Cogeco Inc. (TSX: CGO) – High-Speed Gains or Buffering?
We have the opportunity to buy Cogeco Communications (TSX: CCA) through Cogeco Inc. (TSX: CGO), a well run broadband company at a very attractive valuation of EV/EBITDA of 3.9x and 5.9x EV/EBIT and 3.5x P/FCF (28.6% FCF yield). Broadband companies or internet service providers (ISPs) are great companies to own. The market has de-rated broadband assets over the last few years, providing a great opportunity. We believe, in the long term Cogeco Inc. will provide investors with a superior investment return.
Industry and Context
Before we get into Cogeco (a broadband company), we have to talk a little about the industry and give some context. In the past, broadband companies were seen as great companies and investments (spoiler alert: they still are). Broadband companies are internet service providers that offer high speed wired internet connections. While the main service and profit center are providing internet service, they usually also offer landline and television bundles. Landline and television services (TV Bundles) are a shrinking portion of subscribers and revenues. They still remain profitable to offer but in our view not significant to the future of broadband companies in general.
These companies generally operate as monopolies, duopolies, or oligarchies at worst in the markets they serve. They operate similar to utilities, there is a large capital expenditure in the beginning to lay the cable/fiber and establish the network. But thereafter they are able to collect a toll/subscription every month at a marginal incremental cost over the lifetime of the asset.
Once established in a market it does not (usually) make sense for competitors to establish their own networks to be laid overtop the existing network (e.g. fiber over a fiber network. However, fiber over a cable network is generally profitable). However, this has not stopped some competitors from entering the same markets. To be viable a network needs to secure 25% to 40% of the homes they pass. You need to dominate the markets in which you serve to achieve economies of scale for the venture to provide an adequate rate of return. Eventually, the biggest and best will prevail.
Broadband companies are able to generate moderate to high returns on capital employed with very steady cash flows enabling the liberal use of debt to finance these projects. For years, these companies were able to expand subscribers through acquisition and expansions and increase prices at rates above inflation. These companies also had the wind at their back as more people became connected to the internet and switched from DSL in the areas they served which spurred organic growth. With all this, broadband companies were able to generate excellent returns for their shareholders and the valuation multiples for these companies were extremely high.
However, over the past few years sentiment has changed and broadband assets and companies have de-rated from high to low multiples. Some well run companies have seen their stock prices fall 80% from peak to trough over the years. Currently, broadband companies are now cheap across the board. There are a few reasons this has happened in our opinion:
Overbuilding of fiber in a market due a variety of factors
High prices of existing cable/fiber providers inviting competition and opportunity.
Low interest rates (cheap debt) and a lack of new markets for companies to expand too.
Subscriber losses where in the past there has only been unit and price growth for years.
Cord cutting fears.
Fears of fixed wireless and satellite internet stealing market share
In our opinion, fixed wireless and satellite internet will provide niche use to certain customers and locations but we do not see it posing an existential threat to broadband. Outside of niche applications, we believe wired connections still provide the lowest cost and best option (see Appendix for more details).
These are valid concerns, but the current valuations of broadband assets and specific companies provide an attractive investment opportunity. The assets these companies own are still very valuable and extremely cash generative. These valuations provide a large margin of safety when purchasing one of these companies even if we are wrong about some of these points and their impacts.
Business and Operations
With that out the way let's move onto Cogeco! We are going to be talking about two companies (both called Cogeco) that are tightly linked together. Cogeco Inc. (CGO) is a holding company whose main assets are shares in Cogeco Communications (CCA). CGO owns 28.42% of CCA with 80% of the voting rights. This gives CGO effective control over CCA. CGO also owns some radio station assets that generate about $100M in revenue. The Audet family are major shareholders in CGO and effectively control CGO and thus CCA through super voting shares granting them 20x votes per share. The Audet family owns approximately 18% of CGO’s economic interest. CCA is the operating company that owns and operates the telecommunications assets. Through CGO, your economic interests are better aligned with the Audet family in our opinion.
Cogeco Communications (CCA)
Cogeco Communication via their Canadian and American telecommunications segments provide a wide range of internet, video and phone services primarily to residential customers as well as business services across its coverage areas. The Canadian telecommunication activities are carried out by Cogeco Connexion and US telecommunications activities are carried out by Breezeline. Breezline is 79% owned by CCA and the remaining 21% owned by Caisse de dépôt et placement du Québec (CDPQ).
Cogeco Communications has performed fairly well over the last few years. It is our opinion, that the company is well run operationally with quality assets. EBIT and EBITDA have been increasing over the years. They have been investing in expanding their broadband network, increasing homes passed and overall internet subscribers. They are achieving about 40% subscription rate per home passed. They have also made strategic acquisitions to expand their network and product offerings. The charts below are from the Cogeco Q3 2024 presentation and highlight these points.
CCA and CGO pay a 5.1% and 6.1% dividend yield respectively and have consistently repurchased their stock for the past few years. Overall, we have been satisfied with the capital allocation decisions made at CCA. Going forward, they are going to continue to expand their network and plan to roll out a wireless service under a MVNO framework in Canada and US.
For 2024, Cogeco Communications (CCA) generated $476M in FCF and $613M in FCF if excluding network expansion projects (growth CAPEX). Adjusted EBITDA was $1,442M and maintenance CAPEX was $501M with growth CAPEX an additional $137M. ROC was 26% and 31% when excluding growth CAPEX.
