fund managers some hope that he is engaged in the issues of the day. It might also put some heat on short-sellers -- investors who borrow shares and sell them in the expectation that the price will fall. They control some 20% of Charter's publicly available shares, and signs of life in the stock might persuade them to start buying to cover their positions, a chain of events that could lift the stock price. Alas, aside from a 2002 Securities & Exchange Commission filing hinting that he could take Charter private -- Please do! -- Allen has pretty much opted for silence. Says the source close to Allen: "The company has the money it needs."

IN THE BIZARRO WORLD

All along, Allen has acted in ways that make him seem either oblivious or indifferent to the plight of ordinary shareholders. Most egregious is his record of diluting the value of the shares already in investors' hands. Case in point: In November, 2004, with its shares at $2.75, Charter announced a $750 million convertible bond offering to ease debt. (Convertible bonds turn into equity under some prearranged scenario, usually a bad one.) But the stock plunged 20% the instant the market caught wind of the deal's 2009 conversion price of $2.42, which was unusually close to the share price at the time. With management willing to flood the market with an additional 310 million shares, traders took the deal to be a vote of no-confidence by the company in its stock price.

Management could have avoided some pain by issuing shares when they briefly soared above $5 just 10 months before, but it didn't. The source close to Allen disputes that the deal has diluted shareholders' stakes, since it isn't convertible until 2009. But the market seemed to price in those extra shares immediately. That was bad news for me because I had bought even more shares just months before the deal took place, on the misplaced faith that Allen was about to save the day. What was I thinking?

Worse yet, the same deal called for Charter to fork over 150 million shares to big investors wanting to hedge, or short-sell, against their convertible-bond holdings. In other words, in the Bizarro world of Charter shareholderdom, I was subsidizing hedge funds to help me lose even more. "It may have had a temporary impact [of enabling shorts]," concedes the source close to Allen. "But it was a necessary part of the deal."

During the four-year slump in cable-company valuations, Charter's peers have been doing anything but diluting their shareholders. The Cox family, controllers of Cox Communications Inc., the No. 3 player, took its cable arm private in August, 2004, at a premium price. Comcast has been buying back stock, impressing the likes of Warren Buffett. Cablevision's Dolan family attempted to go private before opting for a big dividend payment to shareholders. UBS (UBS) cable analyst Aryeh B. Bourkoff says that, given the depressed state of the cable industry, it would be an opportune time for Charter's patriarch to shore up his equity investment: "With valuations low, it's logical for him to put in some fresh capital." Not me, though. As far as I'm concerned, this mutt is nothing but a future tax loss.

CHARTER VS. THE SEAHAWKS

To its credit, management has taken advantage of low interest rates to refinance some of its debt and push out maturities. But a couple of hundred million in retired paper here and there hardly makes a dent in a $19.5 billion IOU. "Everything Charter has done until now has been like bringing a Band-Aid to a train wreck," says Shelly Lombard, an analyst at debt-rating shop Gimme Credit.

Allen is not without distractions. He has a $200 million yacht, a private spaceship venture, ownership of the NBA's Portland Trail Blazers and the Super Bowl runner-up Seattle Seahawks, and a plan to commit $1.6 billion to power and agriculture projects in Bangladesh. It's a full plate, to be sure. "What does he care about more: Charter or the Seahawks?" asks Jake Newman of New York capital-structure research firm CreditSights. Newman sees Charter slogging through deeply negative cash flow as far as the eye can see. The company burns through $200 million a quarter.

With so many things competing for Allen's time, you could almost forgive the man for letting Charter become a laughingstock of corporate governance. Almost. Allen controls the company and its board with his supervoting Class B shares, whose 93% voting power affords complete autonomy. So forget about a shareholder activist like Carl Icahn or Nelson Peltz swooping in to shake things up. It'll never happen.

Allen answers to no one, not even his top executives, whom he goes through like Dixie cups. In August, 2002, the FBI, Postal Inspector, and U.S. Attorney's office announced investigations into executive actions at Charter. Shortly thereafter, the company restated two years' worth of financial results, adding $2.6 billion to liabilities, and it disclosed an SEC inquiry into its accounting. The chief operating officer and chief financial officer were fired en route to being indicted for wire fraud and conspiracy and inflating Charter's subscriber count. (They were each sentenced to a year in jail.) It took more than a year for the company to hire a permanent CFO, who would last only seven months on the job. Its CEO at the time ended up resigning, too.

As if all of that weren't embarrassing enough, word got out a year ago that Charter's board of directors was on the brink of suing Allen himself to force him to exchange preferred shares that he bought for $700 million in a cable transaction for the equivalent in common stock, something he promised to do in a 2002 agreement. Apparently, Allen thought common shares were only good enough for suckers like me. The two sides ultimately came to an agreement outside of court. But the absurdity of a board suing its own chairman says all there is to say about the state of affairs at Charter.

Now, Charter is working on its fourth CEO in four years: Neil Smit, a former AOL executive and bright-eyed optimist who joined in August. "We remain sharply focused on achieving profitable revenue growth by executing our strategies to enhance the end-to-end customer experience, improve operating effectiveness, grow sales, and increase retention," he remarked during Charter's latest earnings report. Yeah, try doing that while lugging nearly $20 billion in debt.

I look at the stock quote daily and think about how badly my naivete got me burned. Investing in cable with Paul Allen once seemed like a sure thing: He had $8 billion worth of skin in the game, too much money for it not to work. Instead, I ended up subsidizing the shorts who have made a killing on Allen's company, while he played with his toys -- bought with money he earned from work performed more than two decades ago. In hindsight, $8 billion clearly didn't mean all that much to him. "The market has stopped relying on Paul Allen as a savior," is Bourkoff's blunt way of putting it.

I should have gotten that memo a long time ago.

BusinessWeek's ethics policy prohibits reporters from writing about companies in which they hold stock. We made an exception for this first-person account.

By Roben Farzad


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