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December 17, 2007

2007 MSO of the Year: Charter—Back From the Brink

Charter was buried under $19 billion of debt and left for dead just two years ago. Now, led by a former Navy SEAL commander, the MSO has set out to prove that operational excellence can overcome financial hardship.

SMIT’S TASK UNIT: Charter president and CEO Neil Smit (seated) has relied on (l.-r.) EVP/CTO Marwan Fawaz, SVP, strategic planning, Eloise Schmitz, EVP/COO Mike Lovett and EVP/chief marketing officer Bob Quigley to shift the company’s focus from servicing its debt to rolling out digital phone and selling the triple play.

SMIT’S TASK UNIT: Charter president and CEO Neil Smit (seated) has relied on (l.-r.) EVP/CTO Marwan Fawaz, SVP, strategic planning, Eloise Schmitz, EVP/COO Mike Lovett and EVP/chief marketing officer Bob Quigley to shift the company’s focus from servicing its debt to rolling out digital phone and selling the triple play.

CableWorld’s pick for 2007 MSO of the Year might cause some head scratching. After its third-quarter financial results disappointed Wall Street last month, Charter Communications lost one-third of its market value and shares traded perilously close to $1 amid a broad cable industry sell-off.

Yet the gloom on Wall Street—in the wake of the sub-prime credit crunch and with a housing slowdown threatening cable and satellite growth—belies the remarkable operational turnaround underway at Charter.
Burdened by a mountain of long-term debt and a reputation scarred by years of poor customer service and an accounting scandal that sent two of the four federally indicted former Charter executives to prison for inflating revenue and subscriber numbers, the nation’s fourth-largest MSO appears to have turned the corner.

“We sort of viewed them as gone for dead and irrelevant,” notes Jason Bazinet, cable analyst at CitiGroup Global Markets. “And now they’re hitting operating metrics that are approaching Cablevision.”

Led by president and CEO Neil Smit, a former America Online executive and Navy SEAL who joined Charter in August 2005, the MSO has rapidly rolled out its telephone offering and posted solid growth in broadband and digital video (see chart on page 15). The result has been four consecutive quarters of double-digit revenue growth from continuing operations (excluding systems sold in 2006 and earlier this year). And though its losses continue to mount, operating results that exclude expenses such as interest, taxes and capital equipment—which Wall Street commonly views as a key barometer for business performance—have also climbed by double digits over the past four quarters. The current growth path, combined with the recent refinancing of most of Charter’s $19.7 billion debt, will have the company generating free cash flow in about three years, some on Wall Street say.

“Without a doubt, it’s a decent turnaround. This company was rapidly declining a year ago, with negative [earnings] growth, and now it’s growing and certainly improving,” notes Pali Research media and cable analyst Richard Greenfield. “Charter has had the biggest turnaround from 2006 to 2007, and that should be acknowledged,” he says, adding, however, “with the performance of the cable companies and their equities, I’m not sure anyone deserves to be MSO of the Year.”

DAMN THE TORPEDOES,
BOOST ARPU
Notwithstanding the jitters on Wall Street—based largely on margin pressure and basic subscriber losses that spiked for all the publicly traded MSOs in the third quarter—Charter is performing well: adding nearly 630,000 revenue generating units, or RGUs, in the first three quarters of the year and boosting average revenue per unit, or ARPU, by 12.6% and 13% in the second and third quarters, respectively, driven by advanced services and upgrading customers to higher Internet speeds and programming tiers.

Late to the telephone market, Charter’s making up for lost time, having reached 802,600 telephone customers by the end of September, more than double the customer base at the end of September last year, and nearly tripling telephone revenue in the most recent quarter to $236 million, compared to $86 million in the 2006 third quarter. Even more telling for its future growth prospects, the company has rapidly expanded the footprint of its telephone offering: In 2006 it grew from 3 million homes passed to more than 7 million by year-end, and added another 1.6 million to 8.6 million by the end of October this year. Charter now expects telephone service to reach between 9.5 million and 10 million homes passed by the end of 2008.

