Charter Communications (CHTR, Financial) is one of the top holdings in one of my favorite hedge funds, TCI Fund Management. This firm is one of the most profitable hedge funds of all time. It has a reputation for investing in cash-generative businesses with substantial economies of scale and competitive advantages.
Charter has an 18% weighting in the $42 billion investment portfolio, making it the second-largest holding overall (Alphabet (GOOG, Financial)(GOOGL, Financial) is the largest).
TCI isn't the only hedge fund with a substantial position in this stock. John Armitage's Egerton Capital has invested 7% of its portfolio in the corporation and increased its position by 20% in the third quarter of last year.
Egerton and TCI have excellent track records as investors. I like to keep an eye on their investment moves to see if I can learn anything or discover any interesting positions.
The falling stock
Charter is clearly one of their favorite companies, and shares have been under pressure since the beginning of September last year. The stock has fallen from a high of around $820 per share to $611 at the time of writing. At one point, it was trading as low as $552.
This could present an interesting opportunity. According to my calculations, the stock looks cheap on a discounted cash flow basis. I have been using a 4% discount rate in my valuation models over the past year or so. This assumes a 2% 10-year treasury yield and a 2% margin of safety on top. This discount rate might not be appropriate in the current inflationary environment, but I will not throw it out just yet, as the company could prove resilient to inflation.
Using a 4% discount rate and a 5% per annum free cash flow growth rate indefinitely, my analysis provides a fair value estimate of $1,000 per share. A 5% growth rate is actually a conservative growth rate, in my view, considering the fact that over the past 10 years, the company's free cash flow has grown at a compound annual growth rate of around 16%.
Using a growth rate of 10% and a discount rate of 4% provides a fair value estimate of $1,720. Using an even more conservative discount rate of 8%, designed to account for the current inflation rate, my analysis provides a fair value estimate of $1,100 per share, using a long-term free cash flow growth rate of 10% per annum.
Growing moat
Of course, there are a lot of assumptions going into these figures. Assuming the company can grow at 10% per annum indefinitely is quite risky.
That said, Charter does have a commanding position in its markets, and building the kind of infrastructure the company has been developing over the past couple of decades is not going to get any cheaper or easier. This gives the enterprise a strong and growing competitive advantage. It also gives it significant pricing power, implying there's no reason why it cannot increase prices to consumers by 10% every year. There's also the potential for bolt-on acquisitions and organic growth on top of this pricing growth.
Suppose the company does have a sustainable competitive advantage and room to increase prices every year while retaining customers. In that case, these figures show Charter does appear to look cheap at current levels based on its cash generation.
The world is only becoming more and more reliant on technology, and this suggests the demand for infrastructure to support the technology revolution will only increase. What's more, individuals and companies are only becoming more reliant on technology and its supporting infrastructure, suggesting companies like Charter have increasing pricing power over their customers, who need its services to fit into the digital economy.
This enterprise could be one of the cheapest ways to invest in the growing technology sector without buying a high-flying unicorn tech stock.