Net Debt is $4,748M giving a reasonable 3.3x Net Debt/EBITDA. There are 42.2M shares of CCA outstanding. At a price of $72 a share we get a market cap of $3,040M and EV of $7,788M. Giving us an EV/EBITDA 5.4x
Including growth CAPEX we get a valuation of EV/EBIT 9.7x and P/FCF of 6.4x (15.6% FCF yield). Excluding growth CAPEX we get a valuation of EV/EBIT 8.3x and P/FCF of 5.0x (20% FCF yield). Not bad! But it gets better!
Cogeco Inc (CGO)
Now finally onto CGO! CGO owns CCA shares as their main asset. CGO (the holding company) controls CCA (the operating company).
On December 11, 2023, Cogeco Inc. (CGC), Cogeco Communications (CCA), CDPQ (Caisse de dépôt et placement du Québec), and Rogers Communication Inc. (Rogers) entered into a multi-party share buyback transaction. You can read the full transaction details here. The table below shows the before and after pro forma for both organizations.
The net effect and takeaways for CGO and CCA shareholders are:
CCA shares outstanding were reduced by 5%.
GCO shares outstanding were reduced by 38%, but CGO ownership of CCA was reduced by 20%.
CGO per share economic value was increased by 30%, offset partially by a new $75M loan CGO used to purchase shares.
This transaction, while a little complicated, is accretive to CCA shareholders, but it is VERY accretive to CGO shareholders.
Post the transaction, CGO owns 12M shares of CCA with a share price of $72. CGO currently has net debt of $129M. CGO also owns radio assets with revenues of $100M. I’ve estimated the value of these stations to be worth $87.5M. 100M Revenue * 12.5% Operating Margin * 7x EBIT Multiple = $87.5M . There are 9.64M shares outstanding of CGO with a share price of $61. 12M Shares * $72 - $129M Net Debt + $87.5M Radio Asset = $822M.
The value of CGO is $822M or $85 per share yet the shares trade for $61. A discount of 28%! By owning CGO we are able to get an economic interest in CCA at a valuation EV/EBITDA of 3.9x and EV/EBIT 6.9x and P/FCF of 4.6x (21.7% FCF yield). Excluding growth CAPEX we get EV/EBIT 5.9x and P/FCF of 3.5x (28.6% FCF yield)!!
The main takeaway is that while CCA is a cheap and good company, through CGO we are able to acquire a stake at an even cheaper valuation providing a large margin of safety. Through CGO we are able to acquire CCA at a steep discount.
ColdBerry Capital is a global value investment fund whose investment philosophy is inspired by Warren Buffett and Charlie Munger. To find out more you can contact us here.
Notes
Price of Cogeco Inc. (CGO) was $61/share and Cogeco Communication (CCA) was $72/share as of writing this article
Financials were taken from CGO and CCA most recent annual reports (2024)
Charts and network maps were taken from CGO and CCA 2024 Q4 presentation
All $ are CAD unless otherwise stated
CGO and CCA both trade on the Toronto Stock Exchange (TSX)
CGO and CCA both pay a quarterly dividend of $0.922, CGO owns 12M shares of CCA and only has shares outstanding of 9.64M. CGO will accrue $8.70M annually between what is received from CCA and what is paid to CGO shareholders. If CGO passed along all dividend from CCA, the quarterly dividend would be $1.148 or $4.59 annually with a dividend yield of 7.53%.
Appendix: Fixed Wireless and Satellite Internet
In our opinion, fixed wireless and satellite internet will provide niche use to certain customers and locations. We do not see an existential threat to broadband. Where broadband exists, it will be the lowest cost and best option for the customer.
Our thinking and arguments revolve around what the lowest cost option balanced with user experience would be for the customer. For example, most users expect their internet connection to be a certain speed. This is the mental framework we are approaching this argument with.
From our research, the average household uses about 750GB per month. This number is also growing year over year and shows absolutely no signs of slowing. Households, regardless of fixed wireless, satellite, or broadband will use relatively the same amount of data per month. Wireless data consumption seems to be around 20GB per user per month in the United States.
If a mobile operator wanted to offer fixed wireless or a mobile data plan to its customers it could either offer 1 customer fixed wireless plan or 37.5 mobile data plans for the same amount of bandwidth on their network. Now, this is not a perfect comparison and is not an apples to apples comparison. However, we are using this to illustrate that we do not believe that it makes senses at scale. Lets assume the fixed wireless plan and mobile plan cost roughly the same. Mobile operators would be selling their bandwidth at less than 3% of an equivalent rate per GB a mobile plan could charge.
While the bandwidth has greatly improved it is not unlimited. We think it makes sense for operators to offer fixed wireless services where they have unused slack in their network for incremental marginal revenue. It also makes sense in niche applications where cable or fiber is not present or economical or feasible. Last mile applications are interesting but the network backhaul is still owned by the broadband company.
Fiber is still the best option for urban and suburban applications in our opinion. Satellite internet best fills rural applications with limited mobile coverage and no fiber. Fixed wireless would be best served in between fiber and satellite applications where bandwidth is available. Please note, this is all our opinion from our own research.
Disclaimer
The thesis expressed above contains forward-looking statements and is intended for informational purposes; it is not a recommendation to buy, sell, hold, or otherwise trade the securities of the referenced issuer. The authors/their affiliates do not hold a position with the issuer such as employment, directorship, or consultancy. The authors/their affiliates currently own a position in the referenced issuer's securities; however, that position may change at any time and without notice.