“So they lost 40,000 basic subs,” in the third quarter, acknowledges Bruce Leichtman, of Leichtman Research Group. “They also had tremendous adds on the phone side, and they were also good on broadband.” Investors who overreacted to Charter’s basic sub losses in the third quarter and drove down its stock price, ignoring its triple-play momentum, are looking in the rearview mirror rather than to the future of cable, he says.

“I think they represent what is the evolution of cable; that it’s not just about basics anymore,” Leichtman insists. “Where are they performing? They’re performing very well in the other categories where there are growth opportunities.”

"I tend to look at things—every issue or problem—from a consumer perspective and solve back from that perspective," says Charter president and CEO Neil Smit.

"I tend to look at things—every issue or problem—from a consumer perspective and solve back from that perspective," says Charter president and CEO Neil Smit.

HOW THEY DID IT
Through strong leadership, careful planning and solid execution, Charter went from flirting with bankruptcy 18 months ago to being a company poised for growth, says CitiGroup’s Bazinet. The key to the turnaround has been the deft refinancing of its long-term debt, which has allowed the company to invest in advanced services and operational improvements that were impossible when all its cash had to be devoted to servicing its debt. When Smit arrived, job one was getting the company back to consistent revenue growth by rolling out digital phone and improving customer service, and in order to do that he had to refinance the debt.

“Charter bought itself enough breathing room to consolidate call centers, rationalize head-ends and develop its marketing plan,” Bazinet wrote in a note to investors in June. “Now we’re at a point in the story where we’re just beginning to see signs that the operations are turning around. Voice net adds lead the industry…Collectively, this suggests the free cash flow burn at Charter will likely come down significantly over the next few years.”

Though insiders and cable industry observers praise Smit’s focused leadership as essential to Charter’s turnaround, Smit himself credits his executive team, particularly Eloise Schmitz, the company’s SVP of strategic planning, for the financial acumen that helped the company refinance $14 billion of its $19 billion of debt since he arrived in 2005. “Eloise Schmitz has done a great job of providing us the financial flexibility to be able to invest in the business,” Smit says.

Charter accumulated its massive debt mainly by financing the acquisitions that helped it become the nation’s fourth-largest MSO, after billionaire Microsoft co-founder Paul Allen bought the company in 1998 for about $4.5 billion. In the wake of its acquisition spree in 1999 and 2000, at times nearly one-third of Charter’s revenue was devoted to interest payments, hampering its ability to deliver new products and expand penetration.

“There was a period of time when the balance sheet was in the way of doing those things, and we were having to tailor our operating decisions around short-term objectives…in order to not have [the debt] collapse the company,” recalls Schmitz, who joined Charter in 1998. “Where we were in 2003 and 2004, operating decisions were made in support of the balance sheet. Now the opposite is taking place.”

MIX-AND-MATCH MANAGEMENT
Schmitz is among the handful of cable veterans Smit retained when he assembled his management team in late 2005 and early 2006. Others included EVP and COO Mike Lovett, who joined Charter in 2003, and EVP and chief technology officer Marwan Fawaz, who had run Charter’s Northwest regional operation before leaving in 2003 to become CTO of Adelphia, only to return to Charter as CTO after Adelphia was acquired by Time Warner and Comcast last year.

“We blended seasoned cable vets with accomplished executives from other industries who brought different perspectives on the business,” Smit recalls.

Among those outsiders was longtime friend and colleague at AOL Bob Quigley, coaxed out of semi-retirement by Smit to join Charter as EVP and chief marketing officer in December 2005. Smit and others credit Quigley with implementing a consistent marketing plan that uses data-driven techniques drawn from his years of experience in direct-response marketing and subscription-based businesses.

“I come from a marketplace where over the years there have been some sophisticated tracking systems put into place to measure precisely the effect of marketing spend,” Quigley explains. “For a variety of reasons the cable industry has taken that to a certain level, but not as extensively as the rest of the direct-response industry has.”

“They are the only cable company that has a cogent marketing plan,” agrees CitiGroup’s Bazinet. “The generic cable paradigm is one size fits all. You can have any color you want, as long as it’s black.” Charter’s approach has been research driven, allowing it to modify its marketing model “on the fly to ensure that they’re not only maximizing units but not sacrificing gross profit,” Bazinet adds. “It’s perfect.”

One element of Charter’s marketing strategy borrowed from the direct-response marketplace is the level of tracking the MSO does, not just recording the success rate of a given offer to a demographic, but continuing to track the longevity and spending levels of subscribers based on the marketing offers that landed them. “We follow the reaction to the customer spend a bit further into a customer’s life cycle and are able then to do some more refined testing and move in the direction that test results tell us to move in,” Quigley says.

The blending of executives from both inside and outside the cable industry has been remarkably effective at Charter, observers say, because of Smit’s ability to galvanize his team around a few key objectives, along with the culture of open communication and decisiveness that he has fostered.

“Neil has built a team of folks from different backgrounds, but very similar approaches to business,” notes Lovett. “It’s all about business. There’s a lot of candor at the table in a very healthy way. That leads teams to the right decision, and then you execute well once everyone is on board because they’ve had a voice in the decision.”

“If we see opportunities, we move quickly,” Smit agrees. “That’s part of our culture here; to understand the opportunities and be decisive and move quickly. We’re all about open communications—putting it all on the table and having a facts-based opinion and getting to the answer. We prioritize all the time and focus on doing a few things well, which helps us be nimble. We encourage people to make decisions and move on.”

A NAVY SEAL’S APPROACH TO
MANAGEMENT
Smit attributes this culture of decisiveness and his approach to revamping Charter to his days as a Navy SEAL. “In the SEAL teams you had to understand what the mission was and what your primary objective was,” he recalls. “We were early on very clear on what we were trying to do [at Charter] and what was important. It’s all about simplifying the business, ensuring that everyone is focused on doing a few things very well, and then aligning all parts of the business around those important objectives.”

Lovett notes that consolidating Charter’s operating units from five divisions down to three and rolling up the 29 key market areas (KMAs) the company had in 2003 down to 17 has significantly helped keep the MSO’s 16,000 employees focused on improving the customer experience. So has consolidating and virtualizing the firm’s customer care call centers, which allows it to quickly route customer calls to an appropriate agent—whether billing, technical support, sales or other issues—regardless of where on the integrated network the resource resides.

“We’ve taken a lot of the noise out the system that gets in the way of performance,” Lovett says.

And though Smit concedes Charter still has work to do to improve the customer experience and its battered reputation, refinements like shrinking service windows from eight hours down to three represent a solid start. Smit, who prior to joining AOL in 2000 was a regional VP with Nabisco and held management positions at Pillsbury after spending five years in the Navy SEALs, often winds down at the end of his work day by listening in on customer support calls from his office. He finds it “relaxing,” he says.

“I’ve been in consumer businesses pretty much all my professional careers, except the SEAL teams, which wasn’t really consumer friendly,” Smit quips, “so I tend to look at things—every issue or problem—from a consumer perspective and solve back from that perspective.”
That singular customer focus that Smit has instilled across his team appears to bode well for Charter’s continued turnaround and future growth.

“Long term, Charter is doing tremendously better than it was a year ago,” says Pali Research’s Greenfield. “There has been a massive turn in the company’s prospects as it rolls out the bundle. And telephony is certainly providing a very nice lift to its overall business.”

He adds: “The larger question of where is the industry going as competition is getting more severe, is a great question.”

Charter Communications by the Numbers

Headquarters: St. Louis
Cable systems: 17*
Employees: 16,400
Homes passed: 11,837,000
Basic subscribers: 5,347,800
Basic penetration: 45.2%
Digital TV subscribers: 2,882,900
Digital TV penetration: 24.6%/53.9% (digital homes passed/basic subs)
High-speed Internet subscribers: 2,639,200
High-speed Internet penetration: 49.4%/24.0% (basic subs/high-speed
homes passed)
Digital phone subscribers: 802,600
Digital phone penetration: 15%/9.7% (basic subs/homes passed)
% of systems offering triple play: 73%**
HDTV: 20 channels
Recent HDTV channel additions: Weather Channel, History, A&E

Source: Charter Communications, as of Sept. 30, 2007
*Key Market Areas (KMAs), defined by Charter
**as of Oct. 31, 2007







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